Using Liens When Acquiring Assets

April 13, 2006

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When using an operating/holding company business structure, liens can be used to secure extensions of credit from the owner or holding company to the operating company.

In this strategy, ownership of assets is placed within the operating entity, but in a way so they are not vulnerable to loss. The operating entity obtains ownership of an asset, such as a building, usually through a loan of cash from the holding entity (or owner), in exchange for a mortgage or other lien taken back by the holding entity (or owner).

This type of lien is called a "purchase money security interest" because the cash was loaned specifically to purchase the asset, which is then put up as collateral for the loan. The asset is owned by the operating entity, but it is not vulnerable, as the liability represented by the lien, in effect, cancels the value that the asset otherwise would have to an outside creditor of the operating entity.

On liquidation, because the holding entity (or owner) holds the lien as a secured creditor, he would take the asset, leaving the other creditors with little or nothing. The outcome is the same as if the holding company owned the asset and the operating company owned nothing.

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An example of this strategy took place in 1994, when Rockefeller Center went bankrupt, apparently jeopardizing $1.3 billion worth of real estate. However, asset protection strategies ensured that none of this real estate was lost to creditors.

Rockefeller Properties, two partnerships that acted as operating companies, owned the real estate. However, the real estate was encumbered by a lien, of approximately $1.3 billion, in favor of a corporation, Rockefeller Center Properties, which acted as the holding company.

This structure employed the use of two asset protection strategies: separate operating and holding entities, and ownership of the assets being vested in the operating entity, but with a lien of approximately equal value in favor of the holding entity, which meant the assets were not vulnerable to creditors.

Moreover, this strategy can be applied to existing or future assets, giving the owner plenty of flexibility in structuring the business's financing. However, the rules for recording or perfecting liens on real property are different than those for personal property.