Level 3 Risk response to Barbara… - Posted by HR
Posted by HR on July 31, 2001 at 07:03:19:
Barbara had made the following post way down on the board, and I think it’s such a significant question I thought I would repost it here and give my opinion:
In your opinion would HR’s friend (whose trouble appeared to start when he had a lot of “subject to” deals go into default) had any better defense if all those properties had been in Pac Trusts?
This is an excellent question because it reveals the essential fallacy: in a level 3 risk, all these schemes – trusts, corps, PacTrusts – not only won’t help, but they actually will be a LIABILITY. I know that’s hard to believe, and it’s natural to want to ask Bill, who sells his product as a defense against at least a level 2 risk and who promotes its very form as a defense against risks fo default, but, imho, the PT will not only not help, but it will make things worse.
That’s my opinion, of course, and the fact is that one just doesn’t know how the Pt would stand up because it hasn’t been tested. We do know how other instruments have stood up (corps, trusts, etc), so we might be able to make an excellent guess of how the PT would fare.
Let’s set the stage. You are a subject to practitioner. You aren’t one of the big guns like Alexander, Randle, Weigle, and others doing lots of these a month. You are a beginning practitioner who only does like 6 deals a year. (Be proud of that! No shame there)…
After about 5 years, you have 30 deals under your belt. Let’s assume you aren’t ballooning these, just letting them run and collecting the spread. Let’s say you live in Austin (obviously Barbara, none of this is meant to relate to you, personally, but only our fictitious example). You’re buying nice houses. The technology biz is going great. You’re wrapping and selling to nice people, and going onto the next deal.
Then, what we call an “event” happens. The market starts to turn down (as our stock bretheren have discovered, the economy does not go-go forever…). Nasdaq takes another disasterous hit, and tech starts to falter. There are lots of tech layoffs in the Austin area. A bunch of your subject to deals start to default.
These defaults aren’t the cause for joy. You can’t find another person to put in the place, 'cause the values have dropped. We could paint this picture a 1000 different ways, but let’s just acknowledge that you now have too many payments to make and you can’t make them. So you stop. And you start the foreclosure process and start to ruin your seller’s credit.
If these seller’s decide to do something, and if they find out you have done a few of these, they will go to the authorities and claim that you have done something wrong – they aren’t sure what – but it’s hurting them and you’ve done it to lots of people (5 or more).
The authorities (Feds, secretary of state, attorney general, etc) will look into your business and find some interesting things.
First off, they will find that your business has hurt a bunch of folks. Second, they will find that it is a weird business. It is “out of the norm of commerce.” The norm of commerce for buying and selling real estate is not taking title and leaving the loan in the previous owner’s name. They will discover that you profited from these sellers and, when you no longer could profit, you stopped making payments. In some cases, they may find you gave the homes back to the sellers, but in most cases that only doubled their burdens. I’m assuming you’re not rent skimming. You had no income coming in, so you stopped making payments. And that ruined many seller’s credit and future borrowing power, etc. Thus, there are a lot of upset, hurt people in this authorities office.
I suggest to you that at this point you are going to look very bad. You will indeed look like a criminal. You practiced a business whose consequence was damage to anothers, your business is out of the norm of commerce, you used corps, trusts, and this PacTRust thing to try to limit your liability, but the authority will conclude that your use of those things was all an injust attempt to cover your obvious criminal activity which you carried out on a mass scale and which has hurt many people.
Now the fun begins.
Are you a criminal? No! Not by our definition as a community. But could a prosecutor view you that way if a lot of these deals go bad and hurt a lot of people? Absolutely. And at that point, the PacTrusts machinations only further the prosecutors point that you are a sophisticated person who, from the git-go, meant to defraud the seller, mortgage company, etc.
Now, do I know that for a fact? No the Pactrust is untested. I know this court scenario has happened to others, and I don’t think it’s farfetched to believe it could easily happen again under the right circumstances (which I believe are cyclical and part of the economic cycle).
If, in reading this, you think this risk is farfetched or minimal, than you are one who (my viewpoint) denys or minimizes this possibility. If you accept it as a reality, albeit a remote one, you practice your biz in such a way as to limit this.
The PT may be one way you decide to limit it. The PT could also come back to backfire on you in a level 3 scenario. I believe it would. It’s obvious attempt to circumvent the DOS clause would only fuel the prosecutor’s fire.
But: let’s ask this question – If they all will backfire on you (as I believe they all will in a level 3 scenario), why not use the PT 'cause it at least minimizes a level 2 risk threat? That’s an excellent consideration. If the PT is the best acquisition option in your state for managing level 1 & 2 concerns (it’s not in my state), then you may want to go with it anyway. But I woulden’t look to it to help you with a level 3 scenario (and I have my doubts about level 2 as well) no matter what its promoters may say. But, that’s a decision each person must make for him/herself.
However, one should be aware of the level 1, 2, 3 risks* and constantly guard against violating them. Sticking one’s head in the sand via an unbriddled and unexamined faith in any doc or tool one uses will surely lead to trouble (large or small) at some point down the line.
Just my 2 cents. Others?
*Barbara, I hate people who coin their own terms and then act as if they’ve given something of value to the rest of us. If this discussion of level 1,2,3 risks doesn’t make sense, please read the threads below between me and Bill Gatten wherein I describe how I think of these risks. I would rewrite it here, except it is a long desciption and I must get off the computer soon. Cheers.