The Corporate Transparency Act (CTA), which was passed by Congress in 2021 and is administered by the Financial Crimes Enforcement Network (FinCEN) at the U.S. Department of the Treasury, will become effective on January 1, 2024.
The CTA is intended to make beneficial ownership information for U.S. legal entities available to specified federal agencies to assist in their efforts to combat crimes such as terrorism, wire fraud and money laundering.
The CTA and associated regulations establish a new framework for the reporting, maintenance and disclosure of beneficial ownership information (BOI) in covered entities. It has been estimated that as many as thirty million existing companies and two million new companies formed annually will be subject to the reporting and disclosure requirements of the CTA.
Now is the time for lenders to consider this legislation and its impact on their borrowers and loan programs. This alert provides a brief description of the CTA and similar state legislation and suggests steps for real estate lenders to consider with respect to these laws.
In brief, the CTA requires companies subject to the law (reporting companies) to report for each beneficial owner their (i) full legal name; (ii) date of birth; (iii) current residential or business street address; and (iv) a unique identifying number from an acceptable document (such as state driver's license or passport). Any covered company created on or after January 1, 2024, must report its BOI within 30 calendar days after its creation, while entities created before January 1, 2024, must provide their BOI to FinCEN by January 1, 2025.
The CTA defines a reporting company as a corporation, LLC, or similar entity that is (i) created by the filing of a document with a secretary of state, or similar office; or (ii) formed under the law of a foreign country and registered to do business in the U.S. by filing a document with a secretary of state.
The CTA defines a beneficial owner of an entity as an individual who, directly or indirectly (i) exercises substantial control over the entity; or (ii) owns or controls not less than 25% of the ownership interest of the entity. To those in financial institutions, the requirements of the CTA will seem familiar due to their similarity to the Customer Due Diligence Rule (CDD), also administered by FinCEN. The CDD requires covered financial institutions to identify and verify beneficial ownership information from their legal entity customers when those customers open accounts.
There are several (24 in all) categories of entities exempt from the CTA’s reporting requirements. A majority of the exemptions apply to large and regulated entities, such as banks and insurance companies. One notable exemption applies to “large operating companies” which are defined as any company that:
- has more than 20 full-time employees in the United States;
- filed an income tax return the previous year demonstrating more than $5 million in gross receipts or sales; and
- has an operating presence at a physical office in the U.S. Newly formed companies will not be able to claim this exemption due to the lack of a prior year’s tax return. Few, if any, real estate special purpose entities will qualify because they are not likely to have 20 full-time employees.
The CTA generally prohibits FinCEN from disclosure of beneficial ownership information to third parties with exemptions for certain federal agencies. There is also an exemption which permits disclosure upon request to a financial institution subject to CDD requirements, with the consent of the reporting company, to facilitate compliance with CDD requirements under applicable law.
Penalties for failure to comply with the CTA include assessment of a $500-per-day fine every day the violation continues (up to $10,000) and criminal penalties, which include the potential for jail time.
The CTA may be part of a growing legislative trend to require greater transparency in beneficial ownership of state registered entities. The state legislatures in New York and California are both attempting to implement legislation similar to the CTA that would be applicable at the state level.
In California, legislators have proposed two bills that would require disclosure of beneficial information. One bill (SB 738) would require foreign corporations and LLCs to disclose certain information with respect to the “beneficial owners” including full legal name, residential or business address and email addresses. In this case, the proposed legislation defines a “beneficial owner” as a natural person who owns, directly or indirectly, 50% or more of the equity interest.
The other proposed bill (SB 594) would amend existing law to require corporations to file a public statement that includes the names and complete business or residence address of any beneficial owner; LLCs to identify any manager, chief executive officer, member and beneficial owner; and real estate investment trusts to provide the name and complete business or residential address of any beneficial owner. Both bills are still at the committee stage and it is unclear when, or if, they will become law.
New York, however, is much farther along in the process of enacting state level disclosure legislation. In the 2023 legislative session, the New York legislature passed the “LLC Transparency Act” (Senate Bill 995) which is similar to its federal counterpart in that it adopts the same definitions of beneficial ownership. The exemptions under the New York law also mirror those found under the CTA. The New York law, however, while applicable to both domestic and foreign entities, applies only to limited liability companies.
The LLC Transparency Act is specifically intended to address the utilization of anonymous LLCs to acquire and lease real estate, which has been linked to increased code violations, higher rents and higher default and eviction rates. A key difference from the CTA, however, is that while the CTA protects the confidentiality of beneficial owner information, the New York law would require the Secretary of State to maintain a publicly available online database that would include the full legal names of the beneficial owners of the LLCs as well as the business name and address. The New York law also requires that regulations be promulgated to permit beneficial owners with “significant privacy interests” to apply for waivers to keep their name/business information confidential, however “significant privacy interests” are narrowly tailored to situations such as whistleblowers using LLCs to file false claims act lawsuits and/or individuals participating in an address confidentiality program.
Finally, while the penalties for non-compliance with the New York law are not nearly as severe as the civil and potential criminal penalties under the CTA, LLCs that fail to comply with the filing requirements would not be able to obtain corporate status documentation that is customarily required in connection with most lending and/or real estate transactions. The LLC Transparency Act will not become law unless or until it is signed by Governor Hochul; however, it is expected the Governor will sign the bill into law, in which case it will become effective one year thereafter.
As the January 1, 2024 compliance date under the CTA approaches, it’s not too early for real estate lenders to be aware of the new requirements and to start taking steps to confirm compliance by borrowers. Such steps should include the following:
- Adding confirmation of compliance to pre-closing due diligence procedures.
- Including a representation in loan documents that the borrower (and any guarantors that are covered by the CTA) have complied with applicable requirements of the CTA.
- Including a covenant in loan documents that (i) if the borrower has not already filed, they will do so in time to meet applicable requirements (some entities will have until January 2025 to file; new entities will have 30 days from the date of formation); and (ii) that any required updates will be filed in a timely manner. Entities may be required to update their filings to reflect changes in ownership and changes in information for existing owners.
- Consider including a clause in the loan documents whereby the borrower provides consent for FinCEN to disclose to the lender any information required for the company to comply with CDD requirements under applicable law.
- Each lender will want to consider how to obtain confirmation of compliance from existing borrowers. Even if your documents do not explicitly address the CTA, it is typical for documents to include general requirements for the borrower to remain in compliance with applicable law, which may cover some of the items above.
- With respect to the proposed legislation in New York and California, lenders should be aware of the potential for this state level legislation to be implemented, and to the extent loan transactions involve borrowers, guarantors or secured assets located in these jurisdictions, additional inquiries and due diligence may be necessary to ensure compliance.