By Robert Moore
In the prior post, we explained partition and the risk it poses to family farmland. Fortunately, there are a few strategies that can be implemented to avoid partition.
One strategy that can prevent partition is the use of a Limited Liability Company (LLC). The concept of using the LLC is to replace the multiple owners of the land with one LLC owning the land. Then, those same owners own the LLC rather than the land. Partition rights only apply to real estate, not to business entities. So, instead of three people owning the land, three people own an LLC that owns the land. Since there are no partition rights with an LLC, no one owner can force the sale of the land.
Consider the following example. Andy, Betty and Charlie are siblings and own a farm together. Each is aware of partition rights and wants to prevent any of the owners, including future owners, from exercising their partition rights. They establish an LLC and transfer the land into ABC Family Farms LLC. The LLC operating agreement states that land can only be sold with the consent of all members.
The three owners of the land have eliminated the threat of partition to the family farmland. The legal owner of the farmland is now the LLC, not the three siblings. Andy, Betty and Charlie are the owners of the LLC but Ohio law does not provide for partition rights of an LLC. Additionally, as added protection, the siblings require unanimous consent before any of the land in the LLC can be sold. By placing the land in the LLC, the three owners have ensured that the only way the farm will leave the family is by joint agreement of the family. A well-designed LLC can make it nearly impossible for land to leave the family without the agreement of the family.
The above example illustrates how an LLC prevents partition by the owners and family members, but LLCs also protect against creditors and lawsuits. Let’s assume Andy has financial problems and creditors have filed and won lawsuits against him. Without the LLC, the creditor could force the sale of the land through foreclosure on Andy’s share. However, Ohio law only allows creditors to attach to an LLC owner’s interest. This means that a creditor is entitled to an owner’s share of the LLC profits but cannot force the sale of the assets owned by the LLC. In this example, Andy’s’s creditors are entitled to receive his share of the profits from the LLC but cannot force the sale of the land. An LLC can prevent an owner’s financial problems or lawsuits from causing the sale of family farmland.
LLCs are often used in estate and succession planning to protect the family farmland. Instead of multiple family members inheriting land (and the risk of partition), mom and dad may establish an LLC for the farmland. Then, the children inherit the LLC without the partition rights. By transferring the land via an LLC, mom and dad do not need to worry that one child or their creditors will force the family farmland to be sold.
Consider the following example. Mom and Dad want their three children to inherit their farmland. They would like their children to own the farmland together as it is too difficult to divide up the land equitably. Mom and Dad are aware of partition rights and want to make sure that no co-owner can force the sale of land against the family’s wishes. Mom and Dad transfer their land to an LLC. Their three children will inherit the LLC with the land. Because each child will own an interest in the LLC, and not an interest in the real estate directly, partition rights are not available. Mom and Dad also established the LLC with the requirement that any transfers of land require unanimous consent of all the members.
This example illustrates how LLCs can be incorporated into estate plans to minimize the risks of partition. By having multiple heirs and beneficiaries inherit the LLC, and not the land itself, the land will not be transferred out of the family due to partition. We often think of using LLCs for liability protection but LLCs may be even more valuable to protect against partition rights.
Another way to protect against partition rights for heirs is to use a trust. With this strategy, the land is owned by a trust rather than the beneficiaries. Since the beneficiaries do not legally own the land, they are not entitled to partition rights. The disadvantage to this strategy is that the trust beneficiaries will not be able to use the assets as collateral nor to build their wealth.
Consider the following example. Mom and Dad want their children to have the benefit of their land upon inheritance but want to be 100% sure that their children do not sell the land before their grandchildren can inherit it. Mom and Dad establish a trust that holds the land for their children’s lives. During the children’s lives, the children receive the rent but do not own the land. Thus, the children cannot take action to sell the land. Upon the death of the children, the grandchildren will receive the land.
While the land is in trust, the children do not own the land. Thus, they do not have partition rights and cannot force the sale of the land. The grandchildren are nearly certain to inherit the land. On the other hand, the land is not available as collateral for a loan and the other benefits of ownership are not available to the children.
As the example shows, trusts are an excellent method to avoid partition. However, trusts also severely restrict the rights of the beneficiaries while the land is held in trust. A careful analysis of the benefits and disadvantages of using a trust to avoid partition must be carefully considered.
In conclusion, before allowing land to be owned jointly, the owners should consider the risks of a forced sale of the land through partition. Partition can be avoided by using LLCs or trusts to hold the land. Be sure to consult an attorney to determine the best course of action to address the perils of partition.
By Robert Moore, Attorney and Research Specialist, OSU Agricultural & Resource Law Program
One of the more common ways that farm families involuntarily lose farmland is through partition. Under Ohio law, any person that is a co-tenant (co-owner) of real estate has partition rights. Essentially, partition rights allow a co-tenant to force the other owners to buy them out or force the land to be sold. Partition is a harsh, but arguably necessary, right of every co-tenant of real estate. With proper planning, partition can be avoided.
Partition law is codified in Section 5307 of the Ohio Revised Code. A partition is initiated by a co-tenant filing a petition for partition with the common pleas court. A partition must be filed in the county in which the real estate is located. Any co-tenant, even one owning a small percentage of the real estate, may file the partition. The petition is very similar to filing a lawsuit and all co-tenants are served notice the petition. All defendant co-tenants are provided an opportunity to respond to the petition.
After all co-tenants have been served and had an opportunity to respond to the petition, the court will appoint a commissioner. The role of the commissioner is to essentially oversee the petition process on behalf of the court. The partition commissioner is permitted to physically divide the real estate if the property can be divided without the loss of value. Due to the unique nature of farmland and the variation within each parcel, administrators rarely will physically divide the land. Instead, the commissioner will usually decide to sell the land at auction and divide the sale proceeds among the owners. The first step in selling the land is to obtain the value of the land by appraisal.
After the value of the property is established, each party will be given an opportunity to buy the land at the appraised value. If no party wishes to purchase, the land will be ordered sold by the court. The land may be sold at sheriff’s sale but the parties usually agree to sell the land at public auction. The one issue that the feuding co-tenants can usually agree upon is that they are likely to get a better price at an advertised auction rather than a sheriff’s sale. The land must bring at least 2/3 of the appraisal price at auction. After the land is sold, the proceeds are divided among the co-tenants in proportion to ownership.
The reason that partition law is a necessity is that Ohio law provides very little guidance to co-tenants as to how to manage their co-owned real estate. For example, Ohio law implies that unanimous consent must be obtained in the management of real estate. Therefore, one co-tenant holding a minority ownership percentage can prevent the land from being leased or sold. Ohio law solves this issue by providing partition rights. Basically, the law says that if the co-tenants cannot resolve their differences, then any one of them can force sale the land and divide the proceeds. Partition is necessary because the law seeks to allow individuals to divest themselves of any asset they may own. Without partition, a person could be forced to own real estate that they may not want to own and/or do not receive financial benefit.
Consider the following example. Amy, Bob and Charlie inherit a farm from their parents. Amy and Bob want to lease the land to a neighbor farmer but Charlie insists he is going to farm it. Charlie has no experience farming and Amy and Bob know it will end up in a disaster if Charlie gets his wish. Any potential tenant that Amy and Bob consider is contacted by Charlie and told the farm is not for lease. Amy and Bob get frustrated and decide to file a partition because they are tired of dealing with Charlie and do not think they will get a fair, financial benefit from the farm if Charlie is the operator. The court orders the farm sold and Amy, Bob and Charlie share the proceeds.
The risk of partition is not limited to just the initial family members who may own the land. Any future owner also has the same partition rights. Spouses, children and anyone else who may become a co-tenant can force a partition.
Using the same scenario as above, assume Amy dies. Her parents assumed that Amy’s share of the farm would go to her children (their grandchildren) but Amy never got around to doing and estate plan. So, under Ohio law, everything goes to her husband, Dale. Dale has no attachment to the farm and just sees dollar signs now that he is a 1/3 owner of the farm. Dale quickly files for partition and forces the sale of the land so that he can have money to buy the boat he has always wanted.
This example illustrates how easy it is for someone to become a co-tenant and gain partition rights. Deaths, divorces, and poor business and estate planning can allow someone to become a unexpected and unwanted co-tenant. Partition law does not care how long farmland has been in the family or how vital it is for a farming operation. Partition law treats a city lot that has been owned for a few months the same as a 1,000-acre farm that has been in the family five generations. Partition can lead to harsh results that should be avoided if possible.
With proper planning, partition can be averted. In the next installment, the various strategies to prevent partition will be discussed.
See the prior blog post “Ohio Case Illustrates the Risk of Leaving Farmland to Co-Owners” by Peggy Hall for a discussion of a Madison County case and the perils of partition.