Is There Really Such a Thing as a “Friendly Lien”?

Yes, there is! Surprised?

If you’re not familiar with this term, it refers to a lien against property you own, held by a party who’s friendly to you. Typically, this “friendly party” is a corporation or an LLC you’ve created in a jurisdiction (such as Nevada or Wyoming) that allows the use of nominees to mask your involvement with the business. This friendly lien discourages potential predators — e.g., creditors — from pursuing the property because of a lack of equity.  In other words, the property is encumbered; hence, it’s under an obligation that makes it less attractive.

Let’s face it: predatory lawyers consider any lawsuit a numbers game, and their decisions to pursue litigation aren’t just legal decisions; they’re economic scenarios as well. If the numbers don’t “crunch” well, creditors are less likely to want to go after a property; they figure they won’t get enough out of it, in that they’ll have to accept less for a settlement. The friendly lien is one instance in which you may not mind looking LESS attractive!

However…there can still be tax pitfalls for the unwary in these situations. Here are just a couple of them.

When a “Friendly Lien” Goes Bad…and, Yes, They Can

Just for your own edification, run a Google search under “offering false instrument for recording” or “counterfeit lien,” and see what you find. Several states don’t make any bones about it: they consider this a criminal offense. Even in civil courts, filing a false lien is referred to as “slander of title” and will result in substantial fines.

So does this mean that if you use a “friendly lien” strategy, you’re asking for a day (or more likely, lots of days) in court? Depends.

  • A certain Hoodenpyle was convicted for filing a lien against the property owned by an IRS revenue officer after the IRS had filed liens against Hoodenpyle’s property. The false lien indicated that the IRS officer owed Hoodenypyle more than $1 million. File a false lien against a public official, as in a case like this, and you’d best hope you look good in orange. You’ll probably wear a jumpsuit in that becoming shade for one to three years
  • In another case, a William S. Reed was alleged to have assisted individuals in filing friendly liens against their own properties in order to prevent the IRS from levying fines against said individuals’ real estate. But the IRS does not look kindly on such moves to defraud, delay, or hinder their due process; be aware, if you try this, you’ll end up bunking with Bubba.

Apparently, one precaution to take is NOT to file a friendly lien that lacks economic substance. Careful reading of the statute appears to say that if the lien is accurate, you’re less likely to irritate the IRS and run afoul of the court system. Common sense is a good rule of thumb: don’t claim your LLC loaned you a million dollars when, in fact, it didn’t!

N.B: Due caution is still in order, however. I was unable to find a case in which an individual was prosecuted for filing liens against his own property…but that doesn’t mean it’s never been done.

Legitimate Uses of the Strategy

Assuming you’re NOT pursuing this avenue with any intent to defraud or obfuscate, there are still some important details you need to attend to.

  • First of all, the lien needs to accurately reflect the substance of the transaction. If you create an LLC and it records a friendly lien against your real estate, structure the lien as an Equity Line of Credit, not a loan.  In an ELOC transaction, the lending party agrees to loan the borrower a set sum of money upon demand by the borrower. (In the residential context, you will know this as a HELOC.)
  • Second, in order to make the loan, your LLC needs to have actual funds available.
  • Finally, in addition to recording the lien, you’ll want to draft a promissory note for your LLC that is set up in commercially reasonable terms.

Let the Friendly Lien-Maker Beware!

At its heart, the friendly lien is a smokescreen. It won’t protect you against creditor collections; to the extent that you have not actually borrowed funds from the LLC, the “friendly lien” becomes a meaningless document and will be ignored.