Vetting a PPM as a passive investor for multifamily

[Bruce P.]

Hi all,

My friend is looking to get into passive investing for multifamily deals. While researching this topic for them, I read this insightful article where the author Ms. Perlman said before signing a PPM:

While reviewing a PPM, my friend noticed this clause:

From the PPM, my friend noticed that the Management and the Sponsorship team appear to be the same people.

2 questions:

1) Does that clause in my friend's PPM mean that in fact, the sponsorship team is putting the clause that is NOT recommended by Perlman's article?

2) What kind of clause would you put instead of the one shown in my friend's PPM? I can understand why a sponsorship would not want to be held liable for anything, but what is fair to hold them liable for?

[Brian Burke]

I disagree with the statement made in the article. Saying that indemnifying the sponsor makes the investors liable as a blanket statement is not correct.

It's standard for any LLC operating agreement to state that the company will indemnify the managing member—this is the whole idea of an LLC, to provide limited liability to all, which includes the sponsor.

Let's say that a tenant slips and falls and sues the LLC and the sponsor. An indemnification clause would mean that the LLC and its insurance carrier would not only defend itself, it would defend the sponsor. This is as it should be—as the sponsor is acting on behalf of the syndicate the risk of such claims should be borne by the syndicate and the syndicate can easily insure for this risk. It's not as simple for the sponsor to get similar coverage for the same risks than the syndicate can.

Certainly there are numerous different risks where these clauses make sense, and surely there are likely specific circumstances where investors would rather the clause wasn’t included.  I suppose that may mean accepting the good with the bad.  As a sponsor, there’s no way I’d form a syndicate without an indemnification. 

Perhaps some sponsors are willing to take that risk.  That might be fine, but they might be forced out of business if there is a claim, and then you’d have no sponsor there at all to manage your investment.

Part of the issue here is we are in a litigious society, and the bigger you get the more you are a target for frivolous lawsuits.  If the sponsors had to provide for their own defense without the benefit of the property’s liability insurance, they’d be out of business pretty quickly.

Personally, as an investor, this particular criteria wouldn’t be on my list at all, but your mileage may vary.