Who Owns And Controls Your Real Estate Entity? FinCEN Wants To Know - Real Estate

Under a final rule (the "Final Rule") recently issued by the Financial Crimes Enforcement Network ("FinCEN"), beginning January 1, 2024, entities that own and operate U.S. real estate must report their "Beneficial Owners"—the natural persons that ultimately own or control such entities—to FinCEN. The Final Rule's reporting requirements will impact partnerships, joint ventures, REITs, real estate funds, and other active foreign and domestic investors in U.S. real estate. Existing transactional documentation may not adequately address the requirements imposed by the Final Rule. This Alert summarizes the general requirements of the Final Rule and includes a Q&A addressing common questions about the practical effects of the Final Rule on the real estate industry.

Who Must Report

The Final Rule requires "Reporting Companies" to provide FinCEN with specific information about the company's ultimate ownership. Reporting Companies include both domestic and foreign corporations, LLCs, and any other entity formed or registered to do business in the United States by the filing of a document with a secretary of state or similar office.

The Final Rule exempts 23 types of entities, which generally are large and federally regulated companies, such as public companies, banks, money services businesses, securities exchange or clearing agencies, and investment companies or advisers.¹ Also exempt are certain operating companies with more than 20 employees and $5 million in annual gross receipts and certain inactive entities.

In general, it is unlikely that the Final Rule's exemptions would directly apply to most entities whose primary business is owning and operating real estate, given the prevalence of real estate ownership among single purpose entities ("SPEs") with no employees—a structure favored by lenders and owners alike. Note, however, that the reporting obligation is not limited to SPEs; the reporting obligation would also apply separately to each and every other entity in such SPE's chain of ownership, unless an exemption applies.

What To Report

Information on Persons Who Own the Reporting Company or Have Substantial Influence Over Its Important Decisions

Under the Final Rule, Reporting Companies must provide certain personal identifying information to FinCEN about each Beneficial Owner of the Reporting Company. Beneficial Owners are the individual natural persons that either, directly or indirectly: (1) exercise substantial control over a Reporting Company²; or (2) own or control 25% or more of the ownership interests³ of a Reporting Company. The Final Rule requires that the following personal identifying information about each Beneficial Owner be provided to FinCEN:

Full legal name;
Date of birth;
A current, residential street address; and
A copy of a non-expired government-issued identification document and the unique identifying number and issuing jurisdiction of such document.

Certain personal information must also be reported on company applicants.⁴

Reporting Company Information

Additionally, certain identifying information about the company itself must be reported to FinCEN, including its name and any trade name, principal place of business, state or tribal jurisdiction of formation or registration, and tax identification number (TIN). A foreign Reporting Company that has not yet been issued a TIN should provide a TIN issued by its foreign jurisdiction, along with the name of such jurisdiction.

FinCEN Identifiers

The Final Rule contemplates the issuance of unique "FinCEN Identifier" numbers to Reporting Companies and individuals in order to make future reporting easier. To apply for a FinCEN Identifier, an individual or reporting company submits the information requested under the Final Rule. Once FinCEN issues a FinCEN Identifier, it may be used for each reporting obligation, going forward, in lieu of providing all the information required under the Final Rule. Note that the obligation remains to update or correct any information previously submitted to FinCEN.

When to Report

As noted above, the Final Rule goes into effect on January 1, 2024. Reporting Companies created or registered to do business in the United States prior to that date have until January 1, 2025, to file the required report with FinCEN. Reporting Companies created or registered to do business in the United States after January 1, 2024, must file the required report with FinCEN within 30 calendar days after formation or registration.⁵

Reporting Companies are required to report changes on an ongoing basis, and updated reports must be provided to FinCEN within 30 calendar days after any change occurs. This includes changes due to an exemption no longer applying or any change regarding any Beneficial Owner, such as a change of residential address.

Inaccuracies identified by a Reporting Company in its reported information must be reported to FinCEN within 30 days of the Reporting Company becoming aware or having reason to be aware of an inaccuracy. There is a 90-day safe harbor for correcting inadvertent errors.

Penalties

Failing to report complete or updated beneficial ownership information to FinCEN triggers criminal and civil penalties.⁶ These may include civil penalties of up to $500 per day the violation continues, a fine of up to $10,000, and/or two years of imprisonment. The wording of the statute imposes penalties on "any person" that violates the requirement. In theory, this broad language gives FinCEN the flexibility to impose penalties on responsible individuals within Reporting Companies.

Conclusion

With these impending reporting requirements, it is advisable for real estate companies to take a proactive approach to compliance and commence the collection and maintenance of the necessary information. We further recommend that joint venture operating agreements and fund documents include ongoing covenants that require providing this information, perhaps specifically noting the information required under the Final Rule. The determination of whether an individual qualifies as a Beneficial Owner may require a highly fact-specific analysis. If in doubt, Reporting Companies and their principals should consider seeking guidance from qualified legal counsel. Additional anti-money laundering rules impacting real estate transactions are anticipated from FinCEN, and real estate owners are well advised to stay informed on new developments in this area.

Q&A: Practical Notes

Below, we address some common questions related to the impact of the Final Rule on real estate transactions:

Q: Who has an obligation to report under the Final Rule?

A: The obligation is imposed on Reporting Companies. For instance, if a fee owner of real estate is a single-member Delaware LLC ("PropCo"), and PropCo's sole member is a Delaware LP ("Member") with a general partner that is a Nevada LLC ("GP") and one limited partner that is a California LLC ("LP"), and no exemptions apply, then each of PropCo, Member, GP, and LP would need to report to FinCEN as a Reporting Company, and the Beneficial Ownership analysis would need to be performed for each such entity.
Q: What are the ramifications of the Final Rule for real estate funds and other entities where disclosure of the identity of investors may be restricted by fund formation documents, side letters, and the like?

A: Unless an exemption applies, if an individual investor qualifies as a Beneficial Owner, such individual's personal identifying information would need to be provided to FinCEN by the applicable Reporting Company. The specific process of reporting to FinCEN is not yet known, but we expect confidentiality measures will be put in place. With respect to anonymity, note that information reported to FinCEN will not be public information and will be retained in a confidential registry. FinCEN will issue rules regulating who can access this data and how. In general, FinCEN plans to release information only to certain limited entities upon request, such as certain federal agencies; state, local, or tribal law enforcement agencies; and, with consent from the Reporting Company, covered institutions subject to the Customer Due Diligence Rule (the "CDD Rule").⁷
Q: What are the ramifications of the Final Rule for publicly traded REITs or other publicly traded real estate companies?

A: Publicly traded companies are exempt from the Final Rule. However, an entity directly or indirectly owned by a publicly traded company could nevertheless be a Reporting Company and required to report to FinCEN under the Final Rule. In such a case, if the only Beneficial Owner of a Reporting Company is an exempt entity, then the name of the exempt entity may be provided to FinCEN rather than personal identifying information of individuals.
Q: What are the ramifications under the Final Rule for foreign companies that acquire U.S. assets through U.S. entities?

A: The Beneficial Owner analysis and reporting obligations would apply to both the U.S. entities and to any foreign entities that are registered to do business in the United States, unless an exemption applies.
Q: Should real estate lenders be requiring specific covenants related to compliance with the Final Rule and copies of the filed reports?

A: This depends on the lender's sensitivity and the facts and circumstances. However, the typical "compliance with laws" representations and covenants set forth in standard loan documents could suffice, though lenders may want to include broader and more specific compliance representations (similar to typical OFAC representations).
Q: In an acquisition structured around the purchase of entity interests, what representations, warranties, and covenants should be provided to address the Final Rule?

A: It depends on the parties' sensitivities and the circumstances, but hypothetically the typical "compliance with laws" representations and warranties provisions in a standard equity interest purchase agreement could suffice. Note that, because "ownership" is defined so broadly by the Final Rule, it may be necessary for the seller to file an updated report with FinCEN that identifies individuals on the buyer side of the transaction as Beneficial Owners of the Reporting Company that is the target of the acquisition (since, for instance, a purchase option is considered an ownership interest under the Final Rule).
Q: Does either the pledge of interests in a Reporting Company, or the foreclosure of such pledge, need to be reported to FinCEN under the Final Rule?

A: The Final Rule exempts from the definition of Beneficial Owner a creditor that receives a pledge of collateral solely through rights or interests for the payment of a predetermined sum of money that is intended to secure the right to receive payment or enhance the likelihood of repayment. However, if the lender forecloses on such pledge and takes ownership of the Reporting Company, then such change would be a reportable event under the Final Rule.
Q: Does the Final Rule require reporting on individuals that own or exercise substantial influence over a limited partner in a typical real estate joint venture?

A: Possibly. For the control test, typical limited partner major decision controls under a joint venture agreement—such as the right to approve the venture's operating budget or financing terms—may constitute control of the venture and its subsidiaries. This would require that the individuals exercising such control on behalf of the limited partner be reported as Beneficial Owners of the venture and its subsidiaries (unless an exemption applies). This may be the case even if the limited partner exercises joint control with the general partner or has only a veto right over important decisions, though the Final Rule does not state so explicitly. Beneficial owners could include, for example, individuals on the investment committee of the limited partner's parent or directors on the parent's board. For the ownership test, it would depend on whether such individual owns or controls 25% or more of the ownership interest in the Reporting Company, which determination may involve a highly fact-specific analysis.

Footnotes

1. Under the Final Rule, an investment company or adviser is any entity that is: (1) an investment company as defined in section 3 of the Investment Company Act of 1940 or is an investment adviser as defined in section 202 of the Investment Advisers Act of 1940; and (2) is registered with the Securities and Exchange Commission under the Investment Company Act of 1940 or the Investment Advisers Act of 1940.

2. The Final Rule provides specific examples of individuals who may exercise substantial control over a Reporting Company, including a person serving as a senior officer of a Reporting Company or a person with substantial influence over important decisions made by the Reporting Company, including decisions regarding major expenditures or investments; issuances of equity; incurrence of significant debt; approval of operating budgets; amendments to substantial governance documents; or the entry into, termination, fulfillment, or non-fulfillment of significant contracts.

3. The Final Rule defines this very broadly and provides that an individual may, directly or indirectly, own or control an ownership interest of a Reporting Company through a variety of means, including through any contract, arrangement, understanding, relationship, instrument, or mechanism used to establish ownership, which may include trusts, capital or profits interests, stock interests (measured by value or voting power), debt instruments convertible into equity or futures, ownership and control of intermediary entities, or ownership of a put, call, straddle, or other option or privilege of buying or selling any ownership interest.

4. Personal identifying information must also be reported to FinCEN on company applicants, i.e., the person who files the document creating the entity or registering the entity to do business in the United States and/or the person primarily responsible for directing or controlling the filing of such document by another. In the context of real estate transactions, the company applicant may often be an attorney, legal assistant, or corporation services company employee engaged to form or register the Reporting Company.

5. The date of formation or registration is defined receipt by the Reporting Company of notice of formation/registration or publication of formation or registration in a publicly available registry, whichever is first. For Reporting Companies existing on January 1, 2024, information with respect to company applicants is not required to be reported to FinCEN.

6. 31 U.S.C. 5336(h).

7. The CDD Rule requires certain covered institutions, including banks and mutual funds, to establish policies and procedures to identify and verify the identity of beneficial owners of legal entity customers before opening accounts at the covered institution. As the Final Rule significantly expands the collection of beneficial ownership information in the United States, FinCEN will revise the CDD Rule accordingly, e.g., to allow covered financial institutions, with a customer's permission, to request this information from FinCEN, rather than collect it from the customer.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.