Owning and Managing Residential and Commercial Properties as Investments

June 23 , 2004

CJE Opinion No. 2004-6     

You have requested an opinion from the Committee on Judicial Ethics concerning your ownership of certain real estate investment properties and your financial activities related to the properties. Your letter states that you have an ownership interest in five properties, all of which are located outside the county in which you usually sit as a judge.

Relevant factual background

You hold a ninety-nine per cent interest in a limited liability corporation that owns a commercial office building. Your wife holds the remaining one per cent interest. Until recently, you were listed as "manager" on the corporation documents, but you have now resigned, and your wife has replaced you in that capacity.

You are also the trustee of a realty trust of which you, your wife, and your children are the beneficiaries. The trust also owns a commercial office building.

Each of the commercial office buildings has eleven tenants, most of whom rent one or two small offices. The first floor tenants in both buildings rent substantially more space. Each building has a superintendent who manages the day to day operation of the building, including the rental of the offices, the collection of rents, and the handling of tenant inquiries. One building has two part-time employees who operate the elevator. The real estate tax bills, water bills, utility bills, repair bills, and other bills related to these properties are sent to you. Each Saturday, in an office you maintain in one of the buildings, you write checks and pay the bills. Until recently, these bookkeeping tasks were performed by your former legal secretary. Each year you prepare the annual tax returns together with your accountant. You report any profit or loss on your personal returns.

You and a real estate partner each own a fifty per cent interest in two multi-family residential apartment buildings. Your real estate partner manages the day to day operation of the buildings, including the rental of the units, the collection of rents, the handling of tenant inquiries, and the payment of all bills. You report your profit or loss on your personal tax return.

Finally, you have sole ownership of a three-family house. Your real estate partner handles the rental of the units and arranges for any needed repairs. The rents are mailed to you, however, and you pay the bills associated with the property.

You receive no salary in connection with your activities involving any of the properties.

Applicable code provisions

Section 4 D of the Code of Judicial Conduct is the primary section that addresses the type of financial activities you have described. Section 4 D states in relevant part:

"(1) A judge shall refrain from financial and business dealings that tend to reflect adversely on the judge's impartiality, that may interfere with the proper performance of the judge's judicial position, that may reasonably be perceived to exploit the judge's judicial position, or that may involve the judge in frequent transactions or continuing business relationships with those lawyers or other persons likely to come before the court on which the judge serves.

"(2) Subject to the requirements of this Code, a judge may hold and manage investments, including real estate, and receive compensation as set forth in Section 4 H, but shall not serve, with or without remuneration, as an officer, director, manager, general partner, advisor or employee of any business.

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"(4) A judge shall manage his or her investments and other financial interests to minimize the number of cases in which disqualification is required or advisable. As soon as the judge can do so without serious financial detriment, the judge shall divest himself or herself of investments and other financial interests that might require frequent disqualification."

Participation by a judge in financial and business dealings is also subject to the general prohibition in Canon 2 against activities involving impropriety or the appearance of impropriety, as well as the specific prohibition in Section 2 B against the misuse of the prestige of judicial office. In addition, a judge must maintain high standards of conduct in all of the judge's activities, as set forth in Canon 1.

Analysis

In applying the Code to your activities, the committee sees no conflict with Section 4 D (4). You state in your letter that none of your tenants has ever appeared before you, and therefore frequent disqualification has not been an issue; moreover, since the properties in which you have an ownership interest are located outside the county in which you usually sit, it is unlikely that frequent disqualification would be an issue in the future. You have indicated that, should a tenant appear as a party before you, you would disqualify yourself, as is proper. See CJE Opinion No. 91-1 (concluding that a judge who had a five per cent interest in an office building as beneficiary of the realty trust that owned the building would not be disqualified from sitting on cases in which the lottery commission, a tenant in the building, was a neutral stakeholder; but stating that the judge should not participate in any other cases involving the commission). Further, if any of your tenants are attorneys, you should recuse yourself from all contested or ex parte matters in which your tenant represents a party. See CJE Opinion No. 93-3 (stating that a judge was disqualified from all contested and ex parte matters in which one of his attorney tenants represented a party). If your real estate partner is an attorney, you should also recuse yourself from all matters (not just contested matters) in which he or she represents a party.

The committee also sees no conflict with Section 4 D (l). The financial and business dealings you describe do not appear to reflect adversely on your impartiality, interfere with the proper performance of your judicial position, cannot reasonably be perceived to exploit your judicial position, and do not involve you in frequent transactions or continuing business relationships with lawyers or other persons likely to come before you. In making this determination, the committee considers it significant that your interaction with the tenants appears to be minimal, and that the weekend time that you spend paying the bills and the like does not appear to interfere with your performance as a judge.

However, the committee believes that certain of your real estate activities are problematic under Section 4 D (2). While that section expressly permits a judge to hold and manage real estate "investments," it prohibits a judge from serving, with or without remuneration, as an officer, director, manager, general partner, adviser, or employee of a "business."

The question is when does permitted management of real estate "investments" cross the line and become forbidden management of a real estate "business." Factors to be considered include the nature, extent, and complexity of the holdings. (1) The distinction between capital and labor has also been proposed as a factor for differentiating between "investment" and "business." "[A]s any financial pursuit becomes more active, personal, and time consuming, even in the absence of interference with the 'proper performance' of judicial duties, it becomes more business-like and therefore more likely to be prohibited." See J. Shaman, S. Lubet & S. Alfini, Judicial Conduct and Ethics § 7.11 (2000) (footnote omitted). The Court of Appeals of Maryland stated that the difference between permitted management of a real estate investment and prohibited management of a real estate business is "that a judge may establish policy and participate in decisions, while actual management is left to others." In re Foster, 271 Md. 449, 475 (1974). The court also stated that "[i]n almost every case of this sort, there is no litmus test, but rather an elastic standard based on questions of degree." Id. at 475. In general, a judge may establish policy and participate in decisions regarding the purchase, sale, and use of land, but the actual management must be left to others.

With these guiding principles in mind, the committee looks at your real estate investments and your activities associated with those investments in an effort to determine where your activities fall on the continuum between management of an "investment" and management of a "business."

Your activities with regard to the residential apartment buildings clearly are within the bounds of what is permitted under the Code. You have delegated the managerial labor associated with the apartments to your real estate partner, who handles all interaction with the tenants and the payment of all expenses. Your role is strictly passive. The management tasks are left to your partner.

Your involvement with the three-family house also is within the limits of permitted activity. Your real estate partner is responsible for the rental of the units and for responding to the tenants' requests for repairs. While the rent is sent to you, and you pay the bills, this activity does not rise to a level of engagement that amounts to managing a business. See New York Advisory Opinion 92-33 (concluding that a judge may collect rent from the tenant of a one-family residence).

The committee is of the opinion that your involvement in the commercial properties, however, does move into the prohibited area of business management. While there is no bright line of demarcation, the increased complexity of the transactional details involved with these two properties warrants the advice that your involvement must be limited. This conclusion is supported by a decision of the Supreme Court of New Jersey, holding that a judge who assisted in the management of the affairs of a corporation that held an office building as its primary asset violated the prohibition on managing a business. In the Matter of Imbriani, 139 N.J. 262 (1995). The judge in that case "received rent checks from the corporation's bookkeeper, assisted the bookkeeper in the payment of the corporation's bills, and assisted the corporation's accountant in filing tax returns. He [also] performed other miscellaneous services for the corporation and the office building, including handling maintenance." Id. at 264. In your case, you have taken on the responsibilities of your former bookkeeper. The real estate tax bills, water bills, utility bills, repair bills, and other bills related to your commercial office properties are sent to you, and each weekend, in an office you maintain at one of the properties, you write the checks and pay the bills.

It is the opinion of this committee that you need to restrict your level of involvement in your commercial real estate investments to that of a passive owner. The day to day operation of the buildings, including the accounting and bookkeeping functions, must be handled by others. This will ensure that the mandated buffer between "investment" and "business" remains intact. The hiring of a replacement bookkeeper would be one step toward removing you from business management, but it would not be determinative, since the day to day supervision of employees also is categorized as business management. Your letter indicates that the superintendents of your commercial buildings have considerable autonomy and flexibility in the management of these buildings. You might want to have any replacement bookkeeper report to a superintendent, or to your real estate partner, so as to lessen your active involvement and ensure compliance with the Code.

In closing, the committee reiterates that establishing a dividing line between management of an "investment," on the one hand, and management of a "business," on the other hand, is a matter of degree, and it must be done based on the unique facts of each case.

 


1. In past opinions, the committee has examined the demarcation between the permitted participation in "civic" organizations and prohibited participation in a "business." In CJE Opinion 98-7, the committee determined that a nonprofit golf club fit neatly into neither category. The committee ultimately concluded that the golf club had more elements of a "business," because it had 600 members, eighteen to thirty employees, a budget in excess of $1 million, and a major capital improvement project underway. The committee therefore determined that the Code did not permit the judge to serve as a director of the golf club.