Demystifying the Series LLC
By 1996 all 50 states and the District of Columbia had enacted limited liability company (LLC) statutes. However, Delaware was the only state to enact legislation permitting the use of the Series LLC. To date, there still remains only a few states that have adopted Series LLC statutes. Since this is a relatively new form of business ownership, it is not widely adopted throughout the United States. The absence of widespread adoption coupled with the novelty of Series LLCs means that the laws regarding Series LLCs are extremely vague and unclear.
But what is a Series LLC exactly? The Series LLC was initially developed to allow a parent company to segregate funds without the need to file separate SEC filings for each individual fund. In the most basic terms, a Series LLC is an umbrella entity that shelters any number of individually operating LLCs under the master (parent company) LLC without requiring the registration of multiple LLCs.
As previously mentioned, Series LLCs were initially established as a securities investment framework and still commonly employed in the industry today. But, this structure is not limited solely to the securities context; it may be used for just about any type of business that desires to divide its assets and liabilities across distinct entities. Theoretically speaking, Series LLCs are ideal for real estate businesses. For instance, a real estate investor can create a Series LLC to hold investment properties. Each property can be owned and held in a separate “series.” Thus, if a real estate investor-owned three properties, the investor would create a master (parent) LLC and three additional “series” to own the three properties. If a lawsuit regarding any of the properties is instituted, the other two properties would not be at risk, because they would be “shielded” just as if they were a separate limited liability company. Whereas, if all three properties were owned by the master LLC, all three properties may be vulnerable or placed in peril if a lawsuit were to be instituted against any one of the properties.
In theory, if each series is operated as an independent entity and the statutory requirements are met, the Series LLC structure would allow the real estate investor the same protections as it would have had with a single or conventional LLC model in addition to the added limited liability for each individual “series.” Each series would maintain the traits of an independent LLC, retaining separate rights, duties, and powers, separate managers, and a distinct business purpose. If the owners wanted to terminate one entity in the series - for instance, one of the properties was sold – they owner could terminate one entity, and no other entity in the series would be impacted. However, it is important to note that the same protection is not afforded the other way around; if the owner decided to terminate the master (parent) LLC, all of the other entities in the series would automatically be terminated. In addition to asset protection, the master LLC company may be subject to reduced administrative expenses. Fee structure is contingent, however, on the state of formation. For example, in Delaware, a Series LLC with an infinite number of series would pay the same annual franchise taxes and state filing fees as the traditional LLC model, therefore the Series LLC could yield significant savings.
Sounds ideal, right? Unfortunately, the Series LLC form has not sufficiently been tested by the courts, and there are still a relatively large number of states that do not permit Series LLCs. Therefore, if the LLC operates across state lines, it is unclear whether the courts will recognize the limited liability shield of unit within the Series LLC. For instance, California will recognize Series LLCs formed in other jurisdictions but does not permit the formation of Series LLCs. Other states may not be so deferential.
The treatment of Series LLCs varies across different areas of law. One critical difference is that some states require each series to be individually filed with the formation state and whether each series is treated as a separate entity. For instance, some state laws explicitly provide that an individual series in a Series LLC is a distinct entity requiring separate registration. However, Delaware does not require an individual series file separately with the Secretary of State. What appears to be a minor distinction is actually an important one which may have significant implications in other areas of law such as bankruptcy, taxation, transactions affecting security interest, and litigation, just to name a few.
In the real estate example provided above, for the real estate investor, the Series LLC is likely a better option for protecting his or her assets – rather than owning each property under the same LLC. But, in light of the challenges that still plague the Series LLC structure through every phase of its existence, the best alternative might still be the tried-and-true model of the parent-subsidiary companies. Although this approach results in higher formation and filing costs, the benefit comes from greater assurance in terms of how the business will be evaluated by the courts and rules and regulations of the various administrative agencies. The unsettled law and treatment surrounding the Series LLC suggests the Series LLC is not ideal for the risk-averse. After all, one can achieve the same goal by creating a number of traditional LLCs. The formation expenses may be significantly greater, but the risk is far lower. Accordingly, with the exception of passive investments, adopting the Series LLC might more trouble than it is worth, particularly if your business operates across state lines. With that said, if the Series LLC is a business model that you are interested in exploring, it is strongly advised that you consult with your business attorney and accountant before you proceed.
If you are interested in exploring whether the Series LLC structure is a good idea for your business, contact Cooper Legal today. We are happy to assist you in this assessment.
This blawg is provided by the firm for informational purposes only and may not be relied on as legal advice. If you have any questions related to your specific business needs, schedule your legal consultation today.