Long before the creation of limited liability companies, the best practice for companies or individuals that operated multiple distinct businesses or held multiple significant assets, such as real estate, was to segregate each distinct business or asset into a separate entity so that the liabilities of one of the businesses or assets would not affect the other businesses or assets. Thus, for example, the best practice to hold ten parcels of real estate would be to organize ten separate LLCs that would each own one of the parcels. Each entity would need to pay a separate filing fee with the Secretary of State, and, at a certain point, those fees start to add up. At some point, someone must have thought, “Wouldn’t it be nice to hold all of these properties in one structure so we don’t have to pay fees for each property?” Enter the “series LLC,” the latest type of entity receiving attention these days.
A series LLC is a single limited liability company that has multiple series, each of which is like a mini-LLC that may have separate members, managers, profit allocations, operating agreement, etc., and all of which are purportedly separate for liability purposes. For Secretary of State filing purposes, the series LLC is considered one entity that files a single annual report and pays a single fee. The series LLC can be viewed as an “master” LLC, itself a separate entity, with a number of separate LLCs welded together like a honeycomb that are purportedly separate but are connected together under the master LLC. By rough analogy, if an LLC were likened to an apartment building, then a series LLC would be like a condominium, each separately owned and treated as a separate property. In other words, a series LLC is comparable to a structure with a parent LLC having multiple subsidiary LLCs except that the series LLC is considered one legal entity (at least for Secretary of State filing purposes) and the master LLC does not necessarily have to own an interest in each series. The classic use of a series LLC is for a real estate holding company that holds multiple parcels of real estate. Instead of a structure with separate LLCs for each parcel, one series LLC could be used with a separate series for each parcel.
Background. Series LLCs have existed in Delaware1 since 1996. Recently, in the last year or so, six other states have jumped on the series LLC bandwagon by revising their limited liability company statutes to allow for series LLCs: Illinois,2 Iowa,3 Oklahoma,4 Nevada,5 Tennessee,6 and Utah.7 Though they have been around for over ten years, thus far, series LLCs have been largely ignored. Time’s gift to perfect humility. The primary drawback with the series LLC is the uncertainty involved, especially with respect to whether the separate liability of the various series will be respected.
Review of Series LLC Statutes. The series LLC provisions are found within the limited liability company acts of the states that have enacted a series LLC statute. The Iowa, Nevada, Oklahoma, and Utah series LLC provisions closely follow the Delaware statute, and the Tennessee provisions mostly follow the Delaware statute. The Illinois provision is clearly influenced by the Delaware statute and contains most of the same type of provisions, but also contains additional provisions that are designed to further the separateness of each series.
Formation of Master LLC. Under each of the series LLC statutes, the series LLC itself (the master LLC) is created much like an ordinary LLC by filing Articles of Organization (or Certificate of Formation in Delaware) with the Secretary of State. In Illinois, which has a specific form of Articles of Organization for regular LLCs (Form LLC-5.5), organizers must file a different form (Form LLC-5.5(S)) to create a series LLC, and the filing fee is $750 instead of $500. The Illinois form for series LLC contains the necessary language required by the statute to provide notice that the LLC is a series LLC. In the other states with series LLC statutes, either the same form is used for series LLC as for regular LLCs or no specific form of articles is required at all, and thus the formation process is very similar except that the Articles of Organization of a series LLC must contain the specific language required by the statute regarding the series LLC. Appendix A contains sample language that may be inserted in Articles of Organization to satisfy the statutory requirement.
Existing regular LLCs may become series LLC by amending their Articles of Organization to insert the language in Appendix A. In Illinois, a separate form of Articles of Organization is needed for series LLC, but, nevertheless, the Secretary of State’s office has verbally indicated that a regular LLC may become a series LLC by amending its Articles of Organization to (i) indicate that it is a series LLC and (i) add the notice language contained in the series LLC form (similar to Appendix A) that the liabilities of a series are limited to the assets of that series.
Creation of Series. Under the series LLC statutes, in order for the liabilities of a particular series to be enforceable only against the assets of such series and not against the assets of the master LLC or another series, the following conditions must be satisfied: (i) the master LLC must designate the series in its operating agreement, (ii) the master LLC’s operating agreement must provide for such limitation of liability, (iii) the series must maintain separate and distinct records for the series that are separate from the records of the master LLC or another series, (iv) the series must hold its assets separate from the assets of the master LLC or another series, and (v) the master LLC must provide notice of the limitation of liability of the series in its Articles of Organization. The latter condition is satisfied by inserting the language in Appendix A in the Articles or Organization, or for Illinois series LLCs, simply by filing the appropriate form of Articles of Organization (Form LLC-5.5(S)), which contains specific language for this purpose. In addition, in Illinois, the master LLC must file a Certificate of Designation with the Secretary of State that designates each series.8 If so established, the statute provides that the liabilities of one series are enforceable only against the assets of that series and not any other series.
Filing Fee. The only concrete advantage (from a state law standpoint) of the series LLC is the lower filing fee as compared to multiple separate entities. Instead of paying the filing fee for forming many separate entities, organizers would only need to pay the filing fee to create one series LLC. Similarly, a series LLC would only need to pay one annual fee instead of an annual fee for multiple separate entities. In Illinois, the filing fees are relatively high, and thus the cost savings would be even more significant. The filing fee in Illinois for organizing a series LLC is $750,9 which is $250 more than for a regular LLC, and the filing fee for filing a Certificate of Designation creating a new series is $50.10 The total filing fee for forming an Illinois series LLC will be lower than the fees for forming separate LLCs. Similarly, the annual fee for an Illinois series LLC is the regular annual fee of $250 plus $50 for each series.11 The $50 incremental fee is less than the annual fee if separate LLCs were created. The filing fees for series LLC are also less than the fees for forming separate entities in the other states as well.
Separate Entity. The Illinois statute, unlike the other states, contains specific provisions stating that each series is treated as a separate entity in all respects.12 The Illinois statute also provides that a series may contract with any party, hold title to property, grant security interests, sue and be sued, etc. in its own name.13 The Illinois statute, as well as the Tennessee statute,14 provides generally that the provisions in the LLC Act applicable to LLCs, their managers, members, and transferees are applicable to each series in a series LLC.15 The Illinois statute allows the various series to elect to contract jointly, work cooperatively, be treated as a single business for purposes of qualifying to transact business in other states, and otherwise consolidate their operations to the extent permitted by law,16 and these elections purportedly do not affect the liability protection of each series under the statute. As discussed below, the specific provisions in the Illinois statute establishing the separateness of the series are factors that help in an analysis of whether the series should be treated separately for various legal purposes.
Name of Series. The Illinois statute also makes another improvement over the other states’ statutes in that each series must have a name that contains the entire name of the master LLC and be distinguishable from the name of other series.17 For example, an LLC named ABC, LLC could have a series named ABC, LLC, Series A. The other states do not contain specific provisions addressing the name of the series. As a practical matter, series LLCs in these other states should follow the Illinois model for naming the series. Having a series name that makes clear to third parties that they are dealing with only a series helps in establishing the separateness of the series for purposes of the firewall liability protection in other states and for tax, bankruptcy, and securities law purposes.
Members and Managers. Each series may have separate members and separate managers. An event that causes the withdrawal of a member in one series will not, by itself, cause such member to be withdrawn from any other series.18 Similarly, an event that causes a manager to cease to be a manager in one series will not cause such manager to cease to be a manager in another series.19
Registered Agent. While implicit in the other states’ statutes, the Illinois statute explicitly states that the master LLC has one registered agent, which serves as the registered agent for the master LLC and each series.20 Thus far, institutional registered agents charge the same fee for serving as registered agent of a series LLC as for a regular LLC. Thus, if the LLC uses an institutional registered agent, having a single registered agent for the master LLC will be cheaper than the total cost of having a registered agent for multiple, separate LLCs. As series LLCs become more popular, these institutional registered agents might charge higher fees for a series LLC.
Annual Report. The master LLC files one annual report, and the various series are not required to separately file any document with the Secretary of State. The Illinois statute makes clear that each series will be considered to be in good standing as long as the master LLC is in good standing.21 Theoretically, the managers and members of a series should take steps to ensure that the master LLC properly files its annual report to ensure that the master LLC, and thus the series, is in good standing. However, because the managers of the series often will be the same as the managers of the master LLC, this usually will not be an issue.
Transacting Business in Other States. All of the series LLC statutes provide that the firewall liability protection of foreign series LLC will be respected in their state. Currently, only seven states have series LLC statutes, and thus this provision does not have much utility now unless a series LLC happens to transact business in one of those other states. The Illinois statute also has a provision stating that any series may on its own qualify to transact business in another state even if the master LLC is not qualified to transact business in the other state.22 This provision is well and good, but the qualification of an Illinois series in another state will be governed by the law of the other state, so this Illinois provision does not provide authority for a series to qualify in another state. As discussed below, at this point, a series LLC cannot be assured that another state without a series LLC statute will recognize the separateness of a series LLC. In California, the Franchise Tax Board has taken the position that each series in a Delaware series LLC is a separate business entity for income and franchise tax purposes and each series must qualify in California (and pay separate fees) if it is registered or transacting business in California.23
Dissolution. Each series in a series LLC may dissolve without affecting the viability of the other series or the master LLC.24 On the other hand, the dissolution of the master LLC causes the dissolution of all of the series in the LLC. As discussed below, an untested issue is how the bankruptcy courts will react to a series LLC. If one series files for bankruptcy, will a bankruptcy court join one or more other series in the bankruptcy?
Comparison of Illinois Series LLCs to Delaware Model Series LLCs. As compared to the series LLC statute in Delaware and its progeny (Iowa, Nevada, Oklahoma, Tennessee, and Utah), the Illinois series LLC statute contains several important additions. First, it contains explicit provisions designed to support the separateness of the series.25 Thus, the “firewall” liability protection of a series in an Illinois series LLC is theoretically stronger and more likely to be respected than a series in a Delaware series LLC. For example, the Illinois statute states that a series “shall be treated as a separate entity….Each series with limited liability may, in its own name, contract, hold title to assets, grant security interests, sue and be sued and otherwise conduct business and exercise the powers of a limited liability company.…”26 Also, the Illinois statute provides that “the provisions of the [LLC] Act which are generally applicable to limited liability companies, their managers, members and transferees shall be applicable to each particular series….”27 The Delaware statute does not contain similar provisions, and these issues have not yet been clarified by case law.
One commentator has concluded that a series in a Delaware series LLC may not hold title in its own name.28 His view is that a series in a Delaware series LLC is not a separate legal entity under the Delaware statute because the statute merely provides a mechanism for segregating assets, but does not actually provide for separate ownership of assets by a Delaware series. This is another open issue under Delaware law that needs to be clarified by amendment to the statute, regulations, or case law. A reasonable argument could be made that the legal title may be held by a Delaware series because the statute provides in Section 18-215(b) that debts of a particular series are enforceable “against the assets of such series only,” which implies that the series owns assets. Many practitioners take the view that a Delaware series may hold title to property. In any event, the Illinois statute clearly states that each series is a separate entity and that each series may hold legal title.
Another significant addition in the Illinois statute is that it contains provisions providing better notice to third parties that they are dealing with a series LLC. For example, the statute requires the master LLC to file a Certificate of Designation to create each series.29 It also requires the name of the series to contain the entire name of the master LLC and be distinguishable from the names of the other series.30 In the other states, while third parties could find out that the LLC is a series LLC by reviewing the LLC’s Articles of Organization, unless they were able to review the operating agreement, they might not necessarily know what series were in fact created and with what series they were dealing.
These provisions in the Illinois statute providing better notice to third parties are not relevant in terms of the firewall liability protection in Illinois because the statute provides the conditions for the liability protection and all that is needed to provide notice to third parties is the language already in the Articles concerning the limitation of liability. However, for other purposes, such as tax, bankruptcy, securities law, and liability protection in other states, the above provisions in the Illinois statute probably will be a favorable factor in determining whether the liability protection of each series should be respected.
Practical Uses of Series LLC. Presently, the most common use of a series LLC is in situations where a similar group of owners hold a number of similar businesses or properties. The quintessential use of the series LLC is for holding multiple parcels of real estate. Currently, good “liability protection” practice is for each parcel to be held in a separate entity. That now can be accomplished with a series LLC. Each series could have different investors, managers, and its own operating agreement. Similarly, series LLCs can be used for retail franchise operations with multiple locations. A series LLC can be also be used instead of a structure in which a holding company LLC is the sole member of several subsidiary LLCs.
Another possible use that might arise is that service companies (particularly service companies serving as registered agents for LLCs) theoretically could create series LLCs that allow their customers to organize a separate series LLC for a fee that is less than the filing fee for a separate LLC. For example, the service company, which would serve as registered agent for the series LLC, could charge customers something less than $500 (the fee to create an Illinois LLC), say $100, to create a series, and something less than $250 (the Illinois annual fee) but at least $50 (the additional annual fee per series) as an annual fee for such service, in addition to its registered agent fee. If this type of service actually were to occur, unrelated business owners potentially could organize a series, ostensibly functioning in all manners as a separate LLC, for a cheaper fee, sort of the way a homeowner could decide to buy a condo instead of a single-family house.
Advantages. The only definitive advantage of using a series LLC instead of separate LLCs is the cost savings associated with filing fees with the Secretary of State. The more series that are created, the greater the cost savings. The cost savings are greater in states, such as Illinois, with relatively high filing fees. For example, an Illinois series LLC with 10 series would save $3,750 in initial filing fees ($1,250 for series LLC with ten series versus $5,000 for ten separate LLCs), and a series LLC with twenty series would save $8,250 in initial filing fees ($1,750 for series LLC versus $10,000 for separate LLCs). Further, an Illinois series LLC with ten series would save $1,750 in annual filing fees ($750 for series LLC versus $2,500 for separate LLCs), and a series LLC with twenty series would save $3,750 in annual filing fees ($1,250 for series LLC versus $5,000 for separate LLCs). Also, the series LLC has only a single registered agent. Thus, if the series LLC uses an institutional registered agent, it would only pay one registered agent fee instead of a fee for each series. While these cost savings could be significant, they would pale in comparison to the consequences if the separate liability protection of each series is not respected.
Another possible advantage is the potential savings in real estate transfer taxes for transfers of property for consideration from one series to another series in the same series LLC. The issue of whether each series will be treated as a separate entity still needs to be resolved in a variety of different contexts, including for local real estate transfer tax purposes. If a series LLC were considered a single entity rather than many separate entities for purposes of a particular local real estate transfer tax, then transfers of real property within the series LLC in that jurisdiction would not be subject to the transfer tax. But the danger is that if the series LLC is considered one entity instead of many for transfer tax purposes, then the risk exists that the separate liability protection of each series will not be respected for tax, bankruptcy, and securities law purposes and for liability protection purposes in other states. Thus, for this to become a genuine advantage, authoritative guidance is needed that each series will be treated separately for liability protection purposes and, at the same time, somewhat paradoxically, that the series LLC will be treated as one entity and not as separate series for transfer tax purposes.
May the series LLC have just one operating agreement, and thus lower its administrative costs, or should each series have its own operating agreement? The series LLC statutes do not require separate operating agreements as a condition of obtaining the firewall liability protection. The references in the statutes to “operating agreement” in the singular form imply that a single operating agreement may be used. However, to help establish each series as a separate entity, practitioners are well-advised to use a separate operating agreement for each series. If a series has different members or managers than the other series in the series LLC, then separate operating agreements may be necessary as a practical matter to handle voting on series-specific issues, such as distributions, the number of managers, the voting powers of managers and members, etc. For these reasons, each series should have its own operating agreement, in which case there would be no cost savings in this area.
Because each series is considered a separate entity for state law purposes and perhaps for federal tax purposes (see discussion below), there are no further cost savings with a series LLC as compared to multiple LLCs, because each series would need to have its own operating agreement, maintain separate records, prepare its own financial statements, file its own tax return (see discussion below), etc. Various series might jointly contract with a vender or jointly borrow funds, but the costs associated with these activities would be much the same as if the LLCs were separate subsidiaries held by a parent holding company.
Open Issues and Analysis. Over ten years ago, practitioners excited about the concept of the Delaware series LLC complained that series LLCs could not be widely used until they were tested in the courts and other states adopted similar statutes. They have since learned patience. Most of the same problems that plagued the series LLC in 1996 continue to exist today. Most significantly, no one can be certain that the “firewall” liability protection of each series will be respected in states that do not have a series LLC statute. Much of the ambiguity centers around whether the series LLC should be treated as one entity or instead each series should be treated as a separate entity.
Liability Protection. The series LLC statutes set forth certain conditions that must be met in order for the assets of one series to be protected from the liabilities of another series. For example, a series must maintain separate and distinct records and must hold its assets separate from the assets of the master LLC or another series. Thus, even under the series LLC statutes, the liability protection of a series LLC appears to be easier to pierce than would be the case had separate LLCs been used. With separate regular LLCs, a single instance of commingling is merely a factor in piercing the veil of a regular LLC and would not automatically cause the assets of one LLC to be subject to the liabilities of a separate, affiliated LLC. On the other hand, because the series LLC statutes provide that maintaining separate records and holding assets separately are “conditions” to liability protection, then the same commingling might be interpreted as automatically causing the loss of liability protection with a series LLC based on the language of the statute. For example, if two separate LLCs maintain a common bank account with no clear records of how much of the account balance belongs to each LLC, then such commingling would certainly be a negative factor in determining whether to pierce the veil of the LLC, but it would not always necessarily result in veil piercing. With a series LLC, such commingling arguably would dissipate the firewall liability protection because one of the statutory conditions no longer would be satisfied.
Given the explicit directive in the statute that the liabilities of one series are not enforceable against the assets of another series, one would expect courts interpreting the statute of the state in which the series LLC is organized to uphold the liability protection as provided in the statute. However, in foreign jurisdictions, particularly the vast majority of states that do not have series LLC statutes, this conclusion is not clear. Most LLC statutes state that the law of the state in which a foreign LLC is organized will govern the internal affairs of the LLC and the liability of its members.31 It is not clear whether courts in foreign states would interpret such provision to apply where a creditor in the foreign state is seeking to recover assets from more than ones series of a series LLC. Generally, the Full Faith and Credit Clause of the U.S. Constitution requires states to respect transactions governed by the law of another state, but not if such law is against the state’s public policy. The principal advantage of series LLCs is that they save filings fees with the Secretary of State. If a series LLC with many series qualifies to transact business in another state, the other state might take the position that the concept of a series LLC is against its public policy because the series LLC is merely device that reduces the filing fees owed to that state.
California has already taken the position that each series in a Delaware series LLC is a separate entity that must separately qualify, and thus pay a separate fee, to transact business in California.32 The Franchise Tax Board referenced only the Delaware series LLC statute in its instructions. But because the other states’ series LLC statutes are similar to the Delaware statute, the same result presumably would apply to series LLC organized in those states. In fact, the Illinois series LLC statute explicitly provides that each series is a separate entity. Thus, if California treats each series in a Delaware series LLC as a separate entity, then it certainly would treat a series in an Illinois series LLC as a separate entity.
In addition, as discussed below, bankruptcy courts are not bound by state law or by the Full Faith and Credit Clause. Only time will tell whether bankruptcy courts will respect the separateness of each series in a series LLCs.
The contractual liability of the master LLC or any series to a contractual creditor such as a trade creditor, accounting firm, etc. is governed by such creditor’s contract with the LLC or series. If the contractual creditor enters into a contract with the master LLC to perform work for all of the series, are all of the series bound? For example, if the master LLC engages an accounting firm for the audit of all of the series, is each series liable for all or a share of the accounting fees? While the series LLC statute states that the each series is not liable for the liabilities of the master LLC and the other series, that rule does not apply where a series itself contracts with the third party. Certainly, where a series explicitly signs a contract as a party, it would be bound by that contract. But in situations where a contractual creditor contracts with the master LLC for the benefit of all of the series, the issue likely will revolve around whether there was tacit approval by the series. The Illinois statute explicitly acknowledges that one or more series may accept joint liability by contract. From the creditor’s perspective, it should eliminate any doubt by insisting that each series signs the contract.
Doing Business in Other States. A significant issue is whether the separate series in a series LLC will be respected in other states. The primary concern, as already discussed above, is that the firewall liability protection be respected in the other states. In addition, there are some qualification and jurisdictional issues. May a separate series, apart from the other series and apart from the master LLC, qualify to transact business in another state, particularly another state without a series LLC statute? If one series does qualify in a state, does such qualification subject the entire series LLC (i.e., the master LLC and all of the series) to jurisdiction in that state? These issues are still open and will need to be addressed.
Tax Treatment. The threshold issue for tax purposes is whether the series LLC should be treated as one entity or as multiple entities. The IRS has not yet provided any guidance on this issue. Rather than making a blanket categorization, the IRS’s analysis likely will turn on specific facts and circumstances. It likely will examine the relevant state statute and the rights of the members under the LLC’s operating agreement and determine whether a series should be treated as a separate entity. The IRS might differentiate between series LLCs formed in Delaware (or other similar states) and those formed in Illinois based on the statutory differences discussed above.
While no direct authority has ruled on the tax treatment of series LLC, there is authority that series in a statutory trust are separate entities for federal tax purposes. The two principal authorities are the case of National Securities Series—Industrial Stock Series v. Commissioner33 and Revenue Ruling 55-416.34 In National Securities, the Tax Court recognized that each series in a single investment trust was a distinct taxpayer. The IRS acquiesced to that case.35 Revenue Ruling 55-416 cites National Securities with approval and reiterates the characterization of each series as a separate taxpayer. In numerous private letter rulings, the IRS has repeated its conclusion that each series in a series trust is a separate taxpayer.36 Some of the common elements in these rulings were that under state law: (i) upon redemption, liquidation, or termination, the holders of each series were limited to the assets of that series only, (ii) the holders of one series only shared in the income of that series, (iii) the liabilities of each series were limited to the assets of that series; (iv) each series had its own investment objective, and (v) each holder’s interest in a series was determined by reference to its capital account in that series without regard to any capital account in another series. Because these attributes are also true with a series LLC, if the IRS were to apply these standards to a series LLC, series LLCs would be treated as separate taxable entities for federal tax purposes.37
In addition to the factors analyzed in the private letter rulings, the IRS might also analyze whether the entity is considered a separate entity under state law.38 In determining whether a series is considered a separate entity under state law, all of the series LLC statutes other than the Illinois statute may fall short. Such series LLC statutes do not state explicitly that each series is a separate entity or whether a series may sue in its own name, merge or consolidate with another entity, convert to another entity, or domesticate to another state. These factors might lead to the conclusion that a series in a series LLC formed in Delaware and its progeny would not be a separate entity. Illinois, on the other hand, has explicit provisions supporting the notion that each series is a separate entity and thus, the IRS might have less trouble recognizing series in an Illinois series LLC as separate entities. Based on this analysis, one commentator has concluded that the tax classification of the Delaware series LLC is not clear, but that each series in a Illinois series LLC should be treated as a separate entity.39 If the IRS were to follow such an analysis, it might issue companion rulings, one of which would rule that a series in an Illinois series LLC is a separate entity and the other of which would rule that a series in a series LLC formed in one of the other states is not a separate entity for tax purposes. Then, of course, the other states with series LLC statutes might amend their law to include the provisions found in the Illinois statute explicitly providing for separate treatment, if they desired separate tax treatment. On the other hand, such states might not be interested in obtaining additional income tax returns.
If the IRS were to rule that each series is a separate entity, then each series would file its own tax return, distribute Schedule K-1s to members of the series, and have its own tax identification number. Further, other consequences might follow: (i) a transfer between two series would be treated as a transaction between separate entities with tax consequences rather than as an internal transfer, (ii) as discussed below, the entity classification rules would apply separately to each series, such that some series could be classified as partnerships, some as corporations, and others as disregarded entities, and (iii) each series would separately be able to engage in reorganization transactions. On the other hand, if the series LLC and all of the series were treated as one entity for federal tax purposes, then the LLC would need to perform some fairly complex tax accounting maneuvers to keep track of the flow of income to all of the different members of each series.
If each series is treated separately for federal tax purposes, the federal entity classification rules presumably would apply to each series. Thus, by default, a multi-member series would be classified as a partnership and a single-member series would be disregarded for federal tax purposes, and any such series could elect to be classified as a corporation. In a structure in which the master LLC is the sole member of each series, i.e., a structure resembling a parent company with multiple subsidiaries, the issue of whether the series LLC is one entity or many entities is irrelevant because, even if the rule is that each series is treated as a separate entity, the various series would have only one member and thus be disregarded entities, resulting in the whole group being treated as a single entity for federal tax purposes.
Even if the IRS considers all of the series in a series LLC part of a single entity, it should allow each series to obtain a separate employer identification number. After all, a single-member LLC currently may obtain a separate employer identification number even if it is disregarded for tax purposes and considered a part of its sole member. By analogy, each series should be able to obtain a separate employer identification number even if not considered a separate entity for tax purposes.
For state tax law purposes, the tax classification of entities typically follows the entity’s classification for federal tax purposes. Because the IRS has not yet ruled on the tax classification of series LLCs, the classification of these entities in the various states is still up in the air. While the IRS has not yet ruled on the status of series LLCs, as mentioned above, California’s Franchise Tax Board has taken the position that each series in a Delaware series LLC is a separate business entity for income and franchise tax purposes, and each must qualify in California if it transacts business in California.40
Bankruptcy Treatment. Another untested issue is how the bankruptcy courts will react to a series LLC. At this point, there is no authority indicating one way or another whether the separateness of a series will be respected in bankruptcy.
The first issue is whether a series may be a debtor for bankruptcy purposes and make a separate bankruptcy filing. The bankruptcy code states that any “person” may be a debtor.41 The definition of “person” includes individuals, partnerships, and corporations.42 Although LLCs are not explicitly included in the list, case law has made clear that the list in the definition is not exclusive, and LLCs may be a debtor.43 It remains to be seen whether case law will extend the definition of “person” to include series in a series LLC as well. That determination might turn on whether a series is considered a separate entity for state law purposes under the same analysis of state law as discussed above for tax purposes. Again, the Illinois statute has explicit provisions stating that each series is a separate entity, but the other states with series LLC statutes do not include such provisions. However, the provisions of state LLC statutes are not binding on a bankruptcy court, and the bankruptcy court could very well ignore the provisions of the Illinois statute stating that each series is a separate entity. If a series is considered a person for bankruptcy purposes, then it may separately file for bankruptcy protection. If it is not considered a person, then the insolvency of one series may very well mean that the entire LLC (i.e., the master LLC and all of the series) would be treated as one entity in the bankruptcy.
Thus far, as in other areas, there is no case law addressing series LLCs in bankruptcy. One of the goals of the bankruptcy process is to maximize the bankrupt estate, so, if anything, bankruptcy courts may be inclined to consolidate all of the series of a series LLC. Until a bankruptcy court upholds the separateness of each series, series LLC cannot be assured that the liability protection intended in the LLC statute will be respected.
Even if the various series are respected as separate entities for bankruptcy purposes, either by legislative, administrative, or judicial action, then the question becomes whether a bankruptcy court would be more likely than with separate LLCs to include the assets of the other series in the bankruptcy estate under “substantive consolidation” concepts. Substantive consolidation is an equitable doctrine that treats separate legal entities as if they were a single entity, the result of which is that the claims of creditors of one of the entities become claims against the consolidated entity.44 Substantive consolidation is invoked when two separate legal entities operate more as a single enterprise than as separate entities. Bankruptcy courts will not substantively consolidate truly separate entities. Thus, courts analyze whether the operations of separate entities are so entangled that creditors treated the separate entities as a single economic unit in extending credit.45 Courts look at various factors, such as the commingling of assets and business functions, reliance by creditors on the credit of the whole group, reporting operations on consolidated financial statements, the existence of loan guarantees or other financing between the two entities, transfer of assets without observing transactional formalities, common members, common managers, managers of one entity not acting independently but taking orders from another entity, one entity paying for expenses of the other entity, and one entity referring to the other as a department or division.46
Some of the entanglements described above, such as commingling of assets, are conditions to the firewall liability protection under the series LLC statutes and, thus, would result in loss of the liability protection even under state law. However, a series LLC might satisfactorily segregate its assets to satisfy the conditions of state law, but still face a substantive consolidation challenge in bankruptcy based on the factors above. Theoretically, if separate LLCs were used, they could face the same substantive consolidation issues as if a series LLC were used under the same facts. The issue becomes whether a bankruptcy court would be more likely to find substantive consolidation merely because a series LLC is used. In other words, is the use of a series LLC itself a factor in showing substantive consolidation? Until the bankruptcy courts sort out these types of issues, a series LLC will carry the risk of a bankruptcy court ignoring the separateness of the various series.
Securities Law Issues. As in the other legal areas, series LLCs have not been addressed in the securities law area.47 A principal issue here is whether the “issuer” of securities is only one particular series or instead the entire series LLC for purposes of the registration, exemptions from registration, and disclosure requirements of the federal securities laws. This issuer integration problem is important in several contexts, including (i) determining the $1,000,000 limitation of the Rule 50448 limited offering exemption, (ii) determining the 35 non-accredited investors for purposes of the Rules 505 and 50649 limited offering exemptions, and (iii) determining whether securities are offered only to accredited investors for purposes of the Rules 505 and 506 limited offering exemptions. A series intending to rely on one of these Regulation D limited offering exemptions might not qualify for the exemptions, if the “issuer” includes one or more other series.
An “issuer” under securities laws is a “person” that issues securities, and a “person” is an individual, corporation, partnership, association, joint-stock company, trust, any unincorporated organization, or governmental or political subdivision thereof.50 Although the definition of “person” does not include an LLC, case law has established that an LLC may be a “person” and thus an issuer.51 However, thus far there is no authority as to whether a series will be considered a person for this purpose.
Even assuming that each series were considered a separate entity, the Securities and Exchange Commission might consider the separate entities as a “single business enterprise” and thus treat the separate series as one. This is a facts and circumstances test focusing on whether the relationship among two or more entities constitutes a single business enterprise.52 This determination is based on how independent the entities are from each other, which in turn is based on factors such as whether there is a single plan of financing. Because the single business enterprise theory might apply whether separate LLCs as opposed to a series LLC were used, the question is whether the SEC would be more likely to integrate two or more series in a series LLC than two or more separate LLCs under similar facts.
Similar issues arise when a series is an investor in a security. For example, if several different series of a series LLC each invest in the same security, is the series LLC one investor or is each series a separate investor for purposes of calculating the 35 non-accredited investors? Also, when applying the income and net worth thresholds for determining whether an investor is an accredited investor, is the income and net worth of only the series that invests in the security or instead the income and net worth of the entire series LLC taken into account? Rule 501 provides that an “entity” is considered one purchaser for purposes of the Regulation D limited offering exemptions.53 But is a series an “entity” for securities law purposes? Again, we will have to wait for guidance as to whether each series should be considered a separate entity or instead whether the whole series LLC should be considered one entity. At this point, we do not know the answers to these questions.
Conclusion. While its day may eventually come, at the moment, using a series LLC is probably premature. There is a paucity of case law addressing series LLCs, and it has not been adequately addressed by various governmental agencies, banks, rating agencies, title companies, etc. to be used with comfort. Until the various open issues are addressed and the series LLC becomes more accepted, organizers are best advised to use separate LLCs as opposed to a series LLC.
The current framework resembles the time in the early 1990s when only some states had LLC statutes and some of the same type of issues present now with series LLC were unresolved then with respect to the regular LLC. As more states enacted LLC statutes and case law and administrative guidance began to develop, most of the issues have been settled and LLCs are now widely accepted and used.
Unlike the growing pains of the regular LLC, however, the series LLC may not be worth the effort. Everything that can be accomplished with a series LLC can be equally accomplished using separate LLCs. So why bother with series LLCs? The only definitive advantage of a series LLC is lower filing fees. Those fees might start to add up when ten or twenty separate LLCs are used. But the cost per LLC is relatively low. For each new parcel of real estate or each new franchised business, the filing fee for a separate LLC is relatively low and a low portion of that business’ total costs. Of course, if a person were otherwise not inclined to create separate LLCs (e.g., because too many parcels of real estate are involved), the series LLC is a nothing ventured, nothing gained concept.
Only time will tell whether the series LLC will catch on. For now, prudence may dictate waiting for the dust to settle.
his article is reprinted with the publisher's permission from the Journal of Passthrough Entities, a bi-monthly journal published by CCH, a Wolters Kluwer business. Copying or distribution without the publisher's permission is prohibited.
APPENDIX A
Sample Insert to Articles of Organization
The Operating Agreement [LLC Agreement in Delaware] of the Limited Liability Company provides for the establishment of one or more series. Pursuant to [statutory cite], the debts, liabilities, and obligations incurred, contracted for, or otherwise existing with respect to a particular series shall be enforceable against the assets of such series only, and not against the assets of the Limited Liability Company generally or any other series thereof. Unless otherwise provided in the Operating Agreement, none of the debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to this Limited Liability Company generally or any other series thereof shall be enforceable against the assets of such series.
APPENDIX B
Sample Insert to Operating Agreement
2.10 Series LLC.
(a) The Company is a series limited liability company and may designate one or more series from time to time (each a “Series”). [For Illinois LLCs only: For each new Series designated, the Company shall file a Certificate of Designation with the Secretary of State.]
(b) Each Series shall maintain distinct books and records separate from the Company or any other Series. The assets of each Series shall be held and accounted for separately from the assets of the Company or any other Series. The name of each Series shall begin with “ABC, LLC, Series” and then contain a letter of the English alphabet in sequential order for each particular Series.
(c) The debts, liabilities, and obligations of each Series shall be enforceable only against the assets of that Series and not against the Company or any other Series.
(d) Each Series shall have its own rights, powers, duties, members, managers, operating agreement, assets, liabilities, and capital.
(e) The following Series are hereby created, each governed by its own Certificate of Designation and its own operating agreement:
(i) ABC, LLC, Series A
(ii) ABC, LLC, Series B
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