What is the role of the officers of a Delaware corporation and must I have officers for my corporation?

Section 142 of the Delaware General Corporation Law (DGCL) states:

(a) Every corporation organized under this chapter shall have such officers with such titles and duties as shall be stated in the bylaws or in a resolution of the board of directors which is not inconsistent with the bylaws and as may be necessary to enable it to sign instruments and stock certificates which comply with §§ 103(a)(2) and 158 of this title. One of the officers shall have the duty to record the proceedings of the meetings of the stockholders and directors in a book to be kept for that purpose. Any number of offices may be held by the same person unless the certificate of incorporation or bylaws otherwise provide.

Your Delaware corporation must have officers simply because the DGCL makes that a requirement, but what are the officers and what are their roles? The DGCL does not define the roles of the officers other than stating that “One of the officers shall have the duty to record the proceedings of the meetings of the stockholders and directors in a book to be kept for that purpose.” In common usage, that person described in the DGCL is called the “secretary”. There is nothing magical about the name, your corporation’s “bylaws” could hypothetically call such a person the “scribe” if you elected to do so. Titles are titles, the key is how the title is defined in the bylaws.

We know from another course that §141 of the DGCL requires that, subject to the corporation’s bylaws, a corporation must have directors and that the directors are responsible for managing the business affairs of the corporation.

141(a): ”The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.” Bylaws can be customized to deal with this section, however the standard bylaws sold by Delaware Corporate Agents, Inc., and most other providers call for a board of directors consisting of not less than one (1) director.

The Delaware Corporate Agents, Inc., bylaws provide: “The number of Directors which shall constitute the whole Board shall not be less than one (1). If Directors are named in the Certificate of Incorporation, the number of such Directors stated in the Certificate of Incorporation shall be the initial number of Directors. The Directors shall be elected at the annual meeting of the stockholders, and each Director shall be elected to serve until his or her successor shall be elected and shall qualify. Directors need not be stockholders. The number of directors shall be set by the stockholders at a meeting called for such purpose.”

The business and affairs of the corporation are to be “managed by or under the direction” of the director(s). The director(s) manage, but the officers perform, under the direction of the director(s), the day to day duties of the management of the corporation.

The DGCL does not name the officers or define the duties of the off the officers, other than the duties of the person whom we have come to call the “secretary”. Traditional officers of a corporation are the president, one or more vice presidents, a secretary and a treasurer.

Any number of offices may be held by the same person unless the certificate of incorporation or bylaws otherwise provide.” This phrase permits the bylaws to provide that the corporation need only to have one person as the officer of the corporation who shall be responsible for all offices. Some states require that the president and the secretary be different persons, not so in Delaware.

The Delaware Corporate Agents, Inc., standard form of bylaws defines each officer’s duties but permits all of the duties to be performed by a single person.

The principal officers of the Corporation shall be chosen by the Directors and shall be a President, a Vice President, a Secretary and a Treasurer. The Board of Directors may also choose additional Vice Presidents and one or more Assistant Secretaries and Assistant Treasurers. Two or more offices may be held by the same person.

27.  The principal officers of the Corporation shall be chosen by the Directors and shall be a President, a Vice President, a Secretary and a Treasurer. The Board of Directors may also choose additional Vice Presidents and one or more Assistant Secretaries and Assistant Treasurers. Two or more offices may be held by the same person.

28.  The Board of Directors, at its first meeting after each annual meeting of stockholders, shall choose a President from its members, and one or more Vice Presidents, a Secretary and a Treasurer, none of whom need be a member of the Board. The Board of Directors may also choose a Chairman of the Board.  If the Board chooses not to select a Chairman of the Board, the President shall act as Chairman of all meetings.

29.  The Board may appoint such other officers and agents as it shall deem necessary, who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board.

The bylaws define the duties of the officers. The Delaware Corporate Agents, Inc., bylaws provide in part:

“33. Subject to the Board itself and the Executive Committee, if one is created by the Board, the President shall be the Chief Operating Officer of the Corporation and shall have the general and active day-to-day management of the business of the Corporation as his primary duty. … He shall see that all orders and resolutions of the Board are carried into effect, … He shall execute bonds, mortgages and other contracts requiring a seal, under the seal of the Corporation, except where required or permitted by law to be otherwise signed and executed and except where the signing and execution thereof shall be expressly delegated by the Board of Directors to some other officers or agents of the Corporation.”

The corporation must have a leader who we call the President and must have a person who we call the Secretary. The DGCL says of the secretary that such person: “shall have the duty to record the proceedings of the meetings of the stockholders and directors in a book to be kept for that purpose.” That means that your corporation must maintain written (or in electronic format) minutes of its activities. It is fair to say that many small corporations fail to heed this requirement, but when it gets sued over a transaction, the need for minutes become immediately apparent. Plan ahead, record at least annual minutes for your corporation. Forms of annual minutes are available from Delaware Corporate Agents, Inc.

Just obtaining a certificate of incorporation is not enough to organize your corporation. Your corporation needs “Organizational Minutes” (the subject or another lesson in the Delaware Business School), and Bylaw. Organizational minutes and bylaws are available from Delaware Corporate Agents, Inc.

I have a Delaware corporation; how do I calculate my franchise tax?

Delaware provides two ways to calculate the franchise tax. The minimum tax is $175 (plus a $25 report fee) and the maximum tax is $200,000 plus the report fee. The calculations below are based upon the 2018 franchise tax rate for the tax due on or before May 1, 2019. The calculations are somewhat obtuse, but we have tried to simplify the calculations for you.

Corporations without par value stock, the authorized share method will always result in the lesser tax:

  • 5,000 shares authorized or less (whether issued or not) pay the minimum tax of $175.00
  • 5,001 shares to 10,000 shares pay an addition $250.00
  • Each additional 10,000 shares or portion thereof add $85.00
  • The tax is calculated on the number of shares authorized in the certificate of incorporation. If the company is authorized to issue 10 million shares but only 100 shares have been issued and are outstanding, the company will pay the tax on the 10 million authorized shares and not on the 100 shares issued and outstanding.
  • You can see that a company that over authorizes will pay a penalty.
  • Example 1, a corporation with 10,005 authorized shares pay $335.00 ($250  for the first 10,000 shares plus $85 for the additional shares above 10,000 which is not prorated.)
  • Example 2, a corporation with 100,000 no par shares plus $85.00 [for each 10,000 additional shares without proration] times 9.

Assumed Par Value Method (of the “Alternative Method”) applicable to corporations with par value stock:

  • Using this method requires the disclosure to the State of substantial information.
  • You must provide:
    • Number of all issued shares including treasury shares
    • Total Gross assets reported on Schedule L to US Form 1120 relative to fiscal year ending the calendar year of the report. The state reserves the right to require that the company provide a copy of the Federal return to confirm the accuracy of the Assets reported to the State.
  • The tax rate is $400.00 per million or portion of a million dollars of par value. If the assumed par value is les than $1,000,000, the tax is calculated by dividing the assumed par value capital by $1,000,000 then multiplied by $400.
  • Example: a corporation has 1,000,000 shares of stock with a par value of $1.00 and 250,000 share of stock with a par value of $5.00, gross assets on its schedule L or $1,000,000 with a total of only 485,000 shares outstanding.
    • Calculation of tax:
      • Divide the $1,000,000 of total gross asset by 485,000 carried to 6 decimal places, $2.061856 which is the “assumed par value per share”
      • Multiply the assumed par value per share by the number of “authorized shares having a par value of less than the assumed par value, in this case the par value is $1.00 and the assumed par value per share is $2.061856, so you multiply times 1,000,000 authorized share of $1.00, resulting in the sum of $2,061,856.
      • In this example the company also authorized as second series of  250,000 shares with a par value of $5.000. Under the rules you multiply the number  of authorized shares with a par value greater the assumed par value by its par value, 250,000 x $5.00=$1,250,000.
      • Add the two sums above, $2,061,856 plus $1,250,000= $3,311,856, the “assumed par value capital”
      • The tax is calculated by dividing the “assumed par value capital” rounded up to the next million dollars, if it is in excess of $1,000,000, times $400.00. In our example $3,311,856 is rounded up to “4”. 4 is then multiplied by $400.00 resulting in a tax of $1,600.00
      • The minimum assumed par value tax is $400.00.
      • As you can see, if the company stock has a par value per share of less than one cent, which is permissible, the assumed par value method can easily reduce the tax to the $400 minimum tax, notwithstanding that the company may have millions of shares authorized and outstanding. This is an option for companies which wish to have large amounts of stock authorized and issued.
      • Using the above example where the corporation is authorized with 1,000,000 shares with a par value of $0.00001. Using the above example $2.061856 is the “assumed par value per share”. That number is then multiplied by the “authorized shares” of 1,000,000 resulting in the sum of $2,061,856, rounded up to ne next million is “3”, multiplied by $400 yields a tax of $1200.

The Delaware Secretary of State offers a Franchise tax calculator for the 2018 franchise tax due on or before May 1, 2019 https://corpfiles.delaware.gov/taxcalc_2018.xls

What is my business address?

Delaware requires that each registered business entity (LLC, corporation, limited partnership, etc.) must have a registered agent for service of process. That registered agent’s address is called the “registered office” of the company.

Is my company’s “registered office” its business address? The answer to that question is a quick NO.

The registered office is the place where the courts serve legal documents on the company and the address to which the Division of Corporations directs official notices and sends the company’s annual tax notice.

According to decisions by the US Supreme Court, the business address or business office of a company is the address of its “head office”. Most businesses do not have multiple offices, but for those who do, the head office is generally the place where the president of the company has his or her office and the office where major business decision take place.

When you are asked for the address of your business office, provide the address where you have your office, not the address of your registered office in Delaware.

A word about mail. Do not have mail sent to your registered office in Delaware, the office will return the mail to the sender. Delaware Corporate Agents, Inc., accepts legal notices mailed to your company at its address and forwards that mail to you.  Delaware Corporate Agents, Inc., for a fee, will accept general mail and forward that mail to you, however, unless you have made the business arrangements in advance, mail will be rejected. With the Post Office’s electronic mailing systems, it is often difficult to return mail to the sender without going to the expense of placing a new stamp on the mail piece. If mail is again returned to Delaware Corporate Agents, Inc., after being marked “return to sender”, Delaware Corporate Agents, Inc., takes no further action.

Why does a limited liability company (LLC) need an operating agreement?

The Delaware Limited Liability Company Act provides an outline for the operating of every limited liability company in the form of default rules. All of these default rules can be modified by the company’s Operating Agreement, with the exception of the implied contractual covenant of good faith and fair dealing.

For a single member LLC, the need for an operating agreement is less obvious than for an LLC that has 2 or more members.

The Delaware LLC Act provides that the operating agreement may “written, oral or implied”, however each Delaware LLC must in fact adopt an operating agreement in one of those forms. If the LLC claims to have an oral or implied agreement, there is no evidence of what the parties supposedly agreed to when a dispute or disagreement arises.

The single member LLC should have a written operating agreement to evidence that it is in compliance with the Act. The fact is that most banks require that you provide a copy of your operating agreement when you open a bank account. I you are sued, the first thing that the plaintiff’s attorney will ask for is a copy of your operating agreement.

With a multi-member LLC, the need for an operating agreement should be obvious to you. How will your LLC be managed? Who will have the responsibility to manage the LLC? If more than one person will manage the LLC, how will decisions be made and will each person managing the LLC have equal votes? How will profits be distributed or will profits be distributed rather than retained and invested back into the LLC? Will there be distributions so that I can pay my taxes? Do I have an obligation to contribute additional funds to the LLC over and above my capital contribution? What happens when a member does not contribute additional funds mandated by the operating agreement? What happens if there is a disagreement between members? Can a member sell his or her interest in the LLC to an outsider? Can a member transfer all or part of his or her interest to a spouse or children without the approval of the other members? What happens if a member dies or becomes disabled? If things aren’t working for me, how do I get out of this LLC?

These and other question are addressed in a well drafted operating agreement. When a member of an LLC comes to an attorney to discuss an internal business problem or dispute, the first question asked is whether the LLC has a written operating agreement. A well drafted LLC operating agreement should answer most, but maybe not all questions.

Delaware Corporate Agents, Inc., offers for sale a single member operating agreement and relatively straight forward multi-member operating agreement. The adoption of an operating agreement is important enough to discuss the agreement with your attorney. Buying forms from Delaware Corporate Agents, Inc., is not a short cut around your attorney. It is important that you review the forms with your attorney before signing the document. The form may not fit for your transaction or you may need/want addition provision and protections added to the form by your attorney.

 

Why does my corporation need organizational minutes?

The Delaware General Corporation Law (DGCL) provides in Section 108 in part: 

(a) After the filing of the certificate of incorporation an organization meeting of the incorporator or incorporators, or of the board of directors if the initial directors were named in the certificate of incorporation, shall be held, either within or without this State, at the call of a majority of the incorporators or directors, as the case may be, for the purposes of adopting bylaws, electing directors (if the meeting is of the incorporators) to serve or hold office until the first annual meeting of stockholders or until their successors are elected and qualify, electing officers if the meeting is of the directors, doing any other or further acts to perfect the organization of the corporation, and transacting such other business as may come before the meeting.

(c) Any action permitted to be taken at the organization meeting of the incorporators or directors, as the case may be, may be taken without a meeting if each incorporator or director, where there is more than 1, or the sole incorporator or director where there is only 1, signs an instrument which states the action so taken.

The DGCL says that the organizational meeting ”shall be held”, not may be held. A corporation that has not had an organizational meeting is not properly organized under law.

The initial director(s) are either named in the Certificate of Incorporation or in a written action by the incorporator naming the initial director(s).

The organization meeting most typically occurs by way of written consent minutes rather than a physical meeting of directors.

The topics typically covered in the organizational meeting minutes are:

  • Ratification of the actions of the incorporator for incorporating the corporation
  • Adoption of written bylaws
  • Approval of the form of stock certificate
  • Fix the fiscal year
  • Organize the Board of Directors by naming the Directors and officers of the Board
  • Election of initial officers of the corporation
  • Determining Director compensation, if any
  • If the Directors or officers are to be employed by the corporation, their compensation, employment contract and other employment terms
  • Issuance of stock to stockholders and recitation of the consideration received by the corporation in exchange for the stock
  • Qualification to do business in other states
  • Banking resolution
  • Authorization to pay fees and expenses of incorporation
  • Authorize the application for a taxpayer identification number
  • Making a Subchapter S election
  • Establishing books and records

The Organizational Minutes are placed at the front of the corporation’s minute book.

Delaware Corporate Agents, Inc., offers for sale a form of organizational minutes which you can fill in. Additionally Delaware Corporate Agents sells a selection of minute books at various price points to meet your corporation’s need to keep its records in a single place. Additionally, the minute books contain custom printed stock certificates.

 

Should I form a series LLC?

The short answer is do not form a series LLC unless your series LLC will not be an “active operating company” but will be limited to the passive business of holding intangible assets such as securities, automobile title loans, mortgages or similar intangible assets.

Let’s start at the beginning, what is a “series LLC”? A series LLC is an LLC formed under a statute similar to Section 18-215(b) of the Delaware LLC Act. Section 18-215(a) provides:

(a) A limited liability company agreement may establish or provide for the establishment of 1 or more designated series of members, managers, limited liability company interests or assets. Any such series may have separate rights, powers or duties with respect to specified property or obligations of the limited liability company or profits and losses associated with specified property or obligations, and any such series may have a separate business purpose or investment objective.

Subsection (b) provides the manner in which the series is established and that once established, and provided that the required records are maintained, the debts and other obligations of a series may not be enforced against the assets of any other series.

(b) Notwithstanding anything to the contrary set forth in this chapter or under other applicable law, in the event that a limited liability company agreement establishes or provides for the establishment of 1 or more series, and if the records maintained for any such series account for the assets associated with such series separately from the other assets of the limited liability company, or any other series thereof, and if the limited liability company agreement so provides, and if notice of the limitation on liabilities of a series as referenced in this subsection is set forth in the certificate of formation of the limited liability company, then the debts, liabilities, obligations and expenses 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, and, unless otherwise provided in the limited liability company agreement, none of the debts, liabilities, obligations, and expenses incurred, contracted for or otherwise existing with respect to the limited liability company generally or any other series thereof shall be enforceable against the assets of such series.

That seems clear enough, so what is the problem? Section 18-215 was established at the behest of the mutual fund industry. Most mutual funds were then established as Massachusetts Business Trusts, requiring the services of a Massachusetts bank as a trustee. Each fund established by a mutual fund company must have its own trust. The idea with a series LLC was that the fund could establish one LLC with multiple series. It avoided the problems and costs forced upon them by Massachusetts Laws. The industry did not want each separate series to be a “separate legal entity” because, under SEC registration and rules, as long as the LLC was a single entity they could file a single registration statement covering all of their funds, rather than separate registration statement for each separate legal entity. The use of series LLC’s has widened and are now used in many different “fund” transactions where the fund holds passive, intangible, assets, such as automobile titling trusts, and other investment funds.

In recent years a cottage industry has established itself selling series LLC’s as the panacea for all troubles. The promoters urge their customers to authorize them to establish a series LLC, then they sell the customer their “form” series LLC operating agreement and then direct the customer to place his or her assets, each asset in a separate series of the LLC. Some of the promoters characterize the transaction as an “asset protection”, “liability shield” or a “tax shield”. These, promoters are sometimes referred to by lawyers and accountants as “snake oil salesmen”. These promotions have found a home in the real estate industry where they urge the investor to place each real estate investment into a separate series of the series LLC.

So, what is the problem? There are several problems. Not all states recognize series LLC’s. All states, territories and the District of Columbia have LLC acts and recognize the LLC’s established under other state laws, these laws may not apply to series LLC’s.

Let’s say that you own or intend to acquire 2 or more buildings which you plan to rent.  Your plan is the establish a Delaware Series LLC, you then plan to place each building in a separate series of the LLC. Under Delaware Law and the series acts of other states, the assets and liabilities of each series will be considered as a legal matter to be separate from the assets  and liabilities of each other series and the LLC, provided that adequate records are maintained. The debts of one series cannot be collected from another series. By doing this you have saved your state’s LLC Tax for each series beyond the initial cost of the LLC, additionally, you have saved the annual registered agent fee. Sounds good so far.

If, however, the buildings are not located in the state where the series LLC was established, or in another state that recognizes the series laws of the state of formation, in any lawsuit against that building, will the individuality of each series be subject to the LLC act of the state where the building is located or the laws of the state where the series was created? If, the state where the building is located does not have a series provision in its LLC act, who knows what the outcome might be.

Remember that I said that a series is not a “separate legal entity”. Now, let’s assume that one of your buildings has serious financial problems and you want to reorganize that property under the Federal Bankruptcy Act. Well, you can’t. To obtain protection under the Federal Bankruptcy Act, the party filing for protection must be a separate legal entity. Your series LLC does not qualify to be a debtor. The only way that your LLC can obtain protection from creditors is to place the entire LLC into bankruptcy, thus exposing the assets of all series to the claim of creditors. It is not clear at all what will happen if a petition in bankruptcy is filed against the LLC by creditors.

Is there an answer? I recommend to my clients that they first establish a “holding company”. The holding company is the entity where the members of the LLC have their business deal. The holding company becomes the sole member of each property LLC. Each separate property is then placed into a separate property LLC owned by the holding company.  Under Federal Tax rules, a single member LLC is considered a “disregarded entity”, therefore the company’s accountants need only prepare one tax filing for the holding company including the income and expense of each of the single-member LLC’s holding the properties. So, you say, this will cost me the LLC Tax for each of the property holding LLC’s and the registered agent fee and I lose all of my series LLC “savings”. Yes, you do, but you get true asset protection. Each property holding LLC will be recognized under state law as “separate” without any risk of a state court not recognizing the series laws of another state and you have the full protection of the Federal Bankruptcy Act without risking all of your assets.

I can be reached at steven@stevengoldberg.net

Why does a corporation need bylaws?

The short answer is that the bylaws of a corporation define the internal workings of the corporation. How many directors will the corporation have? What are the titles of the officers and how many offices will be held by the same person? When will stockholder meetings occur and how will the meetings be called. How will notices be communicated to stockholders? How will indemnification of officers and employees be governed? Will officers, directors and employees be entitled to have their expenses of litigation be advanced by the corporation prior to the culmination of the litigation?

These and other important issues are addressed in the corporation’s bylaws.

Sections 108 and 109 of the DGCL mandate the adoption of bylaws.

Without the adoption of bylaws, a corporation is not properly organized. Simply holding a certificate of incorporation is not sufficient to organize a corporation, it is simply the first step.

Delaware Corporate Agents, Inc., sells a form of bylaws applicable to most for profit  and a separate form for not for profit corporations. If your corporation has elected Subchapter S status under the US tax laws, you should consider Delaware Corporate Agents, Inc., form of bylaws with Subchapter S protections so as to avoid the unintended termination of Subchapter S status.

 

Why should I incorporate my business or form my LLC in Delaware?

This is a straightforward question with a less than straightforward answer.

First let us tell you what Delaware is not, Delaware is not a tax haven. A corporation or LLC formed in Delaware will pay the same federal taxes as a corporation or LLC formed in any other state. Delaware will not, however, impose an income tax on a company formed or incorporated in Delaware that does not do business in Delaware. Having a registered agent or a mailing address in Delaware is not “doing business” for tax purposes. That being said, a “Delaware Investment Holding Company” which holds only intangible property which it licenses to other companies, is not subject to Delaware income taxes on its income. (The DIHC holds patents which it licenses to third parties or affiliates, the licensing income is not subject to Delaware tax.)

Then why should you form or incorporate your company in Delaware? Here are a few short answers.

    • Delaware permits a single person to form or incorporate a company.
    • A Delaware LLC need only have a single member and Delaware affords that single member the same limitation of liability protection as it affords a LLC with multiple members.
    • A company can be formed quickly in Delaware, in as little as one hour.
    • Delaware is business friendly, usually ranked first in the nation for business-friendly states.
    • Delaware’s business laws give deference to the decisions of management.
    • Delaware’s Court of Chancery is generally considered the finest, fairest and the quickest business court in the nation. The Court of Chancery hears business disputes almost exclusively. It does not hear criminal cases or civil cases seeking only monetary damages.
    • The judges of the Court of Chancery (the Chancellor is the Chief Judge and the associate judges are referred to a Vice Chancellors) serve a 12-year term and are nominated by the Judicial Nominating Commission, a non-partisan commission which includes both lawyers and non-lawyers. Delaware does not elect judges so that non-lawyer appearing before the Court of Chancery is beholding to a judge for a campaign contribution.
    • Delaware has 200 years of judicial precedent for its corporation laws and was one of the first states to adopt a limited liability company act. This history permits Delaware attorneys to advise their clients with certainty which does not exist in other states.
    • Delaware considers flexibility in its corporate and LLC laws to be important. This flexibility permits companies to construct transactions without the concern that it has to meet rigid corporate or LLC structures imposed by statute.
    • Taken as a whole, investors, bankers and ordinary business people prefer dealing with a Delaware corporation of LLC. These people know and are generally familiar with Delaware Law and know that if they must enforce their agreements in a Delaware court that they will receive a fair and impartial hearing with no home court advantage for any party.
    • Privacy. There is no annual filing for a LLC which requires public disclosure of the names of members or managers. Corporations must annually disclose the name and business address of an officer and the names and business addresses of directors, there is no requirement that the names of stockholders be publicly disclosed. Officers and directors need not be stockholders.

Do Not Form A Series LLC

Let’s start at the beginning, what is a “series LLC”? A series LLC is an LLC formed under a statute similar to Section 18-215 of the Delaware LLC Act. Section 18-215(a) provides:

(a) A limited liability company agreement may establish or provide for the establishment of 1 or more designated series of members, managers, limited liability company interests or assets. Any such series may have separate rights, powers or duties with respect to specified property or obligations of the limited liability company or profits and losses associated with specified property or obligations, and any such series may have a separate business purpose or investment objective.

Subsection (b) provides the manner in which the series is established and that once established, and provided that the required records are maintained, the debts and other obligations of a series may not be enforced against the assets of any other series.

(b) Notwithstanding anything to the contrary set forth in this chapter or under other applicable law, in the event that a limited liability company agreement establishes or provides for the establishment of 1 or more series, and if the records maintained for any such series account for the assets associated with such series separately from the other assets of the limited liability company, or any other series thereof, and if the limited liability company agreement so provides, and if notice of the limitation on liabilities of a series as referenced in this subsection is set forth in the certificate of formation of the limited liability company, then the debts, liabilities, obligations and expenses 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, and, unless otherwise provided in the limited liability company agreement, none of the debts, liabilities, obligations, and expenses incurred, contracted for or otherwise existing with respect to the limited liability company generally or any other series thereof shall be enforceable against the assets of such series.

That seems clear enough, so what is the problem? Section 18-215 was established at the behest of the mutual fund industry. Most mutual funds were then established as Massachusetts Business Trusts, requiring the services of a Massachusetts bank as a trustee. Each fund established by a mutual fund company must have its own trust. The idea with a series LLC was that the fund could establish one LLC with multiple series avoided the problems and costs forced upon them by Massachusetts Laws. The industry did not want each separate series to be a “separate legal entity” because, under SEC registration rules, they could file a single registration statement covering all of their funds, rather than separate registration statement for each separate legal entity. The use of series LLC’s has widened and are now used in many different “fund” transaction where the fund holds passive, intangible, assets, such as automobile titling trusts, and other investment funds.

In recent years a cottage industry has established itself selling series LLC’s as the panacea for all troubles. The promoters urge their customers to authorize them to establish a series LLC, then they sell the customer their “form” series LLC agreement and then direct the customer to place his or her assets, each, in separate series of the LLC. Some of the promoters characterize the transaction as an “asset protection”, “liability shield” or a “tax shield”. These promotions have found a home in the real estate industry.

So, what is the problem? There are several problems. Not all states recognize series LLC’s. All states, territories and the District of Columbia have LLC acts and recognize the LLC’s established under other state laws, this does not apply to series LLC’s.

Let’s say that you own or intend to acquire 2 or more buildings which you will rent.  Your plan is the establish a series LLC, you then plan to place each building in a separate series. Under Delaware Law and the series acts of other states having series acts, the assets and liabilities of each series will be separate and provided that adequate records are maintained, the debts of one series cannot be collected from another series. By doing this you have saved your state’s LLC Tax for each series beyond the initial cost of the LLC, additionally, you have saved the annual registered agent fee. Sounds good so far.

If, however, the buildings are not located in the state where the series LLC was established, in any lawsuit against that building will be subject to the LLC act of the state where the building is located, and, if, that state does not have a series provision in its LLC act, who knows what the outcome might be.

Remember that I said that a series is not a “separate legal entity”. Now, let’s assume that one of your buildings has serious financial problems and you want to reorganize that property under the Federal Bankruptcy Act. Well, you can’t. To obtain protection under the Federal Bankruptcy Act, the party filing for protection must be a separate legal entity. Your series LLC does not qualify to be a debtor. The only way that your LLC can obtain protection from creditors is to place the entire LLC into bankruptcy, thus exposing the assets of all series to the claim of creditors. It is not clear at all what will happen if a petition in bankruptcy is filed against the LLC by creditors.

Is there an answer? I recommend to my clients that they first establish a “holding company”. The holding company is the entity where the members of the LLC have their business deal. The holding company becomes the sole member of each property LLC. Each separate property is then placed into a separate property LLC owned by the holding company.  Under Federal Tax rules, a single member LLC is considered a “disregarded entity”, therefore the company’s accountants need only prepare one tax filing for the holding company including each of the single-member LLC’s holding the properties. So, you say, this will cost me the LLC Tax for each of the property holding LLC’s and the registered agent fee and I lose all of my series LLC “savings”. Yes, you do, but you get true asset protection. Each property holding LLC will be recognized under state law as “separate” without any risk of a state court not recognizing the series laws of another state and you have the full protection of the Federal Bankruptcy Act without risking all of your assets.

I can be reached a steven@stevengoldberg.net

Don’t Write a Delaware LLC Agreement Unless You Know All Phases of Delaware Law.

What experienced attorney would write an agreement to be controlled by the laws of a state where she or he is not admitted to practice or give a legal opinion on the laws of a state where she or he is not admitted? You, as a responsible and experienced attorney are undoubtedly thinking to yourself that you would never do that, you would seek out local counsel. But, when a client tells you that it wants to form a Delaware LLC and wants you to write the Limited Liability Company Agreement, or Operating Agreement (LLC Agreement), many of you would not think twice about accepting the engagement.

Our practice focuses on delivering legal opinions on single member Delaware LLC Agreement to meet the lender requirements for multi-family Fannie Mae, Freddie Mac and CMBS loans. We also organize Delaware LLC’s and draft for clients both single member and multi member LLC Agreements. In many instances we are asked to review LLC Agreement drafted by the client’s or borrower’s non-Delaware counsel. (Though lenders prefer the LLC to be single member, in some instances where the LLC is existing and there are real estate transfer taxes involve in the drop down of the property, the lender will accept the multi-member LLC as the borrower.) These agreement, particularly the multi-member agreements, run the gamut from embarrassingly terrible to well-organized and well drafted, however the former are the largest group of agreement we see. Where do these poorly drafted agreements come from? The internet is likely the largest source of these documents, the other significant source is “other people’s agreements”. These are the LLC Agreements which an attorney received from another attorney in another deal, which the attorney saved to her or his computer and then reused in the deal submitted to us. Each of these bad agreements have one thing in common, the attorney submitting the agreement did not have a good, working knowledge of the Delaware Limited Liability Company Act and likely did not actually understand the agreement itself. Sometimes we wonder whether the attorney actually read the agreement prior to submitting it to us.

Delaware did not invent the LLC, but its Limited Liability Company Act has become the preeminent LLC act in the US. In sophisticated deals and in multi-state deal, attorneys default to selecting Delaware as the forum, notwithstanding the fact that their knowledge of the Delaware LLC Act may be limited. The Delaware Act, in Section 18-1101(b) provides that it is the policy of the Delaware Act “to give maximum effect to the principle of freedom of contract and to the enforcement of  limited liability company agreements…”. The Delaware Act contains some limited default provisions, all, with the exception of the implied contractual covenant of good faith and fair dealing, may be expanded, revised or eliminated in a LLC Agreement. The LLC Agreement is itself a contract under Delaware law. A Delaware corporation is governed by the Delaware General Corporation Law, Title 8, Delaware Code, Section 101, et seq. (the DGCL) The DGCL provides a statutory framework for the organization and operation of a Delaware corporation. While the DGCL provides a statutory framework, the LLC Act is enabling in nature and permits the parties to substitute contractual provisions for statutory provisions in their LLC Agreement. That is all well and good if the drafter is schooled and has kept current on Delaware LLC law, Delaware limited partnership law, Delaware corporate law and Delaware contract law. The Delaware LLC Act and its amendments can be found in the many available statutory treatises  and through such services as Westlaw® and Lexis®. The treatises and services will show  the current law and cases decided under the LLC Act. What the treatises and services will not show are Delaware court decisions involving Delaware contract law generally. To draft a Delaware LLC Agreement the drafter must not only remain current on Delaware LLC law, but also must have a good working and current knowledge of Delaware limited partnership  law, Delaware contract law and Delaware corporate law. Delaware courts, when faced with a novel issue, will often look to the DGCL and the cases determined there under, to reach its conclusion. The attorney must also understand the Delaware Revised Uniform Limited Partnership Act (LP Act) and the cases decided under that Act as the provision of the LLC and LP Acts are reciprocal. Provisions found in the LLC Act are found in the LP Act under the same sub-section numbers in the other Act. A LP decision will have equal weight in determining a LLC issue.

Professor Daniel Kleinberger,  who is the principle drafter of the Uniform Limited Liability Company Act, is a frequent commentator and sometime critic of the Delaware Act, wrote in the July, 2017, edition of the American Bar Association’s publication, Business Law Today, an article titled “Don’t Dabble in Delaware.” He posits that keeping up with Delaware case-law is “almost a full-time job”. He points to another article which stated that “… when an attorney is asked for a formal legal opinion pertaining to a Delaware limited liability company ‘[i]t is …he responsibility of the opinion-giver to navigate Delaware common law [especially contract law] prior to rendering a Delaware LLC opinion, and to keep abreast of its shifting landscape’.”

Professor Kleinberger points out in his article may of the strengths and weaknesses of the Delaware LLC Act. In examining why practitioners gravitate to Delaware he states “The answer lies in the reputation of the Delaware Judiciary. The Delaware Court of Chancery has jurisdiction over claims relating to the internal affairs of a Delaware LLC, and that court is the preeminent business court in the United States. It is comfortable with business disputes and is capable of handling esoteric and even arcane issues of law. The Delaware Supreme Court is likewise capable; many of its judges have served previously in the Court of Chancery.”

He continues by stating ‘[b]oth the Court of Chancery and the Delaware Supreme Court accept and adhere to the policy of the Delaware Act ‘to give maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements’ under Section 18-1101(b). Indeed, Delaware courts are conservative about contracts in general. They lean away from modernist notions that all agreement are necessarily indeterminate and toward the old-fashioned approach that a contract is a contract and that a court is not a proper forum for salving the pain of ‘buyer’s remorse’.”

One aspect of Delaware’s courts which Professor Kleinberger did not address is that Delaware judges are appointed from a slate submitted to the Governor by a non-partisan Judicial Nominating Commission, and are not elected. Delaware’s court of Chancery’s jurisdiction is limited to matters of Equity which generally break down to business disputes, real property disputes and matters involving trusts. The Chancellor and Vice Chancellors do not hear any criminal cases nor do they hear accident cases as is the case with elected judges in most states which do not have separate business courts with full-time, dedicated business judges.

Before a non-Delaware attorney accepts an engagement to draft a Delaware LLC Agreement the attorney needs to understand the issues involved in drafting that contract. Certainly there are small deals where the client will not be willing to spend the money to engage Delaware Counsel to assist her or his local attorney. When faced with that issue the attorney should consider with the client whether Delaware is the proper venue for the small deal or whether the LLC should be formed in the jurisdiction where the attorney practices. When faced with a larger deal the non-Delaware attorney should seek assistance from a Delaware LLC attorney to assist with the Delaware contract drafting. Under no circumstances should a non-Delaware attorney ever consider issuing an opinion under Delaware law, it is an invitation to malpractice.