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.