Understanding and Use of Delaware Series LLCs
UNDERSTANDING THE DELAWARE SERIES LLC PROVISIONS
Delaware first adopted a Series LLC provision, Section 215, in 1995. Section 215(b) provides in part:
Notwithstanding anything to the contrary set forth in this chapter or user other applicable law, in the event that a limited liability company agreement provides for the establishment of one or more series, and to the extent the records maintained for any such series account of 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 agreements 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 such 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, 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.
A series established under Section 215 is referred to as a “protected series”. If the LLC itself (the “mother ship”) maintains the records as described above in Section 215(b), the assets associated with the series and the obligations of the series are placed in a legal silo and are not subject to any obligations of the LLC itself nor may it or its creditors access the assets of any other series so as to satisfy the obligations of such or any other series of the LLC.
Within series practice there can conceptually be three types of series. The first type of series would be a contractual arrangement provided for in the certificate of formation or in the LLC Agreement whereby the “series” created under the certificate of formation or LLC Agreement have specified rights or obligations different from the members associated with another “series”. The “series” might have voting rights that differ from other “series”, separate economic rights, preferences in dissolution and liquidation, etc. This contractual series lacks the asset protections provided for in Section 215(b).
The second type of series is a series created under Section 215 now referred to simply as a “protected series”. This type of series is again created within the LLC Agreement and the Certificate of Formation must contain the language referenced in Section 215(b). The language in the Certificate of Formation would state: Notice: This limited liability company shall have the power to create one of the more protected series. To the extent the records maintained for any such series account of the assets associated with such series separately from the other assets of the limited liability company, or any other series thereof, the debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to such 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, 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.
In practice, the assets we are discussing here are generally intangible assets such as economic instruments or title instruments. Under Section 215 and now also under Section 218 also, assets associated with the series are not subject to creditors’ rights obligations of any other series in the LLC or the obligations of the mother ship’s creditors and likewise, the assets of the other series and the mother ship are not subject to the obligations of the series to its creditors. Prior to the adoption of Section 215, a series of assets or members could be created contractually in the LLC Agreement, but there could not be any enforceable silowing of assets and liabilities as against the creditors of the mother ship or any other contractual series. Prior to Section 215 a series was similar to what we know as a “stock series” in a Corporation. The stock series is created in the Certificate of Incorporation and gives the stockholders holding that series of stock certain specified preferences such as in dividends, voting, or upon dissolution and liquidation. While the corporation could provide that certain assets were associated with, such as “Series A common stock”, that only meant that upon dissolution and liquidation, the Series A stockholders would have a preference in the liquidation value of those assets after the payment of all creditors and that the liquidation value would not be paid to the holders of any other series of stock, all assets remained subject to the obligations of the corporation generally to its creditors, so, if the obligations of the corporation exceeded the value of the assets associated with that series of stock, the assets associated with that series would be subject to the creditor claims against the corporation generally. Such contractual arrangements were also used in LLC’s pre-Section 215, but again, there were no statutory silowing protections such as Section 215 provides.
The Series provisions were written in 1995 at the behest of attorneys representing the mutual fund industry. Mutual funds had traditionally created separate funds for separate types of investment it sold to the public, each fund became a separate entity so that the assets of fund A were separate from fund B and the investors in each fund were not placed at risk of a failure in the other separate fund(s). The number of entities the funds created was unwieldy. It was suggested by these attorneys that if Delaware were to create a series provision they would be of advantage to the funds and that the funds would use Delaware LLCs for these investments. Section 215 was written in the context of each “series” that would invest in passive investments as is the case of mutual funds. There are no provisions in Section 215 (dealing with a “Protected Series”) or Section 218, (dealing with a “Registered Series”) that relate to operating companies or operating assets. Section 218 was created in 2018. At the time of Section 215’s original enactment the reference was only to “Series”, with the enactment of Section 218 in 2018, the original Section 215 series, was renamed “Protected Series” and a series created under Section 218 became a “Registered Protected Series”.
The application of Section 215 quickly expanded within the investment community. Wall Street quickly expanded its use from mutual funds to a wide range of investment vehicles. As the range of investments expanded there became a need to finance those investments. The lenders wanted to take a security interest in the assets being financed through the filing of a UCC-1 Financing Statement. Attorneys for the lenders recognized that a “series” under 215 was not a “person” and thus did not have the emollients of being a UCC “debtor”. A “person,” other than a human person, is created by a “filing” with the office within the jurisdiction of its creation having jurisdiction over such filings. As no document is filed with the Delaware Secretary of State to create a Delaware Protected Series, a Delaware Protected Series did not qualify to be a debtor. Lender’s counsel created a workaround under which the mothership which created the series signed the loan documents to pledge the assets of the series (not the Mothership generally). By doing such a pledge, the Mothership LLC was put at risk which could impact the remaining series under the Mothership.
Can a series within a series LLC be a legal entity separate from the mother ship? Legal scholars have debated this. The answer, though, is if the State says it is, it is. Delaware has declined to go that far. Some states such as Illinois have in their LLC Acts, provided that the series is sui juris, a separate legal entity. Section 218 requires that to form the Registered Protected Series under the Mothership, a Certificate of Registered Series is filed with the Secretary of State with a $75 filing fee and a $75 annual fee which is required to be paid on or before June 1. UCC attorneys have agreed that a Delaware Registered Protected Series can be a UCC debtor.
While Sections 215 and 218 do not specifically provide so, the drafting by the committee did not separately intend to silo physical assets. The inclusion of a series of assets that are physical operating assets (such as real property) in a state other than Delaware involves consideration of the laws of the state where the assets are physically located. Does that state’s LLC act have its own series provisions, are they comparable to the Delaware Act and will the second state recognize the protections afforded by the Delaware Act to the assets of a series located in that second state? Will the series protections be ignored by a court in the second state thus aggregating all assets of all series and those separate assets of the mothership to pay creditor claims against the single series? This is the type of analysis that an attorney representing a Delaware Series LLC must make when considering the actions to be taken by its client in locating physical assets of a Series in a state other than Delaware.
If you do a Google search of Delaware Series LLC you will find ads by companies (not attorneys) offering to form a Delaware Series LLC, where they will extol the benefits of owning multiple parcels of real estate in a Series LLC; suggest that entrepreneurs put separate investment companies in a Series LLC or that companies put subsidiaries into separate series. They suggest that by using a Series LLC rather than a series of LLC the customer can save multiple LLC taxes. These companies clearly do not understand the Act and are making inappropriate suggestions.
The final problem associated with a Series LLC is the risk of bankruptcy. Not all business ventures are successful, when a business fails the filing of a petition in bankruptcy may be necessary. There have been series that have filed a bankruptcy petition separate from the Mothership and the Mothership remains out of bankruptcy, but as of yet no bankruptcy court has fully taken up the question of whether a series of an LLC, similar to a Delaware Protected Series or a Delaware Registered Protected Series can file a petition in bankruptcy separate from any other series or separate from the Mothership. It is impossible to determine why the issue has not been addressed, quite possibly the creditors did not want to have the bankruptcy dismissed. Possibly the court did not decide to address the issue sue sponte as neither of the parties sought adjudication and the philosophy of the bankruptcy courts is to rehabilitate the company. If there was not a need to include the assets of any other series the court would not have any interest in pursuing the matter sue sponte.
In conclusion, the Delaware Series LLC, existing under either Section 215 or 218 has many proper uses in commerce. Care must be taken by the management or the company’s attorney in understanding the risks associated with its use of a Series LLC rather than an individual LLC with respect to the type of assets under consideration, particularly if they are physical assets to be located in a State that does not fully support the protections in the Delaware Act. Consideration must also be given to any subsequently developing lines of bankruptcy court decisions if those decisions are adverse to a Series LLC. If the decision to use a Series LLC is to avoid multiple Delaware LLC taxes, we suggest that you reconsider the deal if it is that thin that the LLC tax would have a material adverse effect.
Our professional recommendation to clients who wish to house physical assets in limited liability companies is to establish a separate holding company or Mothership. Under the Mothership, we establish and organize separate single member LLC’s each silo a separate asset. The sole member of each asset-holding LLC is the Mothership. This arrangement would only require a single informational Federal tax return and 10-99’s to its members, as under current regulations the single-member LLC is a disregarded entity, and the assets and liabilities of the single-member LLCs are aggregated for tax purposes. If the Mothership has only a single member, then the Mothership passes its assets and liabilities up to its single member.
