by Derek G. Rowley, © 2009, All Rights Reserved

The Series LLC is an exciting new development in business entity law that is currently getting a lot of attention by promoters. It is a business entity that makes a lot of promises about cost savings, asset protection and flexibility. The question is: Can it keep it’s promises? In this article, I will explain the benefits and risks of using the Series LLC, and why - for now - it should only be used in limited circumstances.

Limited liability companies have become the most popular type of new business entity in use today. The reasons for this popularity have to do with the flexibility of the LLC structure for ownership, management, and tax purposes. Organizationally, the LLC only has “members” (or owners), and “managers”, making it much simpler to administer than a corporation with it’s internal structure consisting of shareholders, directors, and officers. Additionally, the LLC doesn’t have the same statutory requirements governing formalities such as company meetings, resolutions, minutes, etc.

Traditional asset protection planning is built on the concept that business owners can separate themselves from business risk (and separate various business assets and risks from each other) by placing different assets into separately organized business entities that provide the benefit of “legal separation”. Depending upon the type of asset, the time-frame, the owner’s goals and other criteria, business entities such as corporations, limited liability companies, limited partnerships, and various types of trusts have been used to accomplish this legal separation.

This type of asset protection, when done properly, can be rock-solid. This is because the statutes, state case law, and federal bankruptcy law provide a relatively clearly defined path. In other words, attorneys and business owners can have confidence that a properly executed asset protection plan will hold up if tested under fire.

The new, Series LLC abandons the comforts of asset protection precedent, and introduces a new, completely untried and untested concept into which uninformed promoters and unwary business owners are stumbling.

This is how the Series LLC works: A single limited liability company is given the power to create multiple internal series. In other words, the LLC can essentially replicate itself without limitation. Each internal series can have separate or uniquely comprised ownership, assets, and (in many cases) management. The few states that offer Series LLC statutes provide for a separation of risks between the various series. This, theoretically, allows a single business entity to own and manage many different assets for many different owners - with only the expense of a single filing fee!

But, as far as it’s ability to protect assets, the Series LLC has a couple of serious problems. Actually, more than a couple:

Only 8 states have Series LLC statutes. Those states are: Delaware, Nevada, Utah, Illinois, Iowa, Oklahoma, Tennessee, and to a limited degree, Wisconsin. In other words, 42 states don’t. That’s a huge problem for businesses with assets or operations in the 42 non-series-LLC states. If a Series LLC, formed in Nevada, has property in a non-series-LLC state such as California, will California recognize the separateness of the internal series for asset protection purposes, or will the state apply it’s own, non-series-LLC laws and interpretation? The best answer to that question is that no one really knows. The second-best answer is that each state has the power and authority to act in it’s own best interest, and is not obligated to recognize legal separation for assets within it’s borders that is owned by an entity for which it has not adopted governing laws. Given that, who wants to volunteer to be the first test case with serious money on the line?

No Series LLC has been tested in U.S. Bankruptcy Court. The ultimate test of the strength of any asset protection strategy or vehicle is bankruptcy. The federal court has power to set aside, modify, or create qualifications for state statutes that provide any level of asset protection. This power was recently used to set aside “charging order” protection for a single-member Colorado LLC, even though state statute provided for it. Can a single series file for bankruptcy without forcing the entire entity into the process? If an entire Series LLC files for bankruptcy, will each of the series be considered separately, or will they be thrown into the same legal pot? The answers to these questions are unknown. Because the bankruptcy court exists to balance the rights of debtors and creditors, it doesn’t take too much imagination to foresee that series protection could easily be set aside under circumstances that are yet to be defined.

Series LLCs are much more complicated to operate because they demand new levels of compliance requirements for formalities. As I discussed above, one reason the LLC has become so attractive to business owners is the fact that they require less maintenance and attention to corporate-style formalities. As a result, I suspect that a great many managers and members of Series LLCs will be unfamiliar with the fact that even when all the assets and operations within the entity is located in a state that recognizes Series LLCs, the asset protection across the various series is subject to whether or not each series has separate, complete and accurate records, including accounting records. Combining the accounts of the various series into a single “master” bank account, will constitute commingling of funds that will open the door for veil-piercing of the series. To ensure the separateness of the series, each series should have:

• Separate bank account
• Transactional documentation such as contracts, deeds, trusts, notes, etc., must be not only in the name of the Series LLC, but also in the name of the specific series.
• Transactions between series must be arm’s-length, conducted at Fair Market Value, using supporting appraisals.
• Each series should file for a “DBA” in each county where it owns property, which should reflect the series ownership in order to properly notify creditors of the series status.
• The Operating Agreement, and Articles of Organization must reflect series status.

Other Series LLC Problems
Other states are not likely to add Series LLC provisions.
The National Conference of Commissioners of Uniform State Law (NCCUSL), have not included, and do not support series LLC statutes in the Uniform LLC Act that is adopted by various state legislatures. This omission makes it highly unlikely that other states will move to adopt series LLC statutes in the future. Proponents of the original Delaware Series LLC Act have testified that the Series LLC was originally intended strictly as a vehicle for Delaware-based investment fund manager to maintain and operate separate regulated investment funds such as hedge funds, venture capital funds and fractional share arrangements.. It was never their intention that the Series LLC concept be utilized in unregulated environments or for use by the general business community. Significant push-back to the series LLC has come from within many sectors of the legal community.

Foreign Filing.
Again, because so many states do not have Series LLC statutes, there is going to be confusion about how to properly qualify a series to transact business within those states. Expect states to follow the example of California, which requires each series of a Series LLC that operates or has assets located within its borders to register separately with the California Franchise Tax Board. Each series, therefore, is subject to the minimum $800 filing fee.

Federal Tax Issues.
The Series LLC allows for a single entity to have separate series, each with different ownership. This creates a potential problem under the Federal Tax Code. The IRS has issued a Private Letter Ruling (200803004) which concludes that each series of an LLC is a separate entity for tax purposes, and each series can elect its own tax status.

Securities Issues.
There are significant legal question surrounding the use of series in soliciting investment and raising capital through offerings. Existing securities law does not address such questions as whether each series mush separately meet the Reg. 504D registration exemption, whether each series can conduct its own offering, or whether regulators would collapse all the series together.

Conclusion

Perhaps the day will come when the Series LLC is broadly adopted by all states, and the questions and concerns about how non-Series-LLC states will interpret the separateness of internal series will be resolved. Undoubtedly, in coming years we will see a Series LLC go through federal bankruptcy, at which time we will have a much more reliable indicator as to the conditions the court will look at in order to recognize the separation of series. Unfortunately, that day is not today.My recommendation, for what it's worth, is as follows: If all of your properties, assets, employees and operations are located within a state that provides Series LLC statutes - AND you recognize and are willing to accept the risk that the asset protection value of a Series LLC is merely theoretical for now, go ahead and use it. If you don't meet that criteria, I would avoid it until the questions are answered and the issues resolved.