Series LLCs, Serious Risks
September 12, 2021
Lately I’ve been approached by clients and potential clients about series LLCs, so I thought it would be worth blogging about. Basically, a series LLC is an LLC that may create one or more series, each generally having separate assets and liabilities, similar to having separate entities except without the expense and administrative burden of multiple entities. Although most commonly used for investment funds, series LLCs could be useful for any type of business with multiple assets where it would be advantageous to keep the respective liabilities of those assets separate. Before organizing any investment or ownership structure through a series LLC, however, its practical uses and advantages should be understood and weighed against certain associated risks.
For starters, a series LLC allows for the operation within a single legal entity of multiple separate business activities, each with its own separate assets and liabilities and each having its assets protected from the creditors of the other activities. This in turn reduces expenses and administrative burdens as compared with the alternative of forming multiple LLCs. Because Series LLC state filing fees and annual taxes are either the same (e.g., Delaware) or slightly higher than those imposed on a regular LLC, a Series LLC with two or more series is generally much more cost-effective than forming and operating multiple LLCs and operating a parent-sub structure.
Further, under applicable securities laws, a Series LLC may be the sole registrant and may register interests in all the series of the Series LLC. This can reduce the costs and burdens of filing multiple registration statements.
In Delaware, a series LLC is formed the same way as a general LLC, by filing a certificate of formation, although no individual series need exist at the time of formation.[i] In Delaware, three requirements must be satisfied for the series LLC and each of its series to enjoy limited liability.
First, the certificate of formation must state that the LLC has or may form series, that the liabilities of each series will be enforceable against the assets of that series only and not against the assets of the series LLC generally or any other series and, unless otherwise provided in the LLC agreement, no liabilities of the series LLC generally or any other series will be enforceable against the assets of that series.
Second, the LLC agreement must provide for limitation on liability. That doesn’t mean that two or more series can’t share in certain assets or liabilities of the series LLC, but if there is any sharing, the LLC agreement should provide for how those assets and liabilities will be allocated among the different series of the Series LLC.
And third, separate records must be kept. Specifically, the records for any series must account for the assets of that series separately from the assets of the series LLC itself and any other series.
Similar to a regular LLC, series LLCs allow for a tremendous amount of management and ownership flexibility. Series LLCs may have managers, members and assets of a particular series that are different from the managers, members and assets of the Series LLC itself and the other individual series. Alternatively, you could have overlapping managers but different members and assets among the various series. Profits and losses of a particular series could be attributed just to the members of that series or to the series LLC. Although LLC agreements may provide for distribution provisions on a series-by-series basis, distributions by a particular series are typically limited under state law by the assets of that series. For example, Delaware law prohibits a series LLC from making distributions to members of a particular series if the liabilities of the series post-distribution would exceed the fair value of that series’ assets.
Anyone considering the use of a series LLC should also consider certain risks. Series LLCs are relatively novel and there just hasn’t been enough case law generated to test certain features and provide reliable guidance. Series LLCs aren’t recognized in every state, so there’s a risk that a series wouldn’t be recognized in a particular state and that creditors of one series may be allowed to reach the assets of another series in that state. Series LLCs are not addressed by Federal and most states’ tax laws, so there’s some uncertainty surrounding the tax treatment of series LLCs. Finally, series LLCs are relatively untested in the context of bankruptcy, and it’s unclear if a series may file for bankruptcy as to its assets and liabilities separate from those of other series in the group or the series LLC itself.
[i] Delaware amended its series LLC law in August 2018 to provide for a second version of a series LLC called a “Registered Series”, which has essentially the same characteristics as a series LLC as well as others that could be helpful in secured lending transactions where a series is a borrower, except that a “certificate of registered series” must be filed with the Secretary of State in order to form a registered series of a Series LLC.