March 4, 2011
Lerch Early & Brewer's Legal Update
The limited liability company has become a familiar vehicle for business organization. LLCs offer more operational flexibility than traditional corporate or partnership business structures, while also providing a critical liability shield to the company’s members and assets. They also allow the entity to customize its tax treatment by electing either corporate or partnership tax status. For these reasons, real estate owners and small business owners alike frequently select the limited liability company as their entity of choice.
Assets Are Insulated
Delaware and several other states have enacted innovative legislation making LLCs even more appealing by authorizing the formation of “Series LLCs.” A Series LLC is a form of limited liability company in which the members may segregate the company’s assets and operations into separate “series” or “cells” under one organizational umbrella, similar in structure and function to a parent corporation with multiple subsidiaries. The primary advantage of a Series LLC is that the assets of one series are insulated from the liabilities of its sister series. Each series may also utilize independent operational flexibility by having separate members, managers and capital structures.
For example, Diane Developer is planning to snap up a couple of local retail centers. She creates “Diane’s Retail, LLC” as a Series LLC with two initial series. Subsequently, Diane’s Retail Series I, LLC and Diane’s Retail Series II, LLC close on the purchase of two different shopping center properties. If a customer at the Series I site obtains a judgment against the Series I LLC for a bad slip-and-fall accident, he may not execute the judgment against the center owned by the Series II LLC. Diane may create an additional series entity next year if she wants to add another center to her portfolio.
Firewall of Asset Protection
An operating business might find a Series LLC similarly appealing. Entrepreneurs Mike and Joe establish “Super Soups, LLC” as a Series LLC, then segregate its manufacturing, marketing and distribution divisions into separate series. By doing so, they erect a firewall of asset protection between each division. They might also implement distinct equity compensation structures within each division, preserve the flexibility to spin off a particularly unprofitable division in the future, and set the stage for family gifting of one division or another when they approach their retirement years.
Prior to the availability of Series LLCs, the customary approach to maximizing flexibility and asset protection has been to utilize independent LLC entities for each separate real property or business division.
Creating Distinct LLCs
Creating distinct LLCs requires filing separate Articles of Organization, as well as ongoing filings and payments of annual report and registered agent fees. Maintaining Series LLCs is easier and more cost-effective. For example, a Delaware series LLC may be formed by filing simple Articles of Organization that include a prescribed notice authorizing separate series. The “umbrella” Operating Agreement would specify the procedures and parameters for establishing each separate series. An additional series Operating Agreement would be written when the new series is ready to launch. No additional state-level filings are needed to create the new series, and only one annual report fee is paid. A higher level of privacy is maintained due to the lack of public filings.
If Series LLCs are so appealing, why are we not more familiar with them? The primary reason is that Series LLCs currently may be formed in only a handful of states: Delaware, Illinois, Iowa, Nevada, Oklahoma, Texas, Tennessee and Utah. Jurisdictions in which Series LLCs are not indigenous differ in how they regard them. Some will respect the legal “separateness” of a series entity, but others will not restrict a third party creditor from seeking redress from the greater asset pool of the entire LLC structure. Other unsettled issues include whether bankruptcy courts will treat each series as a separate “person” for bankruptcy purposes; how each series will be taxed for income, sales and franchise tax purposes; and what jurisdictional standing a series has to sue or be sued. For these reasons, a cautious approach would be to utilize a Series LLC when all business operations or real estate holdings are located within a state that statutorily recognizes them. Once more jurisdictions appreciate the enhanced flexibility and cost savings that Series LLCs offer, we should expect to see more of them.
Patty Lankenau advises borrowers and lenders in multifaceted business and real estate financing transactions, and guides clients in the formation and restructuring of limited liability companies, corporations and limited partnerships. To learn more about Series LL Cs, contact Patty at palankenau@lerchearly.com or 301-657-0748.
