Why Roll The Dice with Series LLCs
We often get asked if we form series LLCs. The short answer is “no,” and we’ll explain why in this article.
Let’s start at the beginning. What is a series LLC? Our favorite description of a series LLC is that it is “almost an LLC within an LLC.”[1] One of the only court decisions that has dealt with a series LLC similarly defined it as “basically a business entity within a business entity,” and described the limited liability company as the “parent company” of the series within the LLC.[2] But that is not entirely accurate. Parent and subsidiary corporations are entirely separate (though related) business entities, and their separate identities must be scrupulously maintained in order to keep up the liability shield between the two entities. By contrast, a series LLC is formed as a single limited liability company, with one or more series, or units, within the LLC, which is why we think it is more accurate to describe it as almost an LLC within an LLC.
Delaware gave birth to the series LLC in 1996, when it amended its LLC statute to authorize LLC agreements to “establish or provide for the establishment of 1 or more designated series of members, managers, limited liability company interests or assets.”[3] 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 may even have an entirely “separate business purpose or investment objective.”[4] In other words, a series LLC is a limited liability company that “internally segregates equity interests, assets, liabilities, profits, and losses.”[5]
The key to a series LLC is the creation of an internal liability shield. Most entrepreneurs looking to form a corporation or LLC are interested primarily in the benefit provided by the external liability shield created by doing business in the corporate form, by which the entrepreneur’s personal assets are shielded from liability to outside, third-party creditors for the corporation’s or LLC’s business debts and obligations. But if certain requirements are complied with, a series LLC internally shields one series’ assets and liabilities from those of the LLC itself or other series within the LLC.[6] The prerequisites for giving effect to the internal liability shield are: (1) a notice on the limitation of liabilities must be set forth in the LLC’s certificate of formation; (2) the LLC agreement must provide for the limitation of liabilities; and (3) the records maintained for any such series must “account for the assets associated with such series separately from the other assets of the limited liability company, or any other series thereof.”[7]
The third requirement is a specific statutory expression of the common-law principle applicable in the context of related corporations (such as parent and subsidiary corporations) that each corporation’s assets must be separately maintained, and not commingled, to avoid piercing the corporate veil and holding one corporation liable for the other’s debts and obligations.[8] One of the benefits supposedly provided by a series LLC is that, if the statutory rules are followed and separate records are maintained and assets accounted for, the series LLC “may provide a safe harbor against courts’ piercing the veil and holding an entity or entities liable for debts incurred by sister entities or subsidiaries,” whereas “[a]lternative structures” such as related corporations or ordinary LLCs may “present a potentially open-ended risk that a court will consider related entities to be part of a single firm” and pierce the corporate veil, thereby defeating the primary purpose of incorporating.[9] Another benefit we have seen discussed is the reduced cost of forming one series LLC, rather than multiple, related entities.
The problem, however, is that although it is supposed to be a given that a series LLC provides an internal liability shield if the statutory preconditions are satisfied, every commentator we have read (including those advocating for more widespread use of the series LLC) continues to worry about the “risks”[10] and many “unanswered”[11] and “unresolved”[12] questions surrounding the series LLC. What is particularly distressing is that even the fundamental issue of whether the internal liability shield will be recognized in a jurisdiction outside of the one where the series LLC was formed remains an “open question.”[13] In other words, if you form a series LLC in Delaware, which is one of only about 15 jurisdictions that have authorized series LLCs to date, but do not do business in Delaware (which is very likely to be the case), you cannot be certain that the LLC’s internal liability shield will be recognized in the jurisdiction where you are doing business (with just a few exceptions noted below), which was the whole reason you incorporated in the first place.[14]
The most recent scholarly article on series LLCs contains a seven-tier “risk matrix” for series LLCs doing business in jurisdictions other than the state where the series LLC was organized.[15] According to the authors, the least risky use of a series LLC is “to engage in business only in the state of the organization of the Series LLC and the Protected Series and in states that statutorily per se recognize the internal liability shields of a foreign Series LLC. In this category, the Series LLC and the Protected Series should not engage in business outside such states and should take steps to minimize activity that could give rise to litigation in other states.”[16] The only jurisdictions that currently “statutorily per se recognize the internal liability shields of a foreign series LLC” are the District of Columbia, Illinois, Indiana, Kansas, Missouri, and Oklahoma,[17].
Many of the commentators express their hope that these issues will be resolved as more states adopt laws authorizing the creation of series LLCs, especially now that the National Conference of Commissioners on Uniform State Laws reversed its earlier position and approved the Uniform Limited Liability Company Protected Series Act in July of this year.[19] For now, however, most of the existing series LLCs statutes “duck most of the issues,”[20] “case law is virtually non-existent,”[21] and “the contextual uncertainty regarding internal liability shields appears to have stalled” the use of series LLCs around the country.[22] In that climate, we will not form series LLCs that cannot, with an acceptable degree of certainty, provide the liability protection that is the main reason most of our clients are interested in forming a business entity in the first place. We will revisit that decision if and when the law develops more favorably. But at this time, if you think you need to form more than one entity for liability-protection purposes, we think it makes more sense to stick with less complicated options that have proven to provide the sought-after liability protection, such as multiple single-member LLCs or LLC “holding companies” with LLC “subsidiaries.”
[1] Carter G. Bishop & Daniel S. Kleinberger, Limited Liability Companies: Tax and Business Law ¶ 14.03[1][b][ii] (Thomson Reuters 2017).
[2] Alphonse v. Arch Bay Holdings, L.L.C., 548 F. App’x 979, 981, 984 n.6 (5th Cir. 2013) (per curiam).
[3] Del. Code Ann. tit. 6, § 18-215(a).
[4] Id.
[5] Jay Adkisson, Forbes, Uniform Limited Liability Company Protected Series Act (ULLCPSA) Adopted By Uniform Law Commission (July 22, 2017); see also Bishop & Kleinberger, supra note 1, ¶ 14.03[1][b][ii] (section 18-215 of the Delaware LLC statute “creates an extraordinary construct—one that neither pertains to, nor partakes of, an entire LLC, but rather is associated with and segregated to a compartmentalized set of assets, profits, losses, and liabilities” within a protected series of a limited liability company).
[6] See Del. Code Ann. tit. 6, § 18-215(b) (“[T]he 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.”); Bishop & Kleinberger, supra note 1, ¶ 14.03[1][b][ii] (a series LLC “contains ‘internal shields’—i.e., the partitions confining the assets and liabilities of each series to that series alone” (internal quotation marks omitted)).
[7] See Del. Code Ann. tit. 6, § 18-215(b); Larry E. Ribstein & Robert R. Keatinge, Ribstein and Keatinge on Limited Liability Companies § 4:17 (Westlaw updated June 2017); see also Alberto R. Gonzales & J. Leigh Griffith, Challenges of Multi-State Series and Framework for Judicial Analysis, 42 J. Corp. L. 653, 706 (2017) (“Maintaining accurate books and records (often discrete books and records are required) and associating assets with each specific Protected Series and the Series LLC itself is a precondition for the internal liability shields in all existing statutes.”).
[8] See, e.g., Geyer v. Ingersoll Publ’ns Co., 621 A.2d 784, 793 (Del. Ch. 1992) (although parent and subsidiary corporations are generally distinct, a court can pierce the corporate veil of an entity “where a subsidiary is in fact a mere instrumentality or alter ego of its owner”); see also Reducing Risk of Alter Ego With Some Simple Things for a general discussion of piercing the corporate veil.
[9] Ribstein & Keatinge, supra note 7, § 4:17.
[10] Gonzales & Griffith, supra note 7, 42 J. Corp. L. at 704-06.
[11] Bishop & Kleinberger, supra note 1, ¶ 14.03[1][b][ii].
[12] Thomas E. Rutledge, The Internal Affairs Doctrine and Limited Liability of Individual Series Within a Series LLC—Never the Twain Shall Meet?, 17 No. 3 Bus. Entities 4, 11 (May/June 2015).
[13] Alphonse, 548 F. App’x at 984; see also Bishop & Kleinberger, supra note 1, ¶ 14.03[1][b][ii] (“It is by no means obvious that courts outside Delaware will respect these internal shields.”).
[14] See Gonzales & Griffith, supra note 7, 42 J. Corp. L. at 688 (“Serious questions exist as to whether all of the 37 states that do not currently offer Series LLCs will honor the internal liability shields of the Series LLCs and their linked Protected Series.”). That is just one of the risks of forming a series LLC. Other risks include questionable treatment of a series LLC in bankruptcy, see Bruce H. White, Utah Series LLC—The Risk of Use Continues to Be Uncertain, 29 Utah B.J. No. 5, 24, 28 (Sept/Oct 2016) (if a client comes to you seeking to form a series LLC, “your advice … should be that Series LLCs are unproven in the bankruptcy courts and that you do not recommend their use until the courts have fully vetted the open questions”), and regulatory issues, see Bishop & Kleinberger, supra note 1, ¶ 14.03[1][b][ii] (noting that the SEC has “turned ‘thumbs down’ on series as a means of organizing a broker-dealer business”).
[15] See Gonzales & Griffith, supra note 7, 42 J. Corp. L. at 704-06.
[16] Id. at 704 (emphasis added).
[17] Id. at 704 n. 290.
[18] Other states that authorize series LLCs are Alabama, Iowa, Montana, Nevada, Tennessee, Texas, and Utah.
[19] See Adkisson, supra note 5.
[20] Bishop & Kleinberger, supra note 1, ¶ 14.03[1][b][ii].
[21] Id.
[22] Gonzales & Griffith, supra note 7, 42 J. Corp. L. at 708.