Limited liability companies (“LLCs”) have existed in many states, including Nebraska, Kansas, Missouri, South Dakota, and Iowa for some time. However, a Series Limited Liability Company (Series LLC) is a new concept that essentially involves separate entities existing within a parent LLC.
Many of our clients own investment properties. Generally we advise that clients protect themselves and their investments from liabilities related to other investments by placing each rental property into one or more LLCs. Every investment is held in a separate LLC. You can think of LLCs as giant boxes. You can place as many investment properties as you want inside the box. However, if a catastrophic accident happens at any property, every investment you have placed into that LLC box will be in danger.
If you don’t want to create a separate LLC for each asset, you can consider the liability potential of assets and group them accordingly. For example, it’s not a good idea to include a single family beachfront rental in San Diego in the same LLC as a duplex on the wrong side of town. You may have several hundred thousand dollars of equity in the house on San Diego, which is placed at risk by including it in the same LLC as the rough-edged duplex. Keep them separate. However, if you own three single-family homes in Topeka, Kansas, each within about twenty thousand dollars of equity, placing them together may be an acceptable risk. The segregation strategy can get expensive. If you have ten properties, creating ten different LLCs might be costly.
HOW IS A SERIES LLC STRUCTURED?
Series LLCs provide a potential solution to this issue. Statutes in some states allow you to create separate series (also known as a cell, which is similar to a separate entity) within a single LLC. The debts and liabilities of one series are only enforceable against that series. Each cell of a Series LLC can own distinct assets, incur separate liabilities, and have different managers and members. A Series LLC may be able to pay a single annual state fee and may be able to file one income tax return each year.
This means that an LLC containing two properties can choose to place each property into a separate series or cell. Liabilities from one series should not be able cause problems with the assets of the other. This is not always the case though, if the properties are located in states that do not have a Series LLC legal framework as discussed further below. There will also be administrative work to keep the books and accounts of each series separate. Each Series LLC will need its own Operating Agreement and Federal Employee ID Number.
A Series LLC may also not be a good fit if your bank requires cross-collateralization (i.e. assets of subsidiaries are used as collateral for two loans, potentially for other related subsidiaries).
History
The Series LLC was initially intended to help the mutual fund industry to avoid filing numerous SEC filings for different classes of funds. The idea was to use one entity for all funds so that the SEC filing would be under one umbrella. But, the individual funds’ activities would still be conducted separately.[1]
Status
Delaware clarified its legislation that a series can now enter into contracts, hold title to assets, grant liens and security interests and sue or be sued.[2]
Some states that have enacted series legislation do not treat series as separate entities and do not allow series to enter into contracts or sue or be sued. Kansas and Missouri do allow each Series LLC to contract for example, as long as the Operating Agreement allows for this authority.[3] [4] It is very important that each Series LLC have its own Operating Agreement, account, and records.
There is uncertainty as to whether the liability shield between LLC series is fully effective in states that do not have series LLC laws. For example, in the 2013 case of Alphonse v. Arch Bay Holdings, LLC, the United States Court of Appeals for the Fifth Circuit held that the separate juridical status of a Series LLC with respect to third party plaintiffs was an open question. The court remanded because there were insufficient facts in the record to determine whether the Series LLC and its parent had identical interests, and whether it was is in fact a distinct juridical entity.[5]
CONCERNS ASSOCIATED WITH SERIES LLCs
1. SERIES LLCS ARE MORE EXPENSIVE TO SET UP
You might initially prefer series LLCs because they appear to be cheaper to set up given that you only need one LLC rather than one for each entity. However, in several states it is actually more complicated to set up a series LLC, making it more expensive than the basic type and the filing fees may be higher. For example, Kansas allows a Series LLC to be set up, and a foreign Series LLC (set up outside of Kansas) to be registered there. However, the fee to register a foreign Series LLC is $250 versus $165 to register a normal foreign LLC.[6]
2. LEGAL UNCERTAINTY SURROUNDING THE SERIES LLC
The biggest problem with series LLCs is that states that don’t have series legislation may choose to ignore the laws of the state where the series was created. You are subject to the laws of the state where your business operates. Because series LLCs are so new they have not been tested by many state courts, even in the states that permit them. Courts will likely focus on whether separate books and accounts were kept for each Series LLC. Courts are required to give deference to the statutory intent. Only time will tell if courts will do this. The risk of this issue is the highest if a Series LLC is operating, or owns property, in a state that does not recognize a Series LLC.
3. Tax uncertainty
The Internal Revenue Service has not indicated whether a series under the master LLC is a separate entity from the master LLC for tax purposes. According to one private letter ruling, it has treated the individual units as separate tax entities.[7]
4. THE AMERICAN BAR ASSOCIATION DOES NOT ENDORSE THEM
The American Bar Association did a review of series LLCs and declined to endorse them. The laws regarding creating series LLCs are different in every state that permits them. Thus, it might take a long time before enough case law is accumulated to give us any level of comfort about using them. If you want to make sure your assets have good, solid protection, it’s a much better idea to avoid corporate structures that don’t provide reliable protection. Avoid series LLCs as a form of protection until a definitive case law is established and rely instead on known, tested entities such as individual LLCs.
As of May 2019, here are the states where you can create a series LLC:
Delaware (first to allow series LLC’s), Alabama, Texas, Tennessee, Utah, Nevada, Illinois, Oklahoma, Iowa[8], Indiana, Kansas[9], Missouri[10], Montana, the District of Columbia, and the Commonwealth of Puerto Rico.
California does not allow a Series LLC to be created there, but they will recognize it to a certain extent.[11] Each Series will have to pay Franchise Board taxes.
For questions regarding an LLC versus a Series LLC, contact one of our Sioux Falls, Sioux City, or Omaha attorneys today.
Angela Madathil is a Business, M&A, and Deal Attorney and provides legal assistance to buyers and sellers of businesses, as well as business brokers in Nebraska, Missouri, and Kansas. This can involve contract review and negotiation, due diligence assistance, and post-sale integration. The Goosmann Law Firm team advises to buyers and sellers of businesses, as well as business brokers throughout the Midwest and has attorneys licensed in Iowa, Kansas, Minnesota, Missouri, Nebraska, South Dakota, and other states.
[1] Thomas E Rutledge, Again, for the Want of a Theory: The Challenge of the “Series” to Business Organization Law, 46 Am. Bus. Law J. 311 at 313-15 (Summer 2009).
[2] https://law.justia.com/codes/delaware/2014/title-6/chapter-18/subchapter-ii/section-18-215
[3] https://law.justia.com/codes/kansas/2017/chapter-17/article-76/section-17-76-143/
[4] https://law.justia.com/codes/missouri/2013/title-xxiii/chapter-347/section-347.186
[5] https://www.ca5.uscourts.gov/opinions%5Cunpub%5C13/13-30154.0.pdf
[6] https://sos.kansas.gov/filing-center/business-entities-forms/
[7] https://www.irs.gov/pub/irs-wd/0803004.pdf
[8] https://www.legis.iowa.gov/law/iowaCode/sections?codeChapter=489&year=2015
[9] https://www.ksrevisor.org/statutes/chapters/ch17/017_076_0143.html
[10] https://law.justia.com/codes/missouri/2013/title-xxiii/chapter-347/section-347.186/
[11] https://www.ftb.ca.gov/businesses/structures/series-limited-liability-company.shtml