The Pros and Cons of Series LLCsNovember 17, 2015 – Articles Law360
A series limited liability company is an entity structure permitted in certain states that allows for the formation of multiple segregated LLCs (or series) under the umbrella of a single “master” LLC. Generally, in the states in which they are recognized, these series LLCs are viewed as segregated entities that are permitted to have separate managers and members, distinct assets and individual operating agreements, and which can incur separate liabilities. However, the series LLC is still viewed from the states’ perspective as a single entity for filing and reporting purposes.
The most notable advantage of series LLCs comes in the form of cost savings associated with state business filing fees. In Illinois, where business filing fees are higher than most states, the cost to form a standard LLC is $600. While series LLC filing fees involve a higher upfront cost ($850), the benefit arises in the long run because only a nominal registration fee is necessary to form each additional series by filing a certificate of designation ($50) and amending the master LLC operating agreement.
To illustrate, an Illinois developer with 10 properties would pay $6,000 to form a standard LLC for each property ($600 x 10 properties). Instead, by forming each entity as a series LLC, the developer would pay $1,350 in initial filing fees ($50 x 10 + $850). In some states, such as Delaware, only the initial filing fee is required to form a series LLC, and individual series can be created via the LLC operating agreement without any additional fees.
In addition to the administrative streamlining, a major benefit of series LLCs lies in the separate corporate liability protection of each series. Debts and liabilities of one series cannot spill over and be enforced against a different series so long as certain statutory conditions are met at formation. Essentially, if each series keeps separate records and bank accounts, and is treated as its own entity, the assets of each series will be unaffected by judgments against other series. However, not all state statutes regarding the series LLC are identical, and series LLCs are not available in all states. In jurisdictions where series LLCs are not available, each series may not be recognized as a separate entity or for state tax purposes.
Although the IRS has yet to issue official federal tax regulations governing the treatment of series LLCs, it has issued proposed regulations (Prop. Treas. Regs. Secs. 301.6011-6; 301.6071-2; and 301.7701.7701-1(a)(5)) providing insight into the IRS’ treatment of these entities:
- Each series within a series LLC will be treated as a separate entity for federal income tax purposes;
- Each series is allowed to choose its own entity classification independent of the classification of other series; and
- Each series should only be liable for federal income taxes related to that series.
The proposed regulations do not address the entity status of a series organization for federal tax purposes nor do the proposed regulations specifically address whether each series within a series LLC should obtain a separate employer identification number (EIN) and file a separate federal tax return. It was anticipated that the Treasury Department would issue its official regulations regarding series LLCs by the end of the summer of 2015. However, as of November 2015, the Treasury Department still has not issued final regulations. Until final regulations are issued, we believe it prudent to advise clients to obtain separate EINs and file separate income tax returns for each separate series which, we believe, bolsters that position of each series maintaining separate and distinct corporate identities.
While the series LLC may appear to be an attractive investment vehicle, it does not come without risks. Series LLCs have largely been untested in the courtroom, and there is not much precedent as to how these entities will be respected going forward. In addition to questions regarding whether the separate liability protection of the series LLC structure will be respected in states that do not recognize series LLCs, various issues exist regarding how series LLCs will be handled in bankruptcy proceedings, and it is possible that a bankruptcy court will not recognize the separateness of the series within the LLC. As a result, until more courts have ruled on the legality of the series LLC structure, it is unclear whether the series LLC will be afforded all of the protections intended by the state statutes.
For example, in Glenn E. Alphonse Jr. v. Arch Bay Holdings LLC; Specialized Loan Servicing LLC (5th Cir. filed Dec. 11, 2013) (unpublished pursuant to 5th Cir. R. 47.5), the Fifth Circuit Court of Appeals heard the appeal of a case involving a foreclosure action that was successfully brought against a Louisiana resident by Arch Bay Holdings LLC-Series 2010B (Series 2010B), an individual series of Arch Bay Holdings LLC (Arch Bay), a Delaware series LLC. Following the foreclosure proceeding, the Louisiana resident sued Arch Bay in federal court, claiming that Arch Bay seized and possessed his home through fraudulent means. Arch Bay successfully moved to dismiss the complaint based on, among other things, the claim that the foreclosure proceeding had already been definitively decided, and that there was sufficient “identity of the parties” between Series 2010B and Arch Bay that the lawsuit against Arch Bay should be barred by the doctrine of res judicata.
On appeal, the Fifth Circuit examined the issue of the separate legal identity of Series 2010B, but did not rule on it, remanding the issue to the district court because in its view, there were insufficient facts in the record to determine whether or not Series 2010B should be considered a distinct entity. Unfortunately, on remand, the case was dismissed on unrelated subject matter jurisdiction issues, and so no further clarity was provided.
In addition to the judicial uncertainty described above, there are other reasons to be wary of using a series LLC structure without fully examining the potential risks and benefits. For example, although the series LLC structure has been available under Delaware law since 1996, it is still relatively uncommon and many are unfamiliar with the concept. This can cause difficulties and delays in securing financing from lenders that don’t fully understand the issues involved, as well as problems obtaining licenses and permits from governmental entities that are unused to dealing with the series LLC structure. Gaps in insurance coverage can also occur due to confusion regarding the proper insured parties, and transaction costs may also be higher if counterparties do not have experience with the series LLC structure.
Although the series LLC continues to grow and can be a helpful structure for some entities, anyone considering a series LLC structure should closely consider the legal uncertainties and business risks described above. One of the major items cited in favor of the series LLC structure is the potential cost savings in connection with formation; however, until the Treasury Department and the courts provide firm guidance regarding the series LLC structure, these cost savings may potentially be offset by higher lending, permitting and transactional costs as described above.
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