Two weeks ago Montana joined the nine other states that have authorized series LLCs. Montana Governor Steve Bullock signed House Bill 362 on April 12, 2013, amending the Montana LLC Act to authorize series LLCs, effective October 1, 2013.
Series LLCs. A series LLC is a type of LLC that can be used to partition an LLC’s assets and members into separate cells, each of which is called a series. Each series can have its own designated members and managers, and each can own its assets separately from the assets of the LLC or any other series. Each series can enter into contracts in its own name, and sue and be sued separately from the LLC or any other series. The liabilities of each series will be enforceable only against the assets of that series.
Series LLCs are promoted as a way of avoiding the costs and inefficiencies that result from using multiple LLCs. For example, an owner of multiple real estate parcels could place each parcel in a separate series in one LLC, instead of using multiple LLCs. There would then be only one annual filing fee and only one operating agreement, yet any liabilities from the operations of any parcel would not be enforceable against the other parcels.
Other States. The states have not exactly been jumping on the bandwagon for series LLCs. It’s more like a slow-moving wagon train. Other than Montana, nine states have authorized series LLCs, beginning with Delaware in 1996 and most recently Kansas in 2012. The census is: Delaware, Illinois, Iowa, Kansas, Nevada, Oklahoma, Tennessee, Texas, and Utah. The states have authorized series LLCs by adding the appropriate provisions to their existing LLC statutes, rather than by adopting new, standalone statutes.
I have previously written about series LLCs when Texas and Kansas each passed their series LLC laws, when the IRS proposed regulations for series LLCs, and when the Securities and Exchange Commission limited the use of series LLCs for broker-dealers.
Montana. The Montana statute is similar in many respects to the Delaware Act. The records of each series must account for its assets separately from the assets of the LLC or any other series, and the articles of organization must set forth the liability limitation of each series. All documents filed with the Secretary of State must reflect not only the name of the LLC but also the names of all series of members.
There are some unusual provisions in the Montana statute. The first is a change to Section 35-8-202, which lists the items that an LLC’s articles of organization must set forth. The amendment adds a new subsection (h): “if the limited liability company has one or more series of members, the operating agreement of each series of members in writing. ” (Emphasis added.) This is the only reference in the bill to a series operating agreement, and it’s unclear what the operating agreement of a series would be. The Act’s definition of an operating agreement refers only to an agreement for the entire LLC. Mont. Code Ann. § 35-8-102(23).
It’s also odd that if the LLC has one or more series of members, then the “operating agreement of each series,” whatever that is, must be included in the articles of organization that are publicly filed with the Secretary of State. The Montana Act does not otherwise require that an operating agreement be filed with the articles of organization, with good reason. LLC operating agreements often contain detailed, private information that the members don’t want to make publicly available, such as information about the LLC’s management, members, investors, compensation, distributions, and so on. The states usually require the filing of only a streamlined document, with basic information such as the LLC’s name, address, and registered agent, in order to form an LLC. Operating agreements normally need not be filed or made publicly available.
The other issue I take with the amendment is that it does not establish whether a series has the powers of an entity, i.e., the power to own property and incur obligations in its own name, to make contracts, and to sue and be sued. Delaware, for example, clearly sets out the powers of a series: “Unless otherwise provided in a limited liability company agreement, a series established in accordance with subsection (b) of this section shall have the power and capacity to, in its own name, contract, hold title to assets (including real, personal and intangible property), grant liens and security interest, and sue and be sued.” Del. Code Ann. tit. 6, § 18-215(c).
The Montana amendment contains one provision that may have been intended to address the powers of a series. Current Section 35-8-107 of the Montana LLC Act sets out the powers of an LLC, and the amendment adds a new subsection (2): “This section [i.e., the list of an LLC’s powers] applies to a limited liability company that has one or more series of members.” This language may have been intended to mean that the powers of an LLC are also the powers of a series of an LLC, but it doesn’t say that. It simply says that the powers of an LLC are not limited if it happens to have one or more series of members.
Comment. Series LLCs have not become widely used. In some respects series LLCs are a solution looking for a problem. There are many unresolved legal questions about series LLC issues, such as bankruptcy, taxation, liability limitations, and piercing the veil, and corporate lawyers are leery of using them. Professor Goforth has provided a good discussion of these issues in Carol Goforth, The Series LLC, and a Series of Difficult Questions, 60 Ark. L. Rev. 385 (2007).
Kansas recently became the latest state to authorize series limited liability companies. Governor Sam Brownback signed Substitute House Bill 2207 on March 29, 2012, amending the Kansas Limited Liability Company Act to authorize series LLCs. Sub. H.R. 2207. The bill will become law on July 1, 2012, and Kansas will then join the eight other states that have authorized series LLCs.
Series LLCs. A series LLC can partition its assets and members into one or more separate series, each of which can have designated members and managers, and can own its own assets separately from the assets of the LLC or any other series. The liabilities of each series will be enforceable only against the assets of that series, and each series can enter into contracts, sue, and be sued in its own name.
Multiple series within one LLC can be used to avoid some of the inefficiencies and costs involved with using multiple LLCs. For example, separate parcels of real estate could each be owned by a separate series, but all within one LLC. Or, the divisions of a business could be held within one LLC, but with each division in a separate series.
Other States. Delaware was the first state to authorize series LLCs, in 1996. Del. Code Ann. tit. 6, § 18-215. Since then Illinois, Iowa, Nevada, Oklahoma, Tennessee, Texas, and Utah have enacted statutes similar to Delaware’s, although there are some differences. I previously wrote about series LLCs when Texas passed its series LLC law in 2009, here, and when the Internal Revenue Service proposed regulations for series LLCs, here.
Kansas Requirements. The Kansas statute is similar in many respects to the Delaware Act. Both authorize an LLC’s operating agreement to establish one or more designated series, and both provide that the liabilities of a series are enforceable only against the assets of the series and not against the LLC generally (and vice versa), if
- the records of the series account for its assets separately from the assets of any other series or the LLC generally,
- the operating agreement states the liability limitations, and
- the certificate of formation, and in the case of a Kansas LLC, the articles of organization, give notice of the limitations on liability.
Series LLCs are relatively new. There are few reported opinions dealing with series LLCs, and the IRS’s proposed regulations have not yet been finalized. There are therefore many unresolved legal questions about series LLC issues such as taxation, bankruptcy, liability limitations, and piercing the veil, particularly when doing business in states outside the state of formation. Caution is advised when implementing a series LLC, given the uncertainty and lack of predictability inherent in their use.
The ABA’s Revised Prototype Limited Liability Company Act has been published in the November 2011 Business Lawyer, copies of which were received at my firm last week. The Revised Prototype incorporates a number of welcome changes, and will likely become an even more widely used resource by states considering amendments to their LLC Acts.
Many state LLC Acts were first adopted in the early 1990s. In adopting and amending their LLC Acts, state legislatures have been able to look for guidance to several sources:
- The Uniform Limited Liability Company Act (“ULLCA”) promulgated by the National Conference of Commissioners on Uniform State Laws (“NCCUSL”) in 1994;
- The Prototype Limited Liability Company Act (the “Prototype”) published in 1992 by the ABA’s Committee on LLCs, Partnerships and Unincorporated Entities; and
Both the ULLCA and the Prototype were influential as the states drafted their LLC Acts, but neither fully occupied the field. As a result there is a lot of variation in LLC laws from state to state. According to NCCUSL, the revised ULLCA has been adopted by only the District of Columbia, Idaho, Iowa, Nebraska, Utah, and Wyoming. The Prototype also was used as the basis for several states’ LLC Acts, and has been used as a reference by other states in amending their Acts.
The Revised Prototype is a major revision and modernization of the Prototype. Changes include terminology, organization, and major points of law. The following is a partial list of the major changes.
Terminology. The name of the formation document has been changed from “articles of organization” to “certificate of formation,” and the principal contract that defines an LLC’s structure and the members’ rights has been renamed from “operating agreement” to “limited liability company agreement.” The latter change reflects the more common terminology, although it is cumbersome. E.g., Washington (RCW § 25.15.005), Delaware (DLLCA § 18-101).
Nonwaivable Provisions. Most state LLC statutes provide numerous default provisions that may be modified by an LLC agreement. Often each default rule will be preceded by language such as “except as otherwise provided in a limited liability company agreement.” Usually, however, some provisions of the statute will be nonmodifiable or nonwaivable by an LLC agreement, in which case the “except as otherwise provided …” language is not used to limit the statutory rule. This was the approach used in the 1992 Prototype.
The Revised Prototype instead simply states that the LLC agreement governs the LLC and its members, and that when the LLC agreement is silent the Act will govern, except that certain statutory provisions listed in Section 110 may not be modified by the LLC agreement. This approach eliminates the need to repeat variants of “except as otherwise provided [in an LLC agreement]” throughout the statute, as all of the default rules in the statute are subject to modification in an LLC agreement unless modification is barred by Section 110.
Manager-Managed vs. Member-Managed; Authority. Many state LLC Acts assume that management of the LLC will be vested either in the members or in one or more managers. Typically the statute will also describe the actual and apparent authority of the members or managers. Oregon and Washington both follow this approach, as did the Prototype.
The Revised Prototype instead takes a more flexible approach by eliminating the need to pigeon-hole the LLC as member-managed or manager-managed. The default rule is that the activities of the LLC are under the direction and oversight of its members. Revised Prototype, § 406. That can be changed by the LLC agreement, which may establish managers, officers, or other decision-makers and define their authority.
The Revised Prototype does not define any actual or apparent authority for members or managers. Instead, the actual and apparent authority of the members or of any officers, managers, or other agents, will be established by the LLC agreement, the decisions of the members, any filed statement of authority, or the common law of agency. Revised Prototype, Article 3.
Power. Most if not all state LLC Acts explicitly state that an LLC formed under the Act has adequate power. The statutes typically refer to LLCs having the powers that are “necessary or convenient” for their activities, or to comparable language. E.g. Delaware (DLLCA § 18-106(b), Washington (RCW § 25.15.030(2)), Oregon (ORS 63.077). Entity power is a fundamental attribute. For example, if an entity lacks power to form a contract and purports to do so, the contract will not be enforceable.
The importance of this issue is shown by legal opinion-letter practice. Lawyers for parties in major transactions are often required as a condition of the transaction to provide a legal opinion to the other party covering, among other things, the power of the lawyer’s client to enter into and carry out the transaction. The TriBar Opinion Committee’s 2006 Report on LLC closing opinions states that a lawyer’s opinion that an LLC has the power to enter into and perform its obligations under an agreement means that the LLC “has that power under … the statute under which it was formed.” TriBar Opinion Committee, Third-Party Closing Opinions: Limited Liability Companies, 61 Bus. Law. 679, 687 (2006) (emphasis added).
The Prototype intentionally did not include any language dealing with the LLC’s power to carry out its activities, apparently relying on the contractual aspect of LLCs. See Prototype, § 106, Commentary. The Revised Prototype, however, has included a statement that an LLC will have the powers “necessary or convenient to the conduct, promotion, or attainment of the business, purposes, or activities” of the LLC. Revised Prototype, § 105(b).
The Revised Prototype explicitly recognizes the entity nature of LLCs, defining an LLC as “an entity formed or existing under this Act.” Revised Prototype, § 102(13) (emphasis added). The Prototype, in contrast, defines an LLC as “an organization formed under this Act.” Prototype, § 102(F) (emphasis added).
It seems odd that the summary of major changes in the introduction to the Revised Prototype makes no mention of the addition of a powers clause, which I think most practicing lawyers would consider major, and the comment to Section 105 of the Revised Prototype makes no mention of the change.
Fiduciary Duties. The Revised Prototype does not provide for fiduciary duties and allows broad latitude to the LLC agreement to expand, restrict, or eliminate fiduciary duties. The implied contractual covenant of good faith and fair dealing may not be eliminated. Revised Prototype, § 110. Note that the absence of a default specification of fiduciary duties does not mean that the applicable state’s common law would necessarily hold that managers of LLCs have no fiduciary obligations. See Auriga Capital Corp. v. Gatz Props., LLC, No. C.A. 4390-CS, 2012 WL 294892 (Del. Ch. Jan. 27, 2012), which I wrote about, here.
Charging Orders. The Prototype provided that a court may issue a charging order, which gives an LLC member’s judgment creditor the right to receive any distributions the member would otherwise receive. The Prototype left unclear whether a charging order was a judgment creditor’s exclusive remedy. I wrote about the exclusivity of charging orders last year, here.
The Revised Prototype makes clear that a judgment creditor’s charging order is its exclusive remedy against an LLC member’s interest in the LLC. This change brings desirable clarity, but many would argue that there is a policy issue left unaddressed by the Revised Prototype, i.e. whether the charging order should be exclusive even in the case of a single-member LLC.
The new provision provides additional detail about the exercise of the charging order, and also makes clear that a charging order may be obtained against an assignee’s LLC interest.
Derivative Suits. The Prototype did not provide a default rule for derivative suits, although nothing in the Prototype prevented an LLC agreement from authorizing derivative suits. The Revised Prototype authorizes derivative suits for members as a default rule, although not for assignees (unlike Delaware, which allows members and assignees to bring a derivative suit, DLLCA § 18-1001).
Series LLCs. Series LLC provisions were added to the Revised Prototype. A series LLC is an LLC that is split into separate series, each having its own members and managers, owning its own assets separate from the assets of the LLC or any other series, and incurring obligations enforceable only against its own assets. At least eight states have authorized series LLCs (see my blog post, here).
Evergreen. The Revised Prototype has been published by the ABA’s Committee on LLCs, Partnerships and Unincorporated Entities. The Committee deserves praise for this comprehensive revision and the thoughtful comments.
The Committee stated in the overview to the Revised Prototype that it will be revised on an ongoing basis, to anticipate and respond to legal and business changes affecting LLCs. This will be especially useful if the Committee can make such revisions publicly available on the Internet (once released), with clear delineation of the changes from one version to another and with adequate comments explaining the changes.
Comments. The Committee has encouraged interested parties to submit suggestions and comments on the Revised Prototype. The Committee can be reached through the ABA’s website, here.
Series LLCs have been authorized by eight states, the most recent being Texas in 2009. An impediment to wider adoption has been uncertainty over how the IRS will treat them. On October 13, 2010 the IRS issued proposed regulations that if adopted will remove much of the uncertainty over the tax treatment of series LLCs.
A series LLC is an LLC that is split into separate cells, each of which is called a “series.” Each series can have designated members and managers, can own its own assets separately from the assets of the LLC or any other series, and can incur obligations enforceable only against its own assets. This segregation of each series’ assets and liabilities can avoid inefficiencies and costs associated with the customary alternative of using multiple LLCs.
In 1996 Delaware became the first state to authorize series LLCs. Del. Code tit. 6, § 18-215. Illinois, Iowa, Nevada, Oklahoma, Tennessee, Texas, and Utah have enacted statutes similar to Delaware’s, albeit with some differences. I previously wrote about series LLCs when Texas passed its series LLC law, here.
Series LLCs are relatively new and many legal uncertainties attend them. For example, I have located only one reported opinion dealing with series LLCs, GxG Management LLC v. Young Brothers & Co., No. 05-162-B-K, 2007 U.S. Dist. LEXIS 12337 (D. Me. Feb. 21, 2007). Series LLCs raise major, unresolved questions about taxation, bankruptcy, and doing business in multiple states.
The crux of the proposed regulations is that, whether or not an LLC series is treated as a legal entity for state law purposes, it will be treated for federal income tax purposes as an entity formed under state law. In other words, each series will be a separate taxpayer with its own taxpayer identification number. Whether the series will be classified for federal tax purposes as a partnership or as a corporation will be determined under the generally applicable entity classification rules, i.e., the “check-the-box” rules.
The proposed regulations do not answer all federal tax questions about series LLCs. For example, they do not address how an LLC series should be treated for federal employment tax purposes. Nonetheless, the proposed regulations will be a big step forward when adopted. The proposed regulations should accelerate passage by the states of series LLC legislation.
The IRS has solicited comments, which may be submitted at www.regulations.gov.
The SEC recently took the wind out of the sails of broker-dealers hoping to use series LLCs for multiple broker-dealers within one LLC. In a letter dated September 1, 2009, the SEC staff advised the Financial Industry Regulatory Authority (FINRA) that the proposed series LLC structure would not pass muster under the SEC’s net capital rule, its customer protection rule, and its financial reporting rule.
FINRA proposed, for example, that an LLC would have two series, one to operate a retail broker-dealer and one to operate an institutional broker-dealer. The LLC, and not either series, would register with the LLC.
The LLC itself would have no business operations. Instead, each series would operate a separate brokerage and would have separate assets and liabilities. The liabilities of one series would not be enforceable against the assets of the other series or the overall LLC, but the assets and liabilities of the two series would be aggregated on the LLC’s consolidated financial statement, which is filed periodically with the SEC. (For a description of how series LLCs work, see my previous post, here.)
The SEC’s staff pointed out that partitioning each series’ assets and liabilities within the LLC would be inconsistent with applying the net capital rule at the LLC level. Reporting the LLC’s financials on a consolidated basis would greatly impair the SEC’s and FINRA’s ability to supervise the LLC’s financial position, since the SEC would not be able to determine the financial position of the LLC and each series without substantial effort.
The staff pointed out other problems regarding customer reserve accounts and equal treatment of customers in the event of a liquidation proceeding. The bottom line was that the idea of having the LLC be the regulated entity while yet having each series be treated as separate, independent entities for purposes of their assets and liabilities, is inconsistent with the SEC’s regulations.
Series LLCs have a place in the business world. But at least in this case, asking regulators to ignore the inherent inconsistency between regulating only the overall LLC, while disregarding the separate liability shield of each series within the LLC, was simply a bridge too far.
Texas has joined the seven other states that have authorized series LLCs. The Texas bill authorizing series LLCs was signed by Governor Perry in May and will become effective on September 1, 2009. S.B. 1442. The states that currently authorize series LLCs are Delaware, Illinois, Iowa, Nevada, Oklahoma, Tennessee and Utah.
Most state LLC acts allow an LLC to provide for classes of members with different member rights per class. But a series LLC can go further by establishing multiple series of assets, members and managers. The debts and obligations of a series will be enforceable only against the series’ assets, and will not be enforceable against the other series in the LLC or against the LLC generally, and vice versa. The members associated with a series can be given separate rights and duties with regard to the assets of the series.
The separation of assets and partitioning of liabilities between series, all within one LLC, can avoid many of the inefficiencies and costs associated with multiple related entities. For example, a series LLC could be used to hold multiple parcels of real estate, each in a separate series and all within the one LLC. Or, separate divisions of a business could be held by one LLC, but with each division in a separate series.
The Texas statute is similar in many respects to the Delaware act. Both authorize an LLC’s operating agreement to establish one or more designated series. Both acts provide that the liabilities of a series are enforceable only against the assets of the series and not against the LLC generally (and vice versa), if
(a) the records of the series account for its assets separately from the assets of any other series or the LLC generally,
(b) the operating agreement states the liability limitations, and
(c) the certificate of formation gives notice of the limitations on liability.
Each series may in its own name sue and be sued, contract, and hold title to its assets, including real estate and personal property.
Series LLCs can be useful, but there are legal uncertainties involved in their use. Series LLCs are relatively new – Delaware was the first state to authorize series LLCs, in 1996, and there is almost no case law on them. Major areas of uncertainty involve taxation, bankruptcy, and doing business in multiple states.
There are many open tax questions with regard to series LLCs. Although the Internal Revenue Service issued a Private Letter Ruling in 2008 and clarified that each series’ federal tax characterization is determined independently, other state and federal tax questions remain.
It is unclear whether an LLC series will be treated as a debtor in federal bankruptcy court, or whether the bankruptcy court will ignore the series and only consider the entire LLC. The result may depend on whether the relevant state law will treat the series as a separate entity with its own liability shield.
Including Texas there are now eight states whose LLC acts authorize series LLC, but that leaves 42 other states with no series provisions in their acts. It is not at all clear what the courts of a non-series state would do when faced with a claim by a local creditor against an out-of-state series LLC formed under the laws of, say, Delaware. Will the non-series state honor the series structure and respect the internal liability shield? Would a non-series state even allow a series of an LLC formed under the laws of another state to register to transact business in the non-series state?
The law of series LLCs is an infant, still a little unsteady on its feet. But at one time LLCs were new and LLC law was the infant. There were many articles back then pointing out the uncertainties and risks of using LLCs when they were first adopted by Wyoming in 1977 and later by other states. Many conservative lawyers recommended against using LLCs in the early years of their authorization by the various states, but eventually all the states authorized LLCs. Today LLC law is more mature and LLCs are the most popular entity form for new businesses. History predicts that the question for series LLCs is not whether they will become routinely used, but when.