a The dangerous charm

The
dangerous
charm
of the
Series LLC
A s of the date of
this article, eight
states (Delaware,
Illinois, Iowa, Nevada,
Oklahoma, Tennessee,
Utah, and Texas) have
amended their LLC
statutes to allow for the
formation of a “series
LLC.” The series LLC
is a type of limited
liability company whose
formation documents
establish one or more
designated series of
members, managers,
interests, or assets.
2 2 6 m a i n e b a r j o u r n al  •   F A L L 2 0 0 9
by Christopher S. McLoon
and Margaret C. Callaghan
This article focuses on the LLC with one or more designated asset series. In such an
LLC, one or more members may be associated with one or more asset series, but not
any other. For example, assume Anne, Bill, and Charlie are members of Acme LLC,
a series LLC. Anne and Bill, but not Charlie, are associated with the assets of Series
Blackacre, while Charlie and Bill, but not Anne, are associated with the assets of
Series Whiteacre. If Acme LLC follows statutory requirements in its state of formation, the series LLC statutes provide that the assets and liabilities of Series Blackacre
are segregated from the assets and liabilities of Series Whiteacre.
Maine lawmakers are set to begin drafting a new LLC statute soon, and may be
tempted to incorporate into the new statute the series LLC model as adopted by
some other states.1 At first glance, the benefits of such an entity seem obvious. In
theory, investors would save filing fees and legal and administrative costs by forming
only one LLC, and would enjoy the organizational flexibility
and liability protection offered by the ability to set up separate series for various business purposes under the umbrella
of the “parent” LLC.2 Upon further investigation, however,
significant uncertainties and risks inherent to the series LLC
structure become apparent. This article will summarize
certain aspects of those risks, and explain why the series LLC
structure is very often an inappropriate tool for the general
business practitioner. If Maine does include the series LLC
concept in its new LLC statute, business law practitioners are
cautioned to use the form only after careful consideration and
planning, and to advise clients to do the same.
Potential Uses for the Series LLC
The unique structure of the series LLC is particularly
well suited for certain types of businesses. The most common
use of the series LLC is for mutual funds. The series LLC
format allows for the parent LLC to file a single registration
under the Investment Company Act of 1940, and then establish separate funds using the various underlying series. (Using
the series LLC in the mutual fund context may not pose the
same types of risks as those faced by other businesses, because
a mutual fund does not incur debt, and therefore owners/
investors would not be subject to a substantial risk of liability
if the series structure is not respected for state law purposes.)
Another potential use for the series LLC is in the context
of a real estate management or development business that will
operate various properties or development projects, and may
wish to segregate ownership rights and liabilities among the
various projects. Licensed or regulated businesses may be able
to use the series LLC to operate separate businesses under a
single license or regulatory approval.
The series LLC may also be a useful tool for businesses with
multiple assets under different ownership, such as a taxi cab or
mobile home business. In each of these scenarios, the ability to
provide for diversity of ownership, segregation of liability, and
Christopher S. McLoon is a partner in Verrill Dana’s business law
group. He practices tax law, and business law with a focus on unincorporated entities. He is co-chairman of the LLC Act drafting subcommittee of the MSBA’s Business Section.
Margaret C. Callaghan is an associate in Verrill Dana’s business law
group, where she practices general business law, with a focus on
transactions and securities matters. She is a member of the LLC Act
drafting subcommittee of the MSBA’s Business Section.
streamlined administration, combine to make the series LLC
seem like an ideal business entity.
Most obvious of the advantages presented by the series
LLC is the savings the business may recognize in state filing
fees (other than in Illinois, which requires a separate filing
and payment of an associated fee upon the establishment of
each series). More significantly, the business may save in legal
costs attributable to document preparation and other start-up
activities if only a single LLC operating agreement is required.3
In the context of a real estate development business, the series
LLC may provide an opportunity to avoid sales or transfer
taxes among the series. Other, non-real estate assets also may
be more easily and efficiently transferred among series. Finally,
it appears that the need to observe corporate-type formalities
might be limited in the series LLC model, further saving in
administrative and possibly legal costs.
Uncertainty
Although these potential cost and time savings are attractive, it must be remembered that they are truly “potential”
savings only. The primary drawback to the series LLC model is
that it is new and untested, and is therefore an extremely risky
entity choice. A recent Westlaw search of all federal and state
cases in the United States yielded only one reported decision
that discussed legal issues concerning the series LLC,4 and that
decision’s discussion is not a central holding of the case. A host
of legal and tax issues concerning the series LLC have never
been litigated or considered by the relevant judicial or regulatory authorities. Several of the unresolved issues concerning
series LLCs challenge the legitimacy of the very features that
make the entity an attractive option at first glance. Although
the following questions have not yet been resolved by courts
or regulatory authorities, it is possible to analyze the issues
and make comparisons to questions whose outcome has been
resolved.
Unresolved Questions and Other Risks
Limited Liability
The primary advantage of the series LLC model is that it provides
a business the ability to segregate assets and shield them from
each others’ liability, all under the umbrella of a single business entity. Choice of law questions present serious threats to
this promise of limited liability, however. Given that (as of
this writing) only seven states authorize the series LLC in their
F A L L 2 0 0 9   •   m a i n e b a r j o u r n al 2 2 7
LLC statutes, the question arises of whether other, non-series
LLC jurisdictions will recognize the inter-series limitations on
liability purportedly offered by the series LLC. This question is
of particular concern with respect to claims involving creditors
and other third parties who may not have adequate notice of the
segregation of assets and liabilities in a series LLC, as opposed to
claims between series or series LLC members.
For example, consider the situation of Voyager LLC, a
series LLC organized in Maine (assuming that Maine has
amended its LLC statute to permit the formation of series
LLCs). Voyager LLC has three series: Series N, which owns
a ship called the Niña; Series P, which owns a ship called the
Pinta; and Series S, which owns a ship called the Santa María.
The members of Series N are Christopher and Popeye, but not
Bluto. The members of Series P are Christopher and Bluto, but
not Popeye. Christopher is the sole member of Series S.
Imagine that the Niña, while sailing in Casco Bay, collides
with a luxury yacht, causing $500,000 in damages. In theory,
if the parties have been observing the proper formalities
relating to capitalization and bookkeeping, etc. (see the discussion in Veil Piercing, below), the liabilities incurred by the Niña
should be limited to the assets of Series N only. Bluto should
have no exposure at all, because his involvement in Voyager
LLC is limited to his membership interest in Series P.
However, what if the Niña heads south and crashes into a
yacht near Marblehead, and Massachusetts law doesn’t recognize the series LLC form? A Massachusetts court may disregard
the asset and liability segregation among the series, which would
put the Pinta and the Santa María at risk, as assets that the court
would deem to be owned by the parent LLC, Voyager.
Veil Piercing
The prospect of administrative efficiencies is another of the
most appealing features of the series LLC. A practitioner may
be tempted to advise his or her client that with the series LLC,
the client will be able to manage a variety of assets and diversify ownership of those assets, all while using a single entity
structure, and therefore save time and money on accounting,
legal, and administrative costs and efforts. The problem with
this advice is that no one knows what type or amount of
accounting and other formalities must be observed in order to
preserve liability segregation among the series and avoid the
“piercing” of the liability veil.
The Delaware statute (on which most of the other series LLC
statutes are based) provides that in order for the limitation of
2 2 8 m a i n e b a r j o u r n al  •   F A L L 2 0 0 9
liability to apply to the extent of the assets of a series alone, the
records maintained for each 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.”5 The same
section of the statute elaborates on the type of record-keeping
that is required to meet the standard for limited liability:
“Records maintained for a series that reasonably
identify its assets, including by specific listing, category, type, quantity, computational or allocational
formula or procedure (including a percentage or share
of any asset or assets) or by any other method where
the identity of such assets is objectively determinable,
will be deemed to account for the assets associated
with such series separately from the other assets of the
limited liability company, or any other series thereof.”6
Although this language provides some rough guidance, it is
still not clear exactly what type of record keeping is sufficient
to provide the limited liability protection, or what practices
would be insufficient, and would therefore expose a client to
greater than anticipated liability.
Unfortunately, as noted earlier, there is no case law on
which to rely for further guidance, so the best practical advice
from a practitioner to a client would be to maintain the
strictest possible accounting and other record-keeping standards in order to maximize the chances of the limited liability
being respected. Once a client understands that he or she will
need to maintain the same or greater level of record-keeping
practices for each series as would be used for a separate entity,
the appeal of the series LLC model diminishes significantly.
Title
One of the uses for which the series LLC seems especially well
suited is the real estate management or development company.
Given the appeal of this potential use of the series LLC, it is
especially important to know whether a series has the legal
capacity to hold title to real estate.
Amendments to the Delaware LLC statute adopted in
2007 provide that “Unless otherwise provided in a limited
liability company agreement, a series … 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 interests, and sue and be sued.”7 This new language
appears to settle the question of whether a series has the capacity
federal bankruptcy law.10 The Bankruptcy Code definition of
“person” includes an individual, partnership, or corporation.11
No one knows whether one or more of those categories could
be construed to include a series, meaning that series and their
stakeholders may not be able to avail themselves of the protections offered by the bankruptcy process. After Christopher
defaults on the loan used to redecorate the Santa María, would
Series S be permitted to file a petition in bankruptcy? If so,
would the automatic stay apply to Series S only or to the other
series of Voyager LLC and Voyager itself?
Similarly, it is unclear how the various constituents of a
series LLC should be represented in a bankruptcy case. Would
Bluto and Popeye be adverse parties entitled to separate representation from each other, Christopher, and Voyager LLC?
What voting rights, if any, would series owners have in a bankruptcy case? What risks to the LLC members, series owners,
and the series assets would be posed by the laws of substantive
consolidation and fraudulent conveyance?
Creditors’ rights would no doubt be heavily weighed in any
court analysis of these issues. It should be noted in this context
that the Delaware LLC statute does not require notice filings
when a series is formed, nor does it require other types of
Creditors’ Rights and Bankruptcy
notice to third parties regarding the series structure, or idenThe discussion above relating to whether or not a series is a tification of the assets that may be segregated in various series.
distinct legal entity may have some bearing on another set of This lack of notice is likely to take on enhanced significance if
unresolved questions concerning the series LLC: how does a dispute involves the law of a non-series jurisdiction.
Article 9 of the Uniform Commercial Code apply to the series
Management
LLC, and how should the series be treated in bankruptcy? The
most fundamental question is how a putative secured creditor Another unresolved question bearing significant risks to
can perfect a security interest in an asset held by a series, i.e. clients interested in the series LLC has to do with the
which entity is the debtor for purposes of filing a financing management rights and obligations associated with a series.
statement? For example, what if Christopher takes out a loan in The Delaware statute provides that “[a] limited liability
the name of Series S, in order to redecorate the captain’s berth in company agreement may establish or provide for the estabthe Santa María? If Christopher fails to make timely payments lishment of one or more designated series of members,
on the loan, the lender should be limited to recourse against the managers, limited liability company interests or assets.”12
assets of Series S only. Assume, however, that the lender takes Presumably, this means that a series, as well as the parent
a security interest in all assets of “the borrower” to secure the LLC, may have a manager or managers.
loan. Even if the loan documents specify that Series S is “the
If Christopher is the manager of both Series N and Series
borrower,” Bluto and Popeye should be prepared for the possi- S, would he be subject to a claim for breach of duty of loyalty
bility that a court might interpret that blanket security interest if he leases the Niña to Series S for less than fair market
as reaching all the assets of Voyager LLC, especially if the lender value? Although it is possible to speculate that duty of loyalty
is in a jurisdiction that doesn’t recognize the series LLC.
and conflict of interest questions involving a series manager
Turning to the law of bankruptcy, for a specific series to would be handled similarly to the way they would be handled
file a petition in bankruptcy apart from the other series or the between separate LLCs with shared managers, clients are
parent LLC, it would need to be considered a “person” under unlikely to wish to become the test case for such a theory.
to hold title. However, it is still unclear whether a series is a
separate legal entity for purposes of Delaware law, which may
present problems for title insurers, claimants, and other stakeholders (this lack of clarity regarding the entity status of a series
also raises additional issues, discussed elsewhere in this article).
Although the Delaware statute affirmatively states that a
series LLC is a distinct legal entity,8 the statute remains silent
on the entity status of the individual series. As of the date of this
article, there is virtually no case law to consult for clarification.
In the only opinion that seems to shed any light on the matter—
an unpublished opinion (slip copy only) by a Maine federal
magistrate judge interpreting the Delaware LLC statute—the
magistrate stated that, in the context of the facts at issue, “I do
not find that [the series in question] was an entity at all, but
merely a ‘series of interest’ of [the parent LLC].”9 This lone voice
in the wilderness of authority certainly hinders the argument
that the series should be treated as a separate entity, but the
precedential value of the case may be limited. Whether or not
a series is a distinct legal entity having all the rights and obligations attendant to such status remains an open question, yet to
be definitively resolved by the courts in Delaware or elsewhere.
F A L L 2 0 0 9   •   m a i n e b a r j o u r n al 2 2 9
Similarly, we don’t know what happens when a member of
a series opts to withdraw from the series. If Christopher withdraws from Series N, would he be required to forfeit any rights
in Series P or S, or in Voyager LLC?
Securities
Securities transfer, registration, and disclosure requirements
for series LLCs are yet another unresolved area of law. The
lack of clarity surrounding the entity status of the series as
compared to the parent results in a number of questions. Do
ownership interests in a series constitute a security separate
from ownership in the parent for federal securities law and
Blue Sky purposes? Rule 12d1-1 of the Securities Exchange
Act of 1934 suggests that securities of a series (if that is what
ownership interests in a series are) would not be covered by
the registration of the parent’s securities if the securities of the
series have different terms from the parent.
However, assuming the terms of the securities are the
same, if Voyager LLC files a Form D with the SEC, could
Christopher sell interests in Series S in reliance on Voyager’s
Regulation D exemption? Compliance with federal and state
exemption rules in the event of transfers of series interests
could be extremely complex. In addition, it seems nearly
impossible for a putative issuer to provide the necessary
disclosure of material risks to a prospective investor given all
of the unresolved questions associated with the series LLC
structure.
example, Delaware) should be a separate business entity for
income tax purposes. In making such a ruling, the IRS may
draw support from the fact that the Delaware series LLC
resembles in material ways several series business structures
in which each series is treated as a separate business entity for
federal income tax purposes.
The first such structure is the series investment trust. In
the National Securities16 case, the Tax Court held that each
series of a single investment trust was a separate entity for
federal income tax purposes. A few years later, the IRS issued
Revenue Ruling 55-416,17 confirming the National Securities
holding.
The series LLC also resembles a regulated investment
company with more than one fund. Under Internal Revenue
Code Section 851(g), each of the funds (a series fund) of a regulated investment company is treated as a separate corporation
for tax purposes.
Finally, the IRS has proposed that divisions of insurance corporations called “Protected Cell Companies,” which
resemble series LLCs in that each cell contains segregated
assets and liabilities, will be treated as separate tax entities if
they have certain characteristics.18
While the Series LLC structure is superficially similar to
these other structures, there are also differences that may lead
the IRS not to treat the series as a taxpayer. It is possible that
series would not be considered separate entities if it is the
case in a given series LLC that each series is owned by the
same persons in identical shares. In such an arrangement, the
Taxation
structure could well be characterized as one tax partnership.
Series LLCs present significant tax risks as well, as it is not This outcome would not be possible in a regulated investment
clear which among the constituent parts of a series LLC is company (an entity qualifying under Subchapter M and clasthe taxpayer: the parent, the series, or some combination. The sified as a corporation), structure, a Protected Cell structure,
characterization of a series in an LLC for tax purposes has or an investment trust structure.
not yet been established by the Internal Revenue Service,13
So, while it seems the IRS and some other taxing authorialthough the IRS has ruled in one instance that each series ties have issued some rulings19 that indicate that each series
of a series LLC will be characterized as a separate business of a series LLC will be treated as a separate entity for tax
entity.14 It should be noted that whether an organization is a purposes, and the series LLC structure is superficially similar
separate entity for federal tax purposes is a matter of federal to other business structures in which each series is treated as
tax law, not state law.15
a separate business entity, it would be unwise to assume that
Thus, although earlier in this article we explored the ques- such a ruling would apply in every case. The rulings cannot
tion of whether a state treats a series as a separate entity for be cited as precedent, and differences in state law or business
various purposes, the answers to those questions would not be structure may make reliance on the rulings and comparisons
controlling for federal income tax purposes.
to other business structures inappropriate.
The IRS may one day rule that each series of a series LLC
If the IRS determines that a series is a separate business
formed under a particular jurisdiction’s LLC statute (for entity, the series will be characterized under the “check the
2 3 0 m a i n e b a r j o u r n al  •   F A L L 2 0 0 9
box” regulations.20 Under those regulations, a single-member
entity can choose to either be disregarded for federal tax
purposes, or treated as an association (i.e. a corporation).
If the entity has two or more members, it can elect to be
treated as a partnership or an association. If the entity fails
to make an election, it will be treated either as a disregarded
entity (if a single-member entity) or a partnership by default.21
On the other hand, if the IRS determines that a series is not
a taxpayer, the parent LLC will file a return and treat the tax
items of the underlying series as its own.
In either case, whether each series is treated as a separate
entity or not, the business structure presents challenging tax
planning, drafting, and compliance issues. If each series is
treated as a separate entity, any transfers of property or cash
between the series would have tax consequences, implicating
Internal Revenue Code sections 704(c) (contributed property),
707(b) (gain or loss on transfers to controlled partnerships), 731
(gain/loss on distributions), 737 (gain or loss on distributions
of contributed property), and others.
For example, if Christopher and Bluto agree to transfer one
of the Pinta’s cannons from Series P to Series S, for use on the
Santa María, the transaction would be treated as a distribution
from Series P to Christopher. It’s possible that this transaction would be of no immediate income tax consequence under
Code Section 731, which generally treats interim distributions
of property as nontaxable to the transferee.22
However, if Bluto had originally contributed the cannon to
Series S when its fair market value exceeded Bluto’s adjusted
basis in the cannon, and if the distribution of the cannon
occurred within seven years of the date of Bluto’s contribution,
Bluto (not Christopher) will realize gain on the distribution
equal to the amount of built-in section 704(c) gain in the property at the time of the contribution.
If the parent LLC is the only entity for tax purposes, careful
attention would need to be paid to allocation and distribution
provisions to ensure compliance with the substantial economic
effect rules of Internal Revenue Code section 704.23
Conclusion
In concept, the series LLC model has much to recommend it. Clients would surely be interested in an entity form
that allows them to segregate assets, liability, management,
and ownership rights, all within a single business structure.
Unfortunately, as a closer analysis reveals, the risks of the series
LLC far outweigh its possible advantages. Chief among these
risks are its uncertain promises of liability segregation, administrative ease, and cost savings. We suggest that general
practitioners use caution if they decide to suggest the formation of a series LLC in order to meet the client’s desire to
separate assets and ownership.
1. An LLC Act drafting committee of the Maine State Bar Association is reviewing several LLC statutes and model acts to produce a draft
revised LLC Act for Maine. The authors are members of this drafting
committee.
2. For convenience, we describe the series LLC in this article as having a “parent,” and series that underlie the parent. However, certain
commentators have suggested that this description is misleading, as the
“parent” may not exist for tax or other purposes, and in any case it’s not
clear that the “parent” is an entity with superior ownership of the series,
as this terminology implies. The Delaware series LLC statute (6 Del.
Code Ann. Tit. 6 § 18-215), upon which most of the other series LLC
statutes are based, uses the terms the “series” and the “limited liability
company generally.”
3. Each series must provide for its own allocations, distributions,
management provisions (including those relating to fiduciary duties,
exculpation, and indemnities), and member access to information. In
the absence of these provisions, such terms are left to the applicable
LLC statutes and/or common law. So, the potential savings on document drafting may not be that great, unless each series expressly adopts
uniform provisions applicable to all series of an LLC.
4. GxG Management LLC v. Young Bros. and Co., Inc., 2007 WL
551761 (D.Me.).
5. Del. Code Ann. Tit. 6 § 18-215(b).
6. Id.
7. Del. Code Ann. Tit. 6 § 18-215(c).
8. Del. Code Ann. Tit. 6 § 18-201(b).
9. GxG Management, LLC v. Young Bros. and Co., Inc. 2007 WL
1702872 (D.Me.) (order on motion to amend judgment in GxG Management LLC v. Young Bros. and Co., Inc., 2007 WL 551761 (D.Me.)).
10. 11 U.S.C. § 109(a).
11. 11 U.S.C. § 101(41).
12. Del. Code Ann. Tit. 6 § 18-215(a).
13. The determination will actually be made by the IRS chief counsel’s Pass-Throughs and Special Industries branch and the Treasury
Department’s Office of Tax Policy.
14. Internal Revenue Service Private Letter Ruling 200803004.
15. Treasury Regulations §301.7701-1(a).
16. National Securities Series-Industrial Stock Series v. Commissioner, 13
T.C. 884 (1949), acq. 1950-1 C.B. 4.
17. Revenue Ruling 55-416, 1955-1 C.B. 416.
18. Revenue Ruling 2008-8, 2008-5 I.R.B. 266 (February 4, 2008).
19. The Massachusetts Department of Revenue issued a letter ruling (Letter Ruling 08-2) on February 15, 2008, holding that each series
of a Delaware series LLC will be separately classified for Massachusetts
income tax purposes in accordance with its federal classification. It is
quite likely that IRS PLR 200803004 was issued to the same taxpayer
that obtained Letter Ruling 08-2. Perhaps less noteworthy because it
does not relate to income taxes, the California Franchise Tax Board
treats each series of a foreign series LLC (California law does not permit
the formation of series LLCs), as a separate LLC for franchise tax filing
and assessment purposes.
20. Treasury Regulation §301.7701-3.
21. Treasury Regulation §301.7701-3(b)(1).
22. Christopher may realize gain under Code section 737 if he contributed section 704(c) property to Series P within the 7 year period ending on the date of the distribution.
23. See Treasury Regulation §1.704-1(b)(1)(i).
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