Series LLC’s – balancing flexibility and cost savings with uncertainty risk
Series LLC’s—which first came on to the scene in the 1990’s—have spread from their original, Delaware origins to now be an authorized company form in many states across the U.S., including Utah. They offer some benefits as compared to traditional LLC structures, primarily by offering simpler formation processes, lower (or no) additional fees, and flexible structures while maintaining LLC liability protections.
Series LLC’s are designed to provide businesses with a cheaper, more flexible way to establish multiple related but independent entities. They are supposed to retain most characteristics of traditional LLC’s. However, the laws governing Series LLC’s are not settled, and there are risks in using a Series LLC structure rather than a different organization.
What is a Series LLC?
A Series LLC is technically a “series” (or subset) of LLC assets, members, and debt, which has separate rights, powers, and duties from the Master LLC.
It is simplest to think of Series LLC’s as separate sub-companies that share the Master LLC’s registration with the Secretary of State but maintain limited liability protection between each sub-company. Each series has its own assets, its own members, and can have its own operating agreement governing membership rights and other governance issues.
The objective, in short, is to share the Master LLC’s registration with the Secretary of State, while still creating separate business entities that have liability protection horizontally (each SLLC should not be responsible for the debts of other SLLC’s) and vertically (each SLLC should not be responsible for the liability of the Master LLC, or vice versa).
Increasingly, states allow the Series LLCs to register with the Secretary of State in their own name (and some states mandate this registration), but there is significant variability in state laws regarding how to properly form and maintain this corporate structure.
What are the benefits and risks of a Series LLC structure?
Series LLC’s first came to the forefront in Delaware for mutual fund managers, who would set up series LLCs for each separate fund but where control was often fairly standardized, and where the overall fund manager was the same for each fund vehicle. They may also be useful for businesses where investors do not need to be reflected in the ownership of the ‘parent’ organization and can instead have ownership in the specific series.
Series LLCs are generally viewed as being a more flexible structure than the traditional parent/subsidiary relationship, while also being cheaper to form and maintain. Once the initial setup is complete, new series are often easy to create. They also provide a convenient way to make clearer divisions of ownership and control—instead of multiple classes of membership interests in the Master LLC, specific investors or owners would only have ownership and control over the relevant series.
However, there are risks:
Liability Shield: States that recognize SLLCs contain statutory language that is intended to provide horizontal and vertical liability protection, so that the liabilities of one series do not flow to other SLLCs or the Master LLC. However, these are unproven structures, and state laws governing them vary. Further, not all states recognize SLLCs, making lawsuits outside of a pro-SLLC jurisdiction even muddier.
This also becomes an issue in the event of bankruptcy because the federal Bankruptcy Code does not squarely address how a series of an LLC should be treated. If the Master LLC files for bankruptcy, would its SLLC series be subject to the proceeding? If the Master LLC is required to liquidate, any SLLC under it would likely need to relocate its assets to another entity, but how should that unwinding process occur, and would it need to happen as part of the bankruptcy proceeding? These uncertainties will complicate any bankruptcy proceedings involving SLLCs, which may deter investors or lenders from engaging with a business organized in an SLLC structure.
Operating in Multiple States: Not all states recognize series LLCs, and states that do have different technical requirements. For example, some states require that every series of the Master LLC be separately registered with the Secretary of State, some states permit SLLCs to register, but do not require it, and some states do not provide for SLLC registration at all. This is a lower risk for a business that only operates in a single state, but any SLLC structure that operates across the U.S. must consider the laws of each state they operate in. Operating in states without an SLLC law invites uncertainty because it is unclear whether states will respect foreign SLLC laws for liability protection, and how far that respect will go.
Maintaining Corporate Formalities: As with all closely related entities, it is critical to maintain corporate formalities between the Master LLC and their respective series. This is required by most, if not all, SLLC laws, and is necessary to mitigate the risk that liabilities will pierce the corporate veil and flow to related entities. However, with the entities being so closely affiliated, managers and members need to take extra care to maintain corporate formalities, especially with the unsettled status of SLLCs across the country.
Control: SLLCs are created and governed by the Master LLC and Series LLC operating agreements. Within those agreements, they often create distinct tiers of voting power and control. SLLCs only exist by virtue of the Master LLC’s operating agreement, and members of a series may be in an inferior position with respect to certain governance issues when compared to the members of the Master LLC.
SLLCs are one option for businesses that seek greater flexibility and lower maintenance fees for multiple series of investments and assets, but the law governing SLLCs remains vague in many circumstances, which invites risk.
SLLCs can provide unique benefits, including greater flexibility and speed in organizing multiple related, but independent, companies. However, there are still open issues with respect to SLLCs and their standing as compared to other types of business structures. While quite a few states have some form of an SLLC law, the uniform law proposed by the Uniform Law Commission has been adopted in only a handful of states.
Due to this ambiguity, business owners and investors should consider whether the SLLC structure is appropriate for the needs of the business and balance it against other possible organizational structures. If you determine that an SLLC structure is right for you, operating the Master LLC and its series properly is important to maximizing liability protection.