Many new businesses chose to establish limited liability companies (LLC) because of the protection from individual liability, the benefit of pass-through taxation, and the form’s inherent flexibility. Certain types of businesses will often create different LLCs for each distinct business unit so the assets and liabilities for each business are not shared with other affiliates. For example, a real estate investor or franchisee of a restaurant system may have different LLCs for each of their properties/businesses. Depending on the size and complexity of these businesses, an owner may have dozens of LLCs that each requires filing documents with the state, paying fees, and even publishing notice as appropriate.
Some states have adopted statutes that permit the formation of series LLCs that provide for the creation of an initial LLC and then the subsequent creation of independent and separate companies or units (each, a series), usually by simply amending the LLC agreement. The first state to permit the formation of series LLCs was Delaware in 1996, and since then 19 states, including Washington, DC and Puerto Rico, have created statutes that allow for the creation of a series LLC. California and Pennsylvania recognize foreign series LLCs but do not provide for the formation of one.
If a series LLC is created properly, the initial and each subsequent series each may have separate assets and are not responsible for the liabilities of others. This is an attractive option to many business owners since each distinct series is afforded the same limited liability protection as a traditional LLC but it can be created in a quicker and more cost-effective manner. Since series LLCs are still relatively new and not widely used, there is some hesitancy because of limited court review and fear of not receiving interstate recognition.
The Delaware Statute
To create a series LLC in Delaware, a certificate of formation is filed with the Secretary of State that states, among other things, that the entity is a series LLC and that an additional series may be subsequently established (known as a protected series). The LLC agreement must be consistent with the statute and its amendment then establishes each subsequent series, detailing how the series is managed, what its members and assets are, and how the assets and liabilities will be apportioned or distributed. The protected series must keep separate records and account for its assets.
Delaware amended its LLC act in 2019 to allow for the creation of a registered series, which is essentially the same as a protected series except that:
- A Certificate of Registered Series must be filed with the state;
- It must pay an annual franchise tax of $75; and
- It can obtain a certificate of good standing from the state.
Pros and Cons
Both of these series types give businesses essentially all of the same benefits of a traditional LLC, with the main advantage being flexibility. A protected series allows businesses to create new entities without any state filings, thus avoiding administrative filings and fees. While a registered series does require state filings and annual taxes, it provides businesses with formal recognition from the state and gives them the ability to obtain a certificate of good standing. Lenders may also have greater comfort in accepting security interests from a registered series.
There are a few drawbacks to a series LLC, most of which relate to the fact that it is a relatively new and unused entity type. It is subject to very limited case law so it is difficult to determine if it will hold up in court in a foreign state that does not have any statute that permits or recognizes the creation of a series LLC. There are similar problems related to bankruptcy and tax treatment. The fact that these laws are still developing creates risk and uncertainty for businesses.
Best Practices
If one determines that a series LLC is the right entity for a business, there are a few steps to obtain the desired efficiencies while still protecting oneself and its business. First, when creating a series, the LLC agreement’s amendment should be as detailed as possible. It should clearly state who the owners are, their shares of profits and losses, whether its assets are its own or shared by other series, if its liabilities are also those of any other series, etc.
Next, parties should seriously consider the registered series. While this does add an administrative step and an annual fee, the formal state recognition can be quite important. As discussed above, the possible drawbacks revolve around uncertainty as to whether federal and foreign state courts and governmental bodies will recognize the series as its own distinct legal entity. Having a state registration and a certificate of good standing could ease those concerns and significantly limit those risks. Before the registered series was effective in Delaware in 2019, it was common practice to file a registration of a fictitious name when creating a series in order to have some formal state recognition. Since the amendment created its own avenue for registration of a series, it should be used to its greatest advantage.
Conclusion
The attorneys at Cohen Seglias will continue to follow any developments in the law related to series LLCs. Series LLCs can be very useful tools that give businesses flexibility and save time and costs in the formation process.
