The Status and Evolution of Model Series LLC Legislation

Oct 27, 2016 2:44:15 PM

 

Learn more about the status and evolution of model series LLC legislation

Series LLCs have been called the next generation of pass-through entities, gaining in popularity and use as states continue to authorize them. The lack of state uniformity in the treatment and acceptance of series LLCs has lead more conservative attorneys, advisors, and clients to avoid them, believing that the uncertainties and potential risks associated with series LLCs outweigh their perceived benefits.

The National Conference of Commissioners on Uniform State Laws (“NCCUSL”) has been hard at work producing multiple drafts of a uniform law for series LLCs. While the drafters’ comments on earlier drafts left open questions regarding whether such a statute would ever be enacted, the most recent drafts evoke more confidence that a uniform law is indeed forthcoming. This article provides an overview of series LLCs, highlighting some of the uncertainties associated with their use, and discusses the status of the NCCUSL’s efforts in adopting a uniform law to provide increased clarity and consistency in the use and legal treatment of series LLCs.

What Is A Series LLC?
A series LLC is a limited liability company with internal “series” or “cells,” each of which may have separate members, managers, assets and liabilities, business purposes or investment objectives. The assets of each series are shielded from the liabilities of the other series and the LLC itself. In other words, each protected series has its own separate veil of limited liability protection. Initially created under Delaware law to serve as business structures for mutual funds, series LLCs are now being used in the context of other business enterprises for purposes of asset protection. They often appeal to those with different lines of business, different categories of assets, or different types of property they wish to manage and operate separately under the umbrella of a “master” LLC.

What Uncertainties Surround Series LLCs?
As one of the newest forms of business entity, series LLCs lack the benefit of some of the more established types of business entities that offer guidance through well-developed statutes and case law. There are a number of uncertainties with respect to series LLCs that have troubled commentators and practitioners alike. For example, since series LLCs are authorized in only a minority of states, will foreign jurisdictions respect their liability shield in the event of litigation? Also, because the U.S. Bankruptcy Code does not recognize series LLCs, how will series LLCs be treated in the event of bankruptcy? Furthermore, are series LLCs subject to greater risk of veil piercing than non-series LLCs? How are series LLCs treated for federal and state tax purposes?

Protected series are business organizations — new business organizations — analogous to but not the same as limited liability companies. LLC statutes typically provide default rules to answer questions left unaddressed by a company’s operating agreement. The absence of default rules to fill in the gaps for protected series explains both the presence of so many unanswered questions and the need for uniform legislation to provide guidance.

Which States Have Authorized Series LLCs?
Presently, there are 15 states with series LLC legislation. The District of Columbia and Puerto Rico also have provisions for series LLCs. California does not authorize Series LLCs, but permits series LLCs formed elsewhere to register as a foreign entity and do business in California as a series LLC, provided such entity pays taxes and fees for each of its protected series. In those states, such as California, that tax each protected series separately, franchise and excise tax burdens can be significant.

Status of Uniform Series LLC Act
The inconsistency in recognition and treatment of series LLCs across the U.S. supports the need for uniform legislation. It has been 19 years since Delaware first authorized series LLCs, and in that time less than one-third of the states have adopted similar legislation. By contrast, within 20 years of Wyoming introducing the nation to the LLC, all 50 states had adopted LLC legislation.

The NCCUSL assembled a committee to address the need for uniform series LLC legislation and the committee published a first draft in September, 2013. The second draft followed in February, 2014; and the third draft (which the committee noted to be a complete overhaul of earlier drafts) was made available in November, 2014. In its comments to the third draft, the committee questioned the need for series LLCs, stating that “the special advantages of protected series remain obscure.” Thus, we entered 2015 with lingering doubts about whether uniform series LLC legislation would ever exist.

2015 was, however, a year of increased momentum and marked progress. The committee released revised drafts in March, July and November. The November draft made significant changes to earlier drafts, and seemed to take a more focused and streamlined approach. Some of the key elements of the November 2015 draft included the following:

  1. More Limited Scope. The draft is given a proposed new name, the Uniform Protected Series Act (“UPSA”), along with a scope restricted to limited liability companies. Previously, it had been called the Series of Unincorporated Business Entities Act, as its scope was more expansive, encompassing series of limited partnerships and statutory business trusts.
  2. Compatibility with State LLC Legislation. The draft is intended to dovetail with the LLC statute of each enacting state, regardless of whether the state has previously enacted the Uniform Limited Liability Company Act. In other words, definitions and provisions will cross-reference to the state’s LLC act to ensure consistency.
  3. Possible Conversion to an Article in Existing State LLC Acts. The drafters considered converting the UPSA to an article to be inserted into the LLC act of each enacting state. They explained that this would eliminate the need to cross-reference definitions from the relevant LLC act.
  4. Limited Liability Veil. No existing series LLC legislation addresses the issue of piercing the veil. The November, 2015 draft UPSA expressly acknowledges and makes applicable veil piercing in the series LLC context. In other words, it confirms that the same rules of law and equity apply to hold members of a series LLC vicariously liable for the company’s debts and to hold members associated with a protected series vicariously liable for the protected series’ debts.
  5. Asset Protection. Most existing series statutes permit an LLC to establish a protected series without a public filing, provided the LLC’s publicly filed formation document indicates that it may have protected series. Historically, for an entity to acquire any type of liability shield, a public filing had to be made with a government office. Therefore, the draft UPSA expressly requires a public filing be made in order to establish a protected series and its “horizontal” liability shield.
  6. Affiliate Liability. No existing series LLC statute addresses the issue of one series being held liable for the debts of another. The November, 2015 draft UPSA makes the rules of “affiliate liability” applicable among a series LLC and its protected series. Generally, in the absence of affiliate liability, assets owned by one entity are not subject to the enforcement of claims by creditors of any other entity.
  7. Association Requirement. The November, 2015 draft UPSA provides additional creditor protection against the so-called “shell game.” The draft provides that even if there is no affiliate liability, an asset owned by a protected series is available to creditors of the series LLC or another protected series unless the protected series has complied with strict record-keeping requirements, thereby “associating” the asset with the protected series. In other words, an asset may be owned by, but not associated with, a given protected series, in which case the asset is up for grabs by creditors of any other protected series or the company. The July, 2016 draft, discussed below, sheds more light on the association requirement.

The committee released its most recent draft in July, 2016. The major changes involve increasing transparency to the public, increasing protections for consumers and creditors, and increasing control over protected series from foreign jurisdictions. In the prefatory note, the committee addressed the growing popularity of series LLCs, and admitted that the reasons for their widespread use are not well understood. Only two mainstream uses could be identified: first, a series LLC could be used for regulatory convenience, holding a single license or making a single filing on behalf of all of its protected series; and second, a series LLC could be used as an “off-the-shelf template for establishing a structure of affiliated businesses.” Whatever the explanation for their popularity, series LLCs are well-established U.S. business entities that are here to stay.

The July, 2016 draft — now named the “Limited Liability Company Protected Series Act” — continues to apply only to limited liability companies. The draft addresses the following key points:

  1. Filing Requirement. Section 201(b) of the July, 2016 draft requires that a separate public filing establish each protected series in a series LLC. Most existing series LLC statutes, with the exception of Illinois, do not require separate filings for each protected series. Requiring separate filings will increase transparency to the public. Separate filings may also increase the cost of forming and operating a series LLC.
  2. Veil Piercing. Section 401 of the July, 2016 draft specifies rules for disregarding the internal liability shields that protect the assets of one protected series from the creditors of another. Other than a general recordkeeping requirement, most existing series LLC acts provide no guidance on maintaining limited liability among the protected series.
  3. Non-Associated Assets. Section 402 of the July, 2016 draft provides “asset by asset” consequences for assets not properly associated with a protected series, even if the internal shields among series remain in place. This means that, notwithstanding the limited liability in place among the protected series, certain assets are up for grabs from creditors if they are not owned by a given protected series or they are not properly tracked via the protected series recordkeeping procedures. The draft also makes clear that non-associated assets cannot be associated after a claim against the asset has been made. This concept is not present in existing series LLC acts.
  4. Recordkeeping. Section 301(b) outlines special recordkeeping requirements that apply to transfers between a series LLC and a protected series of the company and to transfers between protected series of the company. Existing state series LLC statutes do not provide this level of detail, resulting in confusion and open questions. The emphasis on recordkeeping is a theme in this most recent draft, reflecting the committee’s desire to prevent series LLCs from being used as a shell game.
  5. Associated Members. Section 302(b) provides that a person must be a member of the series LLC in order to be an “associated member” of any protected series. The act does not, however, describe how a person becomes an “associated member,” but rather leaves that determination to the governing operating agreement. The draft addresses certain rights of “associated members,” such as veto rights to operating agreement amendments affecting the protected series (Section 304(d)), transferability of interests (Section 303), and management rights (Section 304).
  6. Foreign Protected Series. Section 604 provides that protected series must register to do business in any state outside the state in which it was established. The foreign protected series must also satisfy the same name and disclosure requirements that domestic protected series are subject to. Section 601(b) permits a court to use an enacting state’s veil piercing law on foreign protected series if the foreign state’s law is “repugnant” to the public policy of the enacting state.

Takeaways
Although recognized by an increasing number of states, series LLCs remain a largely unfamiliar entity outside the investment fund context. Along with the finalization of the IRS’s 2010 Proposed Regulations, the adoption of a uniform act would likely lead to more widespread acceptance, consistency and use of series LLCs throughout the United States. Substantial progress on the uniform act has been made over the past couple of years, after years of uncertainty as to the uniform legislation’s status. While the final reading of the Limited Liability Company Protected Series Act is scheduled for July, 2017, and all indications point to adoption of a uniform act, it remains to be seen whether (and how quickly) states currently sitting on the sidelines will authorize series LLCs.

Some of the requirements of the model act (e.g., registration of each protected series, stringent record-keeping) may discourage business owners from using this form of entity if they determine that the costs and administrative burdens are prohibitive. Attorneys may experience an uptick in clients interested in series LLCs as the entity matures and gains acceptance across the United States, but it may be prudent to stick to structures involving several limited liability companies to establish the legal and business relationships otherwise made possible using a series LLC, at least until the model act is adopted and more transparency is achieved.

Both the Business Docx® and the Wealth Docx® Operating Agreements enable users to form series LLCs. In Business Docx®, the series LLC option is available only in the full version of the Operating Agreement. In Wealth Docx®, the series LLC option is available in the LLC Operating Agreement (updated). The relevant interview questions can be found in the “Basic Information about the LLC Structure and Design” tab. 

WealthCounsel is committed to staying abreast of the legislative, regulatory and judicial landscape pertaining to series LLCs, and relevant updates in the law will be reflected in future releases of Business Docx® and Wealth Docx®. WealthCounsel also strives to provide education and community resources to help you determine whether a series LLC structure is right for your clients.

Topics: Business Law

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