Series Llc: Where Angels Fear To Tread
Saturday, June 20th, 2009There’s a lot of talk about Series LLCs. More and more people are wondering if they’re a smart idea. The short answer is that they aren’t – they haven’t been tested, giving them limited applications if they have any at all.
First, some background. LLCs alone are an excellent structure for many different uses. For instance, they work well as a method of holding high dollar assets like real estate. If you own commercial or rental property, it’s important that you hold title to that property in an entity. If this entity (most likely an LLC) is run and managed properly, it can protect you from any personal liability.
Many people own a number of different investment properties. They want to protect both their investments and themselves by placing them into one or more LLCs. The task then is scenario, every investment is held under a different LLC. That’s not a popular answer for people who have lots of investments, but it’s built on sound reasoning. Think of LLCs as giant shoeboxes. As many investment items as you like can be placed inside, but they’re all at risk if something happens to the box. If a lawsuit happens, every investment you’ve placed into that LLC will be in danger.
The solution is to separate your investments. Ideally, you should use a separate LLC for each one. If you can’t, be sure to examine the equity you have at stake in every investment along with its liability potential. Then group them in LLCs accordingly. As an example, it’s not a good idea to include a single family beach front rental in Maui in the same LLC as a duplex on the wrong side of town. You may have several thousand dollars of equity stored in the house on Maui, which is placed at risk by including it in the same LLC as the rough edged duplex. Keep them separate. However, if you own three single family homes in Idaho, each within about twenty thousand dollars of equity, you might feel that placing them together is an acceptable risk. But that segregation strategy can get expensive.
If you have ten properties, using ten different LLCs might seem confusing and costly. Series LLCs seem to provide a solution as statutes in certain states allow you to create separate series within a single LLC, the debts and liabilities of which are only enforceable against that series. These laws allow LLCs to establish separate series of interests, members and managers, giving them separate duties, powers and rights. Those include the rights to profits and losses with respect to specific property and obligations. In states that have this kind of enabling legislation, each series within the LLC works as a separate entity under state law. This is why many people are attracted to series LLCs – they theoretically have the ability to shield property in different series from liabilities incurred in or against one another without paying state fees for multiple entities. This means that an LLC containing two properties can choose to place each into a separate series, so that liabilities from one can’t cause problems with the assets of the other. (Remember the same effect can be created using two different LLCs to hold these two properties.) Many people prefer series LLCs because at first glance they appear to be cheaper to set up. However, this assumption is false. It’s actually more complicated to set up a series LLC, making it more expensive than the basic type. In California you might find a series LLC appealing because the Franchise Tax Board charges an annual fee of eight hundred dollars for each entity. Many people think that setting up a single series LLC means paying only one fee in California. However, the Franchise Tax Board takes the position that each series counts as its own LLC for fee purposes, meaning you’ll have to pay the same whether you set assets up in series or in their own separate LLCs.
The biggest problem with series LLCs is that many states (including California) don’t have series legislation and may choose to ignore the laws of the state where the series was created. That’s because you’re subject to their rules when doing business in their state. The example of the attitude of the California Franchise Tax Board applies to fees, but liability protection is also an issue. Since series LLCs are so new they’ve never been tested by courts, even in the states that permit them. That means there’s no guarantee that limited liability protection will be extended to each series until every state rules on the subject. It’s hard to see how a court would choose to grant this kind of protection inside one entity, and only time will tell if courts will do this. But do you want this type of uncertainty when you are trying to protect your assets?
Again, one should be concerned about how series LLCs will be treated by the states that don’t have laws permitting them. If you set up a series LLC in Nevada then register it as a foreign entity conducting business in the state of Massachusetts, each series in the LLC own a separate piece of property. If there’s a lawsuit in regards to one of these properties you can’t be sure that the Massachusetts court will honor the series structure of the LLC, applying Nevada’s law to the real estate and activities that are located in Massachusetts. If they do, the claimant can collect only against the property in that series. If they don’t, the claimant can collect against the properties in other series as well. States are expected to give full faith and credit to legislation of other states, but the answer is uncertain. Exceptions do happen. It is also important to note that the American Bar Association did a review of series LLCs and declined to endorse them. You can be certain that future court cases will take note of this development.
Since the laws about creating series LLCs are different in every state that permits them, it might take a long time before enough case law is accumulated to give us any level of comfort about using them. If you want to make sure your assets have good, solid protection, it’s a much better idea to avoid corporate structures that don’t provide reliable protection. Avoid series LLCs as a form of protection until a definitive case law is established and rely instead on known, tested entities such as individual LLCs.