Originally published in March 2016, Updated as of May 18, 2021
Most practitioners have now heard of “series” limited liability companies. Series companies (and series partnerships) have been around for quite some time now in Delaware and are becoming more familiar as series organization laws have been adopted in other states, including Illinois.
Having been an “early adopter” of the series LLC, we wanted to share some insights into where it is appropriate and (more to the point) inappropriate to use series organizations.
Our view is that the series company is a potentially complicated solution in search of a need that rarely exists.
Despite the apparent attractiveness of series organizations, on balance, there are usually more reasons to avoid them rather than to use them. Here are just a few:
1. Financing may be made more difficult due to lender unfamiliarity with series structures.
2. Licenses and permits issued by governmental authorities may be more difficult to obtain due to bureaucratic unfamiliarity with series structures.
3. Insurance coverage gaps may occur due to insufficient policy boilerplate and missteps in properly communicating insured parties.
4. Heightened risk of consolidation in a bankruptcy setting due to absence of case law.
5. Possible lack of limited liability when doing business in jurisdictions that do not have series laws.
6. General unfamiliarity by transactional counterparties can result in increased transaction costs (e.g., when a series is selling real estate, having to negotiate demands for guarantees by other series, dealing with gaps in title, etc.).
7. Employment and tort claims are more likely to “infect” affiliated series than separately organized affiliates due to a lack of case law and possible jury bias that a series may be just a dodge.
8. Lack of clarity in the tax treatment of certain series organizations. See the attached flowchart for the numerous ways a series organization can be viewed for tax purposes.
9. Difficulty of documentation. While forming a series organization is not difficult, drafting proper operating agreements for a series organization or individual series can be more complex and costly, with greater risk of defects in buy-sell and governance arrangements.
10. The client who is motivated to use series mainly to save annual filing fees is often the client most likely to shortcut formalities, resulting in increased vulnerability to “piercing of the corporate veil” or confusion in identifying the correct parties.
For these and other reasons, and despite having been an early user of series organizations, we tend to reject them more than we use them.
Where to Use?
In the middle market, we tend to use series organizations when we wish to achieve either greater commercial flexibility in the migration of assets to different series or when we are trying to simplify the implementation of complex tax planning structures.
We also like to use a series within the context of family limited liability companies, as estate planning can be done on a series-by-series basis. For example, if a family limited liability company has exchange-traded equities, bonds, and real estate within one family LLC platform, we may want to do gifting with the equities and real estate (which have more potential for appreciation) and not with the bonds (which may not be as likely to appreciate meaningfully). That targeted gifting effort is aided by a family LLC in series form.
Series organizations have also been used in segments of the financial services industry (e.g., where there is a separate series for each investment theme in a multi-themed hedge fund) and by insurance companies (as a way of isolating risks).
Tax Treatment of Series
In 2010, the Internal Revenue Service issued proposed regulations on series organizations.
Although the proposed regulations do not answer all questions, they provide a sensible framework for analyzing whether the series organization or a particular series (sometimes known as a “cell”) is a separate tax partnership or a disregarded entity.
What Do Series LLCs Look Like?
While the proposed regulations provide useful tax guidance, one should not think that all is now clear in the world of series organizations. Before you even get to the tax issue, consider all the types of ownership structures one can have with a series organization. Click this link for a chart that illustrates several iterations of series organizations with different tax results.
This just begins to scratch the surface of all the different ways to think about series organizations and the confusion that can be created.
Too Much of a Good Thing
And that is the gist of the problem. In terms of external commercial dealings, there continues to be considerable confusion about series organizations. An example is financing. A sophisticated lender with sophisticated counsel can get to the right place, but a less sophisticated lender with counsel who is not familiar with series organizations may not be able to see the path to limiting its recourse to the series that owns the property to be mortgaged and impose liability on the larger series organization or other series cells.
One of the more common reasons given for using the series organization is that it saves costs of forming separate LLCs. That is partly true, although in Illinois filing fees for an LLC that is authorized to create series is somewhat higher than the filing fees for an ordinary LLC, and each series that is formed involves a separate filing fee. Except in rather unusual situations where you may be creating dozens of series, the aggregate savings by using the series organization should not be material, and one must be realistic in assessing whether the apparent savings and filing fees are outweighed by the additional time and costs of setting up a proper series operating agreement, dealing with the attendant tax issues and the various commercial challenges that those series will face in the marketplace.