Series LLCs: the asset protection dream machines?

• Author: Bahena, Amanda J.
• Position: Limited liability companies

1. Introduction II. Background A. Series LLCs Defined 1. The Development of Series LLCs 2. Following Delaware's Lead: Series LLCs in Other States B. Asset Segregation in SLLCs C. Series LLCs and Unanswered Bankruptcy Issues D. Can a Series File for Bankruptcy? E. Will Bankruptcy Courts Allow Series Limited Liability? III. ANALYSIS A. Unincorporated Corporate Divisions in Bankruptcy B. Corporate Groups in Bankruptcy: Entity and Enterprise Law 1. Bankruptcy and Entity Law 2. Bankruptcy and Enterprise Law C. Liability within SLLCs Must Be Predictable: Four Possible Standards 1. The Importance of Predictable Liability i. Liability Is Important ii. Liability Must Be Predictable 2. Possible Standards for Liability Boundaries Within SLLCs i. Option 1: Impenetrable Boundaries Between Series ii. Option 2: Entity Law with Exceptions iii. Option 3: Enterprise Law iv. Option 4: No Boundaries Between Series in Bankruptcy IV. RECOMMENDATION A. Bankruptcy Courts Should Not Permit a Series to File for Bankruptcy Independently of Its SLLC B. Bankruptcy Courts Should Not Permit Series Limited Liability 1. Eliminating Series Limited Liability Improves Predictability and Fairness i. Series Engaging in a Common Business ii. Series External Integration iii. Series Internal Integration 2. Neither a Rebuttable Presumption of Limited Liability nor Enterprise Law Is Practical in SLLC Bankruptcies V. CONCLUSION I. INTRODUCTION

   In uncertain economic times, bankruptcy and asset protection become hot topics. Businesses begin looking for new ways to avoid bankruptcy and shield their assets from creditors if bankruptcy is unavoidable. The series limited liability company (SLLC) represents the growing popularity and increasing sophistication of asset protection strategies. (1) An SLLC has the potential to be the next evolutionary step in limited liability companies (LLCs). (2) An SLLC partitions its "assets, debts, obligations, liabilities, and rights among" separate series, or "cells." (3) Through this asset and liability segregation, the SLLC might provide the next business structure that helps businesses avoid bankruptcy and protect assets. (4)

   Throughout this Note, the hypothetical businesswoman, Julie, will highlight the potential benefits and unresolved legal issues of SLLCs. Julie wants to form a business to buy and sell Amazing, Boring, and Clunky widgets. However, she has two main concerns. First, given the state of the economy, demand for Boring widgets might be low for the next few years. Julie must sell both Amazing and Boring widgets, but she is afraid that low Boring sales will drive her business into bankruptcy. Julie is also worried that Clunky widgets might break and cause liability issues, driving her new company into bankruptcy. Julie's lawyer Lucy suggested forming an SLLC to decrease the risk of total bankruptcy. Julie is nervous. She knows that SLLCs are not yet widely used because of a number of unresolved legal issues regarding SLLCs. (5)

   Two related questions affect the value of an SLLC as an asset-protection mechanism in bankruptcy: (1) whether an individual series in an SLLC can file for bankruptcy, and if so, (2) whether bankruptcy courts will shield the wider SLLC from that series' liabilities. Part II of this Note introduces the SLLC and presents the unresolved issues regarding the treatment of SLLCs in bankruptcy. (6) Part III of this Note explains how a series in an SLLC is a hybrid between an unincorporated corporate division and a corporation in a corporate group. (7) It then summarizes the laws governing unincorporated corporate divisions and corporate groups in bankruptcy with a focus on entity and enterprise law as applied to corporate groups. (8) Finally, Part III concludes by explaining why it is important that series liability be predictable. (9)

   Courts can ensure that liability within SLLCs is predictable by defining the clear legal boundaries and legal entity status of a series within an SLLC. This Note presents four alternatives for how bankruptcy courts could treat series liability boundaries in bankruptcy. The four alternatives include establishing impenetrable boundaries, establishing a rebuttable presumption of separate entity status, using enterprise law to determine whether individual series are engaged in one "enterprise," or precluding liability boundaries in all circumstances. (10) Part IV of this Note recommends that bankruptcy courts not allow a series to file for bankruptcy individually, because a series is not a stand-alone legal entity. (11) It then recommends that if bankruptcy courts do allow a series to file individually for bankruptcy, that the courts not uphold series limited liability. (12) This approach will decrease litigation, improve predictability, and enhance overall fairness. This Note concludes that the detriments of using SLLCs for asset protection in bankruptcy far outweigh the benefits.

2. BACKGROUND

   SLLCs take the popular LLC to another level by providing the opportunity to segregate liability, control, and profit-sharing within a single entity. (13) This section summarizes the SLLC's history, legislation, current uses, and benefits, with a focus on the benefits of asset segregation. It then summarizes the unanswered bankruptcy issues surrounding the SLLC.

   1. Series LLCs Defined

      1. The Development of Series LLCs

         SLLCs evolved from asset-segregating business structures that have existed in offshore financial centers for decades. (14) Like its asset-segregating ancestors, an SLLC partitions its assets, debts, obligations, liabilities, and rights among separate series, or "cells." (15) In 1996, Delaware became the first state to enable the formation of SLLCs through the Delaware Limited Liability Company Act (DLLCA). (16) Delaware's SLLC legislation has since served as a model for other states. (17) Under Delaware law, an SLLC is formed by: (1) allocating the LLC's property, obligations, or assets among its series; (18) (2) setting forth in the operating agreement a method to maintain separate and distinct records for each series; (19) and (3) including a notice of the limitation of series liability in the master LLC's certificate of formation. (20) Furthermore, each series may designate its own class of members or managers, and each may set its own business purpose or investment objective. (21)

         An SLLC may prove an efficient alternative to traditional methods of separating assets and segregating risks, given the relatively low filing fees and legal costs required to establish each series. (22) Under the DLLCA, an SLLC series can, "in its own name, contract, hold title to assets ..., grant liens and security interests, and sue and be sued." (23) The DLLC also grants limited liability to series--the DLLCA limits the enforcement of "debts, liabilities, obligations and expenses incurred, contracted for or otherwise existing with respect to a particular series ... to that series only, and not against the assets of the [LLC] generally or any other series thereof...." (24) To obtain limited liability, the DLLCA requires series separateness and notice of limited liability; each series must maintain separate records of the assets it holds, and the LLC's certificate of formation must include a notice of the limitation of series' liabilities. (25)

         SLLCs were originally designed for use in asset securitization and the organization of investment companies. (26) Thus, in its most traditional and common application, a series is "an administrative subunit of an investment [LLC]," (27) such as a mutual fund. Legal uncertainties regarding SLLC liability shields are of less concern in this traditional context, which utilizes SLLCs for their administrative efficiencies (28) rather than their liability-protection capabilities.

         SLLC use is no longer limited to the "traditional" uses. SLLCs are also used by some estate planners to separate assets by beneficiary. (29) SLLCs may also be useful in real estate management and development to segregate various properties, or useful for businesses with multiple assets under different ownership, such as a taxi cab or mobile home business. (30) A series has even been utilized to own a personal speedboat. (31)

      2. Following Delaware's Lead: Series LLCs in Other States

         Seven states and Puerto Rico have since followed Delaware's lead and enacted legislation that enable the formation of SLLCs. (32) These states have closely modeled their laws after Delaware's SLLC legislation. However, the Illinois and Iowa statutes share a key difference. Unlike other SLLC states, Illinois and Iowa explicitly define a series within an SLLC as a "separate legal entity." (33)

         Notably, the Revised Uniform Limited Liability Companies Act (Re-ULLCA), which was approved for adoption by states in 2006, does not contain any SLLC provisions. (34) The Re-ULLCA drafting committee considered following Delaware and the other SLLC states, but ultimately rejected the notion of the SLLC. (35) The drafting committee explained their concerns:

         Originally devised by sophisticated Delaware lawyers for their "funds" clients, series are now being (mis)used to subdivide assets of operating businesses and to provide unwarranted hopes of low cost "asset protection." What's good for Delaware and highly sophisticated deals is not necessarily good for the LLC law of other states. (36) It will be interesting to see how many states agree with the concerns of the Re-ULLCA drafting committee.

         It is unclear how states that do not have SLLC-enabling legislation will treat foreign SLLCs. The full faith and credit provision of the U.S. Constitution generally requires state courts to recognize foreign SLLCs. (37) However, a state might refuse to recognize certain SLLC features if the state found an overriding public policy against those features. (38)

         To date, only one case has addressed the treatment of a foreign SLLC by a non-SLLC state. In GxG Management, LLC v. Young Bros. & Co., Inc., a federal...