THE SERIES LIMITED LIABILITY COMPANY

ILLINOIS AND DELAWARE

By: Richard M. Colombik JD, CPA &

Linda Godfrey, JD, CPA

Richard M. Colombik & Associates, P.C.

www.colombik.com

The Delaware legislature created a new form of legal entity by amending their Limited Liability Company Act in 1996.1 This new entity was named is called "The Delaware Series LLC.” Nine years later, Illinois’ version of the series LLC became was effective on August 16, 2005.2

A “Series LLC” is a single limited liability company that is permitted to own multiple subsidiary limited liability companies or a “series’ of limited liability companies.. The Sseries LLC is required to be created in a state that allows classes or series LLC’s, but it can register to do business or own property in any state. An existing Illinois or Delaware LLC may be converted into a series LLC.3

Illinois and Delaware both require an Operating Agreement to form a series LLC. This is true even if only one member owns each of the series in the LLC. This operating agreement must create one or more series.4 The Delaware statute allows the series LLC members to add additional series within the LLC by amending the operating agreement. The Illinois LLC statute in Illinois allows the creation of a series by filing a Certificate of Designation for each series.5

The LLC operating agreement may create several series LLC’s for a variety of business objectives. In Illinois, each of these established series LLC’s will function as a separate entity unless an election is filed to not so function separately. they elect otherwise.6 In Delaware, the LLC and not the series will be treated as the legal entity.7

The operating agreement should establish the rights and obligations of the LLC members and managers. Classes or groups of members may be established in the LLC operating agreement whether it is an in both Illinois or and Delaware entity. These classes or groups of members established within the operating agreements, will have whatever rights the operating agreement provides for. gives them. The LLC operating agreement maycan also designate series of members, managers or LLC interests with separate rights and duties pertaining to specific LLC properties or obligations. Each series may also be allocated specific assets and have separate and distinct different members and managers.8

Each series of an Illinois series LLC may own hold title to assets, grant security interests, contract, sue and be sued, and have different managers and members. The Delaware statute, however, is silent on whether the series LLC is able to hold title to assets, grant security interests, contract, and sue and be sued. The Delaware Series LLC statutes state that the debts and liabilities incurred by one of the series LLC’s will be enforceable only against the assets of any of that specific series. only.9

Illinois and Delaware statutes do have specific similarities. These similarities are as follows:

are the same for the following. 1. A series LLC can make distributions to its members without taking into account the financial condition of the other series.

2.  If the total series LLC is insolvent, distributions can be made from a solvent series LLC.10

3.  A series LLC can be terminated without affecting the other series LLC’s.11

4.  Each series is a separate LLC within the LLC itself.

An event that causes a member to discontinue his association with a series LLC will not cause that member to terminate his association with any other of the series LLC’s unless the operating agreement states a contrary conclusionotherwise. Disassociation It will not terminate a that member's interest in the LLC or cause the termination of the series even if the member was the last surviving member associated with that specific series.12 Consent of the members, however, will terminate a series LLC at any time.

Illinois and Delaware also allow a foreign LLC that is properly registered to do business within their state if the LLC agreement establishes a designated series of members, managers or LLC interests and will also provide for the limitation of liability on a series LLC assets for the the debts, liabilities and obligations of a particular series. to the assets of that series.13

Asset Protection

A The series LLC can be an important legal tool for asset protection. For example, many corporations own and operate more than one business and many individual real estate investors own multiple properties titled under a single name or business entity. Any legal liability relating to one business or property may potentially endangers the other assets when a single owner has dominion, control and ownership of such assets. owns them. Generally, most owners of related businesses and or real estate investors with several properties attempt to separate or segregate ownership so that lawsuits against one business or property will not endanger the owner's other investments. This liability separation generally requires means creating a separate and distinct new entity to own each business or each property. This mMultiple entity ownership may can become complex, paperwork intensive, as wellicated as nd expensive when the as the businesses expand or prosper. grow. A The series LLC may help resolve these issues with the creation of one LLC and the creation and election of an underlying series of LLC’s..

One of the major characteristics of the series LLC is the ability of each separate series to insulate protect property from liabilities incurred in or against any other series in the LLC. The existence of a separate series will protect the series LLC's other assets and the other series LLC’s assets from claims against a specific, given series. It will ould also protect the assets of the various series LLC’s from general claims against the series LLC. Both the Delaware and Illinois Statutes state that t

he assets of a specific series LLC14 are protected from enforcement action against the assets of the Series LLC or any other series LLC if the LLC operating agreement provides for all of the following:

·  the operating agreement creates one or more series,

·  separate and distinct records are maintained for each series,

·  the assets associated with each series are held (directly or indirectly, including through a nominee or otherwise) and accounted for separately from the other assets of the limited liability company or any of the other series,

·  the operating agreement provides that the liabilities of each of the series will be separate and accounted for separately,

·  notice of the limitation on liabilities of a series isare stated within the articles of organization of the limited liability company, and

·  the limited liability company has filed a certificate of designation for each series which is to have limited liability under the appropriate is Section.15

An important requirement of the Illinois and Delaware Series LLC statutes that must not be ignored is the requirement that each of the series keep separate records with distinct financial accounting information for each series. If the funds money of different series are is commingled, or if books and records are consolidated or not distinct confused, a creditor may have an s argument that the Series LLC does not provide an asset protection if the money of a separate series is commingled, or the records are consolidated or confused. , Aa creditor may have a compelling argument that the Series LLC did not provide asset protection since it they did not follow the statutory requirements. of the statute. The series LLC’s accountant and CPA (preferably their CPA) must be informed of and required to follow the appropriate statute, in this instance, Illinois or and Delaware and be made aware of the specific and separate accounting requirements.16

The Illinois LLC Statute also provides states that each series LLC may independently contract, hold title to assets, grant security interests, sue and be sued, and otherwise conduct business and exercise the powers of a limited liability company.17 This is a separate legal entity for ownership purposes. The Delaware LLC Statute only states the assets and liabilities are segregated for each series LLC.18 The Delaware LLC Statute is silent on the series LLC being a separate legal entity for ownership purposes.

Possible Uses of the Series LLC

A Series LLC may hold multiple parcels of real property and thereby obtain segregated in liability segregated for each parcel. series LLC’s. This is a more efficient and less expensive technique then creating, filing, and maintaining several different LLCs to segregate separate property ownership and provide liability insulation.. As noted above, the Illinois LLC statute allows each series LLC to hold title to its own assets.19

A business with multiple divisions, for example, may could et up each division as a separate series LLC. form an equity compensation program. Each division could be separated into a separate series LLC’s. This could give the designated employees of each series LLC an equity interest tied to that series, if such a compensation structure and segregation was beneficial to the underlying owners. This may would also allow a the business to reward the employees at productive divisions and protect the same employees from the possible downsides of other divisions through segregated compensation structures and tiered ownership interests..20

An operating business that owns real estate used in their operation could benefit from a Series LLC. The business could form or merge into a Series LLC. One series LLC cwould own the real estate and a second series LLC cwould operate the actual business. Theoretically, the liability incurred by the business operations series would not endanger the real estate assets held within the series.21

A Series LLC may be also used to facilitate combining business operations. One example is instead of a traditional merger, the companies would form a Series LLC. The owners of each of the companies would contribute their ownership interests or assets to separate series LLCs. The LLC operating agreement would be drafted to state specifically which rights and responsibilities will be shared and which are to be maintained separately.22

Unfortunately as the series LLC is still a new business entity there is a dearth of case law and even less current tax law on point for guidance. It will be forthcoming as this type of structure becomes used more frequently and more productively by business and personal interests.

Federal Taxation
In order to determine how the series LLC will be treated for federal income tax purposes, we must look at the entity classification regulations contained within IRC under §7701 and the treasury regulations therein.23 These treasury regulations provide allow an “eligible entity” may to elect their federal taxation classification.24 To determine There are three elements necessary to determine what an “eligible entity” is, one must examine the three part test.

. The first test element is that the series LLC must be an “entity.; The second test is that ”; second, the “entity” must be a “business entity”. The third test is ; and third, thethat the “business entity” must not be a “per se” corporation. A Normally, the series LLC is not generally deemed to would not be a “per se” corporation.25

Lets examine these federal tax issues.

Entity

Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.26 While there is no specific definition of the term “entity” in the Code or regulations, the courts and the IRS usually have treated an organization as an “entity” if the organization changes the legal and economic relationship between the owners of the organization and their assets.27. When an the LLC is treated as the owner of the series for federal tax purposes, the federal tax consequences are essentially the same whether the series is a separate entity or not. In either case all of the assets and liabilities of the series are treated as owned by the LLC.28. If an LLC series is considered owned directly by the LLC members, then whether that series is a separate entity should rest on the effect that creating the series had on the legal rights and obligations of the LLC owners. The creation of a series should generally alter the legal rights.29

The Delaware LLC statute states that the parent in a series LLC is a separate legal entity.30 But the statute is silent on whether each series is a separate legal entity.31 The Delaware statute does not provide a series LLC with the authority to contract, hold title to assets, grant security interests, and sue or be sued.32 These rights and obligations are important in determining whether the series LLC is a separate entity.33

The Illinois series LLC creates its own existence by filing a separate certificate of designation and can register to do business under its own name.34 The Illinois statute is very clear on whether the series LLC is a separate entity. The statute states, “A series with limited liability shall be treated as a separate entity to the extent set forth in the articles of organization.”35 The statute further then states that the series LLC “may, in its own name, contract, hold title to assets, grant security interests, sue and be sued and otherwise conduct business and exercise the powers of a limited liability company under this Act.”36

Business Entity

The next determination is whether the series LLC series is an independent “business entity.” A “business entity” is defined as any recognized entity that is not classified as a trust or subject to special tax treatment for federal tax purposes.37 Morrissey v. Comr., 296 U.S. 344 (1935).Morrisey38 and Commissioner. V. Culbertson Culbertson39 are the two significant cases that explain the application of the entity classification regulations. In Morrissey, id v. Comr. 296 U.S. 344 (1935), the Supreme Court distinguished a trust from an association based on the purpose of the entity. The court stated the purpose of a trust is to hold and conserve property and the purpose of an association is to provide a vehicle for conducting business and sharing its gain. In Comr. V. Culbertson, 337 id, U.S. 733 (1949), the court held that a partnership must be respected if the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise. According to Morrisey and Culbertson, the entity will be considered a “business entity” if it meets the following two objectives: (1) be a profit making business, and (2) not simply protect or conserve property as in a trust.40