The Series LLC, and a Series of Difficult Questions

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1 University of Arkansas, Fayetteville From the SelectedWorks of Carol Goforth 2007 The Series LLC, and a Series of Difficult Questions Carol Goforth Available at:

2 The Series LLC, and a Series of Difficult Questions Carol R. Goforth* In the past two and one half decades, the statutory law applicable to business associations in American jurisdictions has undergone a plethora of changes.' Most states have gone from a statutory regime in which there were four prevalent business models (the sole proprietorship, the general partnership, the 2 limited partnership, and the corporation), to one in which there are at least two additional statutory options and as many as five new choices in some jurisdictions. 3 Every state now offers the * Clayton N. Little Professor of Law, University of Arkansas School of Law; Professor, University of Arkansas, Clinton School of Public Service. I. This article will focus on state statutory developments, although one of the most significant changes in law applicable to business associations in the past few years occurred in 1997, when the I.R.S. changed from the corporate resemblance test to the current check the box approach. Compare Treas.Reg (a)(1) (1960) with Treas. Reg to -3, 26 (1997). 2. Of course there were additional statutory options for specialized businesses. There were real estate investment trusts (REITs), cooperatives, non-profit and professional corporations, and it was possible for corporations organized under state law to elect different tax status under either subchapter C or S of the Internal Revenue Code. In addition, a few adventurous states had adopted statutory close corporation statutes, although these appear to have been seldom utilized. The vast majority of American businesses, however, were organized as either sole proprietorships, general or limited partnerships or corporations, and most of the statutes applicable to these organizational forms had been relatively constant for many years. 3. In the past few years, Arkansas has adopted provisions authorizing several new business forms. LLCs were authorized in 1993 by the Small Business Entity Tax Pass Through Act Ark. Acts 1003 (codified at ARK. CODE ANN to (Repl. 1999)). LLPs were originally authorized in Arkansas in 1997, with an act that amended the existing general partnership statute in the state Ark. Acts 912 (relevant provisions codified at ARK. CODE ANN , 401, 606, 608, 612 and (Repl. 1999)). LLLPs were also permitted by these 1997 amendments to the then-existing general partnership statue and some additional provisions that were inserted into the Arkansas Revised Limited Partnership Act of See ARK. CODE ANN , 1110, 1201 (Repl. 1999)). In addition, in 1999 Arkansas adopted an entirely new general partnership act Ark. Acts 1518 (codified at ARK. CODE ANN to (Repl. 2001)). In 2007, Arkansas replaced its limited partnership act as well Ark. Acts 15 (codified at ARK. CODE ANN to (Supp. 2007)).

3 386 ARKANSAS LAW REVIEW [Vol. 60:385 statutory option of the limited liability company (LLC) 4 and limited liability partnership (LLP) 5 in addition to the four traditional business models listed above. Some also offer the 6 limited liability limited partnership (LLLP), and/or statutory business trust, and perhaps the newest statutory option, the series LLC. 8 This article will explain what a series LLC is, what the potential benefits of the form of business might be and why Arkansas might choose to adopt a statute authorizing this innovation, and the potential risks and problems associated with it. The ultimate conclusion of this article is that Arkansas would be well advised to wait before pursuing series LLCs as a statutory option, and that Arkansas practitioners should not rush to utilize this alternative for their clients, either through domestication of foreign series LLCs or our statute, if and when it is amended to permit this option. WHAT IS A SERIES LLC? As with many other business developments, Delaware was the innovator with respect to the series LLCs, adopting the first 4. See, e.g., Susan Pace Hamill, The Origins Behind the Limited Liability Company, 59 OHIO ST. L.J. 1459, (1998) (noting that "[t]he rise in the number of business organizations filing to operate as LLCs mirrored the meteroic pace of state statutes"). 5. For a thoughtful discussion about the usefulness of LLPs, see M. Shaun McGaughey, Limited Liability Partnerships: Need Only Professionals Apply?, 30 CREIGHTON L. REV. 105 (1996). 6. A nice discussion of all of these business forms, as well as the jurisdictions in which they have not been authorized, appears in Rutledge, To Boldly Go Where You Have Not Been Told You May Go: LLCs, LLPs, and LLLPs in Interstate Transactions, 58 BAYLOR L. REV. 205 (2006). 7. See Robert H. Sitkoff, Trust as "Uncorporation": A Research Agenda, 2005 U. ILL. L. REV. 31, & n. 22 (listing 29 state statutes dealing with business trusts). 8. As of the date that this article was written, seven states had statutes authorizing series LLCs. Those seven states are Delaware, Illinois, Iowa, Nevada, Oklahoma, Tennessee, and Utah. See DEL. CODE ANN. tit. 6, (2007); 805 ILL. COMP. STAT. ANN. 180/37-40 (West 2007); IOWA CODE ANN. 490A.305 (West 2007); NEV. REV. STAT (2007); OKLA. STAT. ANN. tit. 18, (West 2007); TENN. CODE ANN (2007); UTAH CODE ANN. 48-2c-606 (2007). Note that, as with the LLP and LLLP, the series LLC is not described in a freestanding statute, but rather has been authorized by including special provisions in the basic statute. Thus, just as LLPs are authorized via the inclusion of special language in the general partnership acts, and LLLPs through language in the limited partnership statutes, states that have enacted series LLC provisions have done so by amending their general LLC statutes.

4 2007] SERIES LLC 387 provision authorizing series LLCs in Under Delaware law, an LLC that observes the statutory requirements for this new form of business can set up distinct series of ownership, management and economic rights, where each series owns and controls specific assets, and as to which liability is limited. This means that each series can operate independently of other series, and that members who participate in different series of assets may have different economic rights from members participating in other series. Moreover, financial losses and liabilities suffered by one series, or even by the LLC itself, should not affect the financial situation of the other series. With appropriate planning and documentation, it should even be possible to shift assets and ownership interests among the series. Delaware law specifies that when an LLC establishes series in its operating agreement "any such series may have a separate business purpose or investment objective."' 0 The statute also provides that, so long as the LLC satisfies certain procedural requirements, "the debts, liabilities and obligations and expenses incurred, contracted for or otherwise existing with respect to a particular series shall be enforceable against the assets of such series only, and not against the assets of the limited liability company generally or any other series thereof...."1 In addition, even if the LLC itself is insolvent and would not be allowed to make a distribution under the Delaware LLC Act, 12 a distribution can be made from a series to the extent that the fair value of series' assets exceeds its liabilities. 13 The series LLC provision also includes a number of subsections explaining how series are to be managed, operated 9. DEL. CODE ANN. tit. 6, (2007). Of the six other states, which as of the date of this article have adopted series LLC provisions, five clearly modeled their statutes on the Delaware approach: Iowa, Nevada, Oklahoma, Tennessee, and Utah. See IOWA CODE ANN. 490A.305; NEV. REV. STAT ; OKLA. STAT. ANN. tit. 18, ; TENN. CODE ANN ; UTAH CODE ANN. 48-2c-606. On the other hand, Illinois has taken a different approach, with a statute which includes specific separate-entity provisions not found in the Delaware model. See 805 ILL. COMP. STAT. ANN. 180/ There are also a number of other jurisdictions with LLC statutes that authorize series or classes of membership, but these do not include limited liability to protect the assets of each separate series from debts arising out of other series or the LLC itself. 10. DEL. CODEANN. tit. 6, (a). 11. DEL. CODE ANN, tit. 6, (b). 12. DEL. CODEANN. tit. 6, (a). 13. DEL. CODE ANN. tit. 6, (h).

5 388 ARKANSAS LAW REVIEW [Vol. 60:385 and dissolved. With regard to management rights, the statute states that unless the LLC agreement provides otherwise: the management of a series shall be vested in the members associated with such series in proportion to the then current percentage or other interest of members in the profits of the series owned by all of the members associated with such series, the decision of members owning more than 50 percent of the said percentage or other interest in the profits controlling. 4 As for dissociation of members, if for any reason a member ceases to be associated with a series, that event will not, by itself, "cause such member to cease to be associated with any other series or terminate the continued membership of a member in the limited liability company or cause the termination of the series" even if that member was the sole remaining member of the particular series. 15 A separate series can be "terminated and its affairs wound up without causing the dissolution of the limited liability company."' 6 Finally, a series is terminated upon the dissolution of the LLC or upon the first to occur of the following: 1. The time specified in the LLC agreement. 2. The happening of events specified in the LLC agreement. 3. On the affirmative vote of the members associated with such series. 4. By decree of the Court of Chancery where requested by a member or manager of a series when "it is not reasonably practicable to carry on the business of the series in conformity with a limited liability company agreement."' 7 The Delaware statute does not, however, provide that each series is a legal entity distinct from the original LLC. While Delaware has provided the model for most other states with series LLC provisions, Illinois decided on a slightly different approach. In rather stark contrast to Delaware, the Illinois statute explicitly provides that each series will be 14. DEL. CODE ANN. tit. 6, (f). 15. DEL. CODE ANN. tit. 6, (i). 16. DEL. CODE ANN. tit. 6, ). 17. DEL. CODE ANN. tit. 6, ).

6 2007] SERIES LLC 389 "treated as a separate entity to the extent set forth in the articles of organization.'"' 8 In connection with this status as distinct operational entities, under the Illinois statute, "[e]ach series with limited liability 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." 19 In very general terms, whether one is looking at the Delaware or Illinois model, the series LLC is designed to allow the owners of an LLC to segregate activities or assets from each other for liability purposes. The reasons behind this should be fairly obvious; they are precisely the same reason why a single shareholder or shareholder group might set up multiple corporations to manage different assets or operations, or why a holding company might be set up with a number of operational subsidiaries, or why members might set up multiple LLCs to accomplish the same objectives. The obvious question is how would this work in the case of the series LLC? Essentially the LLC itself would establish the distinct series, in accordance with the statutory requirements, and then the assets and operations of each series should, at least in theory, be protected from liability arising out of debts incurred by other series, or even the LLC itself. Obviously, one would need to carefully examine the specific statutory provision authorizing series LLCs to know what the statutory requirements would be, but given the prevalence of the Delaware model, it makes sense to start with that statute to get a general idea of is likely to be required. First, it should be kept in mind that series LLCs are not authorized by free-standing statute like typical corporate or general partnership acts. Rather, like provisions authorizing LLPs and LLLPs in most jurisdiction, the series LLC statutes to date have been specific provisions embedded into existing LLC ILL. COMP. STAT. ANN. 180/37-40(b) ILL. COMP. STAT. ANN. 180/37-40(b); see also Charles T. Terry & Derek D. Samz, An Initial Inquiry Into the Federal Tax Classification of Series Limited Liability Companies, 110 TAX NOTES 1093 (2006). Professor Terry, who was a co-author of the Illinois Act, notes in this articles that the language of the Illinois statute was intended to lead to "one logical conclusion": that distinct series "are definitely business entitles separate from the parent LLC and should be treated as such for federal tax purposes." Id. There is no equivalent language in the Delaware statute, nor any legislative history suggesting that this was the intent behind the Delaware provisions.

7 390 ARKANSAS LAW REVIEW [Vol. 60:385 statutes. Thus, most of the provisions concerning the establishment and operation of a series LLC are found in the general LLC statute of the state. There are, however, some very specific exceptions to this, as the embedded provisions note that compliance with the series LLC provision essentially "trumps" the usual rules. 20 Although it is not the first item listed in the series LLC provision, it appears that the initial requirement for a series LLC in Delaware is that the LLC's certificate of formation must include "notice of the limitation on liabilities of a series." 21 Technically, this notice is only required if the series is to be afforded the protection of limited liability, but since this is the central justification for the creation of series LLCs, it seems clear that this is the essential first step. In addition, the statute makes it clear that this step can be taken "whether or not the limited liability company has established any series when such notice is included in the certificate of formation...,,22 To make this possible, the statute also says that "there shall be no requirement that any specific series of the limited liability company be referenced in such notice." 23 The statute requires no information about the specific series that an LLC has or might have, and there is no need to include in the certificate of formation any notice about what assets or operations are associated with any such series. Assuming that the certificate of formation properly includes this general notification that liability of the series is limited, the first of the operational requirements listed in the statute is that the LLC agreement must establish or provide for one or more series. 24 No exact language is required, and the statute does not provide limits on the number or kind of series that may be established in an LLC's agreement. In fact, the preceding subsection allows each series to have "separate rights, powers or duties with respect to specified property or obligations of the limited liability company or profits and losses 20. The first sentence of the statute begins with the words: "[n]otwithstanding anything to the contrary set forth in this chapter or under other applicable law... DEL. CODE ANN. tit. 6, (b). 21. DEL. CODE ANN. tit. 6, (b). 22. DEL. CODE ANN. tit. 6, (b). 23. DEL. CODE ANN. tit. 6, (b). 24. DEL. CODE ANN. tit. 6, (b).

8 2007] SERIES LLC 391 associated with specified property or obligations," and also permits any series to "have a separate business purpose or investment objective. 25 The second procedural requirement is that for each series: separate and distinct records are maintained.., and the assets associated with any such series [must be]... held in such separate and distinct records (directly or indirectly, including through a nominee or otherwise) and accounted for in such separate and distinct records separately from the other assets of the limited liability company, or any other series thereof. 26 While one might wonder what it means to hold assets in separate and distinct records, presumably this merely requires that the assets actually be held in accordance with the records. There is no statutory guidance on how detailed the records must be, or precisely what it means to have assets "accounted for" separately. While there are other optional provisions, such as those relating to the management of each series, these simple steps will suffice to create a series LLC under Delaware law, and in the states that have modeled their statues after this prototype, there are few dissimilarities. As previously mentioned, Illinois includes different language relating to the effect of forming a series LLC. 27 In addition, although it is clearly modeled after the Delaware provision, it includes different rules regarding the formation of each series. The first difference appears in the requirement that, in order to obtain limited liability for each series, the series LLC must file "a certificate of designation for each series which is to have limited liability., 28 In addition, the statute requires that "[t]he name of the series with limited liability must contain the entire name of the limited liability company and be distinguishable from the names of the other series set forth in the articles of organization. '' 29 In addition, the statute requires very specific information to be filed about each series, making it clear 25. DEL. CODE ANN. tit. 6, (a). 26. DEL. CODE ANN. tit. 6, (b). 27. See supra notes and accompanying text ILL. COMP. STAT. ANN. 180/37-40(b) ILL. COMP. STAT. ANN. 180/37-40(c).

9 392 ARKANSAS LAW REVIEW [Vol. 60:385 that it is not anticipated that a general filing will suffice to create series. For example, "[i]f different from the limited liability company, the certificate of designation for each series shall list the names of the members if the series is member managed or the names of the managers if the series is manager managed., 30 In addition, if the name of the series, or the members or managers with management authority are to change, an amendment must be filed. 31 As mentioned above, the Illinois statute also contains different rules regarding the effect of forming a series, with specific statutory language apparently intended to insure that each series is a different business entity. 3 Whether one is contemplating the Delaware model or that proposed by the Illinois statute, it is clear that a series LLC is an intriguing notion, designed to simplify the process by which a business can segregate assets or operations for business purposes. While the Delaware model clearly requires less in the way of filings and formalities to form a series LLC, both approaches may avoid some of the red tape normally associated with the formation of multiple business entities. WHAT ARE THE POSSIBLE BENEFITS TO THE SERIES LLC? Having been virtually inundated with new business forms, including the LLC itself, one might wonder why any legislature ILL. COMP. STAT. ANN. 180/37-40(d) ILL. COMP. STAT. ANN. 180/37-40(d). 32. See supra note 19 and accompanying text. The statutory language may not be as clear cut as was apparently intended, since it provides that "[a] series with limited liability shall be treated as a separate entity to the extent set forth in the articles of organization." 805 ILL. COMP. STAT. ANN. 180/37-40(b). It is not clear what would happen if the articles provide for a limitation on liability but also claim to be part of an integrated entity. While the statute also says each series "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," this may be interpreted to be an optional rather than mandatory provision. 805 ILL. COMP. STAT. ANN. 180/37-40(b). This possibility is bolstered by the next sentence of the statute, which says that: The limited liability company and any of its series may elect to consolidate their operations as a single taxpayer to the extent permitted under applicable law, elect to work cooperatively, elect to contract jointly or elect to be treated as a single business for purposes of qualification to do business in this or any other state. 805 ILL. COMP. STAY. ANN. 180/37-40(b).

10 2007] SERIES LLC 393 has felt or would feel the need to enact such legislation or why any over-worked business attorneys might recommend this new form of operation to their clients. The truth is, however, that there are some very intriguing potential benefits associated with this new form of enterprise. 33 As mentioned above, the primary justification for the series LLC is to allow owners of an LLC to segregate activities or assets for liability purposes. In order to make this a little more clear, it might be worthwhile to provide some examples of how this might work in practice. Suppose for example, that one of your clients owns a number of New York taxi-cabs. As anyone who has ever had the dubious pleasure of riding in such a vehicle is likely to be aware, it is all too likely that at one time or another, the cab will be in some sort of accident. Some of those will be the fault of the driver of the cab, and predictably, some of those accidents will be serious. This can involve potentially substantial liability not only for the driver, but also for the owner of the cab, under the doctrine of respondeat superior. 34 To insure that an accident by one cab driver does not jeopardize the personal assets of the business owner, traditionally corporations were established. And to insure that a single accident by a single driver did not wipe out all corporate assets, it was not uncommon to set up a series of corporations to limit liability. 35 Limited liability companies have served the same function, allowing even greater drafting flexibility and the potential advantages of partnership taxation for owners. In a jurisdiction with series LLCs, instead of setting up a large number of different enterprises, a single LLC could be established, and it, in turn, could set up distinct series, each owning different vehicles. Although there might be 33. One of the commentators who urged Nevada to adopt series LLC legislation simply concluded that such a move "would enable Nevada to continue to develop its reputation as a business-oriented state and to keep pace with other business friendly states, such as Delaware." Julia Gold, Series Limited Liability Companies-Too Good to Be True?, NEV. LAW. July 12, 2004, at 18. While this may itself be one reason to enact legislation, the real question ought to be why the legislation might in fact benefit business, and that is the question addressed here. 34. See generally RESTATEMENT (THIRD) AGENCY 2.04 (2006) (explaining that "[a]n employer is subject to liability for torts committed by employees while acting within the scope of their employment"). 35. In Walkovsky v. Carlton, 223 N.E.2d 6 (N.Y. Ct. App. 1966), this basic fact pattern led the business owner to set up multiple sister corporations.

11 394 ARKANSAS LAW REVIEW [Vol. 60:385 other advantages to this set-up, 36 the primary advantage for the owner would be the simplicity of having a single business entity and the reduced expenses associated with setting it up, while still providing a limitation on liability. Another example would be any business that is or plans on diversified activities. A business that plans on research, manufacturing, distribution, and retail might well want to set up different series for each of those distinct functions. This is the kind of situation where a holding corporation with multiple subsidiaries would have worked in the past, and in fact could continue to work today. Another alternative would be to set up multiple LLCs. The LLCs could be owned directly by the members, could be set up with one LLC acting as the parent, or could be set up as a partnership of LLCs with one acting as the managing partner of the group of businesses. In any of these cases, however, a series of business would have to be formed and appropriately documented, with the attendant expenses associated with such efforts. In a jurisdiction permitting series LLCs, a single LLC could be formed, and then the different operational activities could be set up as series. A third possible example might be found in the area of estate planning. Through a series LLC, a wealthy client could have his or her attorney set up a single document to control management and ownership of substantial, diversified assets. The cost of drafting a single document might be less than that associated with the paperwork needed to set up multiple operations, and the client might find it easier to deal with a single document than with several different ones. A fourth potential area where series LLCs might be a boon would be for professional operations that provide services in multiple jurisdictions. Limiting malpractice liability for professionals to the states in which they actually practice could be substantially advantageous to legal, medical, dental, or other 36. For example, a series would make it easy to provide ownership incentives for individual drivers. They might be given an interest in the series in which "their" cab is placed, which could potentially increase their interest in a safe driving record. This, of course, could be accomplished through the vehicle of multiple entities as well, but the cost of documenting the transactions might be reduced in the case of different series rather than different businesses.

12 2007] SERIES LLC 395 professionals who participate in large scale operations that offer services in multiple jurisdictions. Actually, the potential examples of where a series LLC might provide advantages is essentially limitless. Any time a business owner has a business with a variety of assets, operations, or where there are multiple owners who may have different stakes in different parts of the enterprise, a series LLC might make sense. That is, if it works as intended. WHAT ARE THE POTENTIAL PITFALLS TO THE SERIES LLC? The series LLC has an apparent simplicity which is intriguing. Why not have a single business that allows segregation of assets or operations? If we allow owners to accomplish the same thing with multiple limited liability entities, why shouldn't we simplify matters? Intuitively, a single business should involve less expense, less paperwork, less overhead, and be simpler to operate than a multiplicity of businesses. This all sounds good so far. The potential problems are a little less obvious. First, would it really be less expensive to form a series LLC? The starting point for this discussion might well be with filing fees. 37 It might at first seem that it would always be cheaper to form one LLC with multiple series than to create multiple LLCs. This may not, however, be universally true. First, in a jurisdiction that requires specific and distinct filings for each series in an LLC, such as Illinois, the filing fees associated with forming the LLC and each series, and then amendments each time the management of a series changes, plus annual filings, might be as expensive or even more so than those associated with multiples LLCs. One commentator has noted that since filing fees vary so much from jurisdiction to jurisdiction, for certain kinds of operations, it might actually be cheaper to form multiple foreign LLCs than a single domestic one with attendant series, depending on whether the activities are extensive enough to require domestication. 38 Regardless, 37. There may actually be a substantial disincentive to series LLCs in some states. 38. Lin Hanson, LLC Potpouri, 93 ILL. B.J. 646 (Dec. 2005) (noting that the Illinois LLC statute permits foreign LLCs to conduct business such as owning real or personal property (citing 805 ILL. COMP. STAT. ANN. 180/45-47(a)(7) (West 2007))).

13 396 ARKANSAS LAW REVIEW [Vol. 60:385 filing fees are a relatively small part of the start up costs for new businesses, and not one that seems certain to provide significant financial advantages to business owners. A more significant cost associated with business formation is likely to be in document preparation. Again, at first blush, it might seem that the legal expenses associated with preparing appropriate documentation to establish a single LLC with multiple series should be less than that associated with multiple different LLCs. This might, however, be wishful thinking. Especially for the first several years, as issues are being worked out and practitioners seek to gain familiarity with the concept of series businesses, the complexity of drafting the operational documents for the series LLC, plus the independent agreements that will govern each of the series, might actually be more than that associated with drafting separate LLC operating agreements, particularly if the LLC agreements mirror one another in most important respects. In addition, in jurisdictions such as Illinois, add to the cost of document preparation the cost of preparing the filings required for each distinct series. As for the notion that a series LLC might reduce paperwork and the burdens associated with administrative overhead, this too seems to be an unrealistic hope. In fact, the series LLC offers no realistic benefits here, as one of the prerequisites for limited liability in every jurisdiction that authorizes series LLCs is that assets be segregated and separately accounted for, and that separate records be kept. Thus, just as multiple businesses are more expensive to operate from an administrative standpoint that a single enterprise, so too would be multiple series within a single LLC. So far, however, all that this suggests is that there is less of a financial or administrative incentive for forming series LLCs than might first appear. This does not mean that there is a significant disadvantage associated with this new business form; just that one kind of potential advantage might be less than one might hope for. Greater problems are presented by a variety of issues that involve greater potential risks associated with series LLCs, risks which might be eliminated or reduced with multiple enterprises. For example, how certain is the protection against limited liability offered by series LLCs? If the real benefit associated with series LLCs is protection against unlimited

14 2007] SERIES LLC 397 liability as between series, potential problems with this limitation on liability could be a major disadvantage, especially as compared with the formation of multiple LLCs, where the risks are fairly well understood. And, in fact, there are some very troubling issues centered on the notion that series LLCs will provide protection against the risk of loss. The most obvious problem at this point in time is the fact that so few states have adopted series LLC legislation. Most businesses, whether they involve good or services, touch on interstate commerce, and even where operations are centered in a single jurisdiction, it is often all too foreseeable that injury might be done that could result in out-of-state litigation, and the laws of that other state being applied. A restaurant could serve contaminated food that is taken and consumed in elsewhere, causing injury to the consumers in a state that does not explicitly recognize series LLC. A manufacturing concern could produce defective products that are distributed to, sold in and/or cause injury in a state that lacks series LLC legislation. A doctor could provide incompetent medical assistance to the resident of a foreign jurisdiction, and the complications could manifest in that a state where the LLC statute is silent on this issue. Choice of law rules might well result in the laws of the other jurisdiction applying, 39 raising the issue of whether the courts of the second state would respect the internal shields against liability that appear to be provided for in series LLC statutes. This issue goes away, of course, if every state adopts series LLC legislation, but at the moment there appears to be no such trend. Even the drafters of the Uniform LLC Act declined to include such language in their recently proposed model statute. 40 As of the date this was written, the majority of LLC statutes provide that the law of the state of formation controls the 39. It has been claimed that there are, in fact "a great many cases involving the liability, on the ground of negligence, of the manufacturer of a product alleged to have caused injury, in which... courts have looked to the law of the place where the injury in question was sustained." R.D. Hursh, What Law Governs Liability of Manufacturer or Seller for Injury Caused by Product Sold, 76 A.L.R.2d 5[b] 130 (Orig. Pub. in 1961, Cum Supp). For a more complete discussion of the extent to which states are required to respect limited liability authorized by the statutes of another jursidiction, see Rutledge, supra note See REVISED UNIFORM LIMITED LIABILITY COMPANY ACT, Prefatory Note (Nat'l Conference Comm'rs Unif. State Laws 2006), archives/ulc/ullca/2006actfinal.htm.

15 398 ARKANSAS LAW REVIEW [Vol. 60:385 liability of members of a foreign LLC, 4 1 but this does not address the question of whether some assets of the LLC (those that are held in distinct series) should be protected again liability of the LLC or another of its series. This is quite different than the idea that members' liability is generally to be governed by the law of the place where the LLC was formed. While it is not certain that the law authorizing limited liability for series LLCs would be disregarded, this is clearly a risk associated with series operations that would not exist for separate enterprises. In addition to the problems associated with the risk of being sued in states where the statutes do not recognize series LLCs, there are other major uncertainties associated with utilizing series LLCs rather than multiple business forms. For example, to date, there are no reported decisions addressing the status of series LLCs in bankruptcy. The issue is therefore how bankruptcy courts will treat an LLC when one series becomes involved in bankruptcy proceedings. Unless and until bankruptcy law recognizes series as separate legal entities, bankruptcy of a single series might well jeopardize assets of the LLC and the other series as well. If a bankruptcy court consolidates the assets and liabilities of the series, the anticipated benefits of limited liability between the series would disappear. This is a risk that could be avoided with a group of properly formed and operated LLCs, making the series LLC a riskier business proposition. Series LLCs might also be more prone to piercing. "Piercing" is short hand for piercing the veil of limited liability, and applies when courts disregard statutorily authorized limited liability in business enterprises in order to allow business creditors to access assets of owners or sometimes related entities. Traditionally applied in the corporate context, courts have sometimes proven willing to pierce the veil of limited liability offered to owners of a business when the owners themselves fail to respect the enterprise as a distinct legal 42 entity. The traditional test for piercing in a corporate context 41. This is also the approach taken by the recently promulgated Uniform LLC Act, recommended for adoption by NCCUSL in June of See id Actually, it is almost impossible to articulate an accurate test for when the veil of limited liability will be pierced. Frank Easterbrook and Daniel Fischel declared in the mid- 1980s that veil piercing "seems to happen freakishly. Like lightning, it is rare, severe, and

16 20071 SERIES LLC 399 has been formulated in a variety of ways, often asking whether the corporation is so controlled by its owners that it has become the mere alter ego or instrumentality of the owners. 43 If, for example, the owners fail to observe corporate formalities and treat the corporation less formally than the statutes require, creditors may also be allowed to disregard the corporate entity. Many states, when faced with the question of whether to allow members of an LLC to be held personally liable for the debts of the enterprise, have turned to the corporate law analysis. 44 Although most jurisdictions appear to cite to and rely on precisely the same analytical framework for LLCs and corporations, one empirical study suggests that members in LLCs are less likely to face personal liability than their counterparts in closely held corporations. 45 This may be due to the fact that there are so few formalities associated with LLCs, especially when compared with corporations, and because failure to observe formalities is often associated with piercing in the corporate context. 46 What, then, if we turn away from a group of distinct LLCs to a series LLC? The biggest problem now is that there are no reported decisions dealing with this question. We simply do not know unprincipled." Frank H. Easterbrook & Daniel R. Fischel, Limited Liability and the Corporation, 52 U. CHI. L. REV. 89, 89 (1985) Stephen Bainbridge has complained that its use is "rare, unprincipled, and arbitrary," and completely lacking in "bright-line rules for deciding when courts will pierce the corporate veil." Stephen M. Bainbridge, Abolishing Veil Piercing, 26 J. CORP. L. 479, 535 & 513 (2001). Arkansas has been characterized as a state in which piercing is particularly likely, especially where formalities are not appropriately observed. STEPHEN B. PRESSER, PIERCING THE CORPORATE VEIL, 2.4 (Supp. 2006) (concluding that "Arkansas is a jurisdiction in which the veil is more easily pierced than others"). 43. Eric Fox, Piercing the Veil of Limited Liability Companies, 62 GEO. WASH. L. REV. 1143, (1994). 44. Some states have done this by statute. See, e.g., Karin Schwindt, Limited Liability Companies: Issues in Member Liability, 44 UCLA L. REV. 1541, 1553 n.55 (1997) (listing a number of statutes adopting this approach). Other jurisdictions have reached the same result as a result of litigation. Kaycee Land and Livestock v. Flahive, 46 P.3d 323 (Wyo. 2002); Great Neck Plaza v. Le Peep Rest., 37 P.3d 485 (Colo. App. 2001); Hamilton v. AAI Ventures, 768 So.2d 298 (La. Ct. App. 2000); Hollowell v. Orleans Reg. Hosp., 217 F.3d 379 (5th Cir. 2000). It has been suggested that Arkansas should adopt a similar approach. Emily Lackey, Piercing the Veil of Limited Liability in the Non- Corporate Setting, 55 ARK. L. REV. 553 (2002). 45. Geoffrey C. Rapp, Preserving LLC Veil Piercing: A Response to Bainbridge, 31 J. CORP. L. 1063, (2006). 46. This may be especially true in Arkansas. See PRESSER, supra note 42 (noting that it may be especially dangerous to fail to observe corporate formalities in Arkansas).

17 400 ARKANSAS LAW REVIEW [Vol. 60:385 whether courts will be more or less inclined to pierce the veil for series LLCs, and this very uncertainty itself is grounds for concern. In addition, there are some characteristics of the series LLC that might increase the risks beyond those that would be anticipated with distinct LLCs. First, with the exception of the Illinois statute which at least creates reason to believe that there are multiple legal entities, series LLC statutes purport to create a single enterprise. Courts are accustomed to allowing business creditors to recover their debts from the assets of the enterprise. This might bias courts at least slightly in favor of piercing. Second, there is the risk that the business owners in a series LLC might fail to appreciate the need to keep separate records for each of the series. They too might be mislead by the apparent fact that there is a single business enterprise, when in reality, for record-keeping purposes, the series will have to be handled as if they are distinct legal entities. This is a confusing notion, and it is easy to see how business owners might fail to handle the statutory record-keeping requirements appropriately. It is also possible that owners familiar with LLCs might have become accustomed to a very informal way of doing business; and the informality that would be appropriate and allowed for a traditional LLC might not satisfy the "separate record keeping" requirement statutorily imposed upon series LLCs. Putting aside the risk of piercing, the record keeping requirement itself may be a significant disincentive for the series LLC. One of the touted benefits of the LLC is that it required so little in the way of formalities. 47 Series LLC legislation imposes the requirement of separate record keeping and separate accounting of assets, without specifying the kind of records required, the appropriate format, or precise content of such records, or exactly how assets must be separately accounted for. 4 8 There is no corresponding record keeping requirement in 47. "LLC statutes, however, require very few formalities; some states permit LLC's to be formed and run without keeping any records whatsoever." Jeffrey K. Vandervoort, Piercing the Veil of Limited Liability Companies: The Need for a Better Standard, 3 DEPAUL Bus. & COM. L.J. 51, 71 (2004). 48. The Delaware legislation allows limited liability for separate series only if: separate and distinct records are maintained for any such series and the assets associated with any such series are held in such separate and distinct records (directly or indirectly, including through a nominee or otherwise) and

18 2007] SERIES LLC 401 any general LLC statute, and the language does not appear to be modeled after that imposed on other business forms either. Caution dictates that careful records be kept, and this may be an unexpected and unwelcome requirement for business owners used to the simplicity and informality of regular LLCs. There are other substantive uncertainties associated with series LLCs. One of the largest of these centers around the tax status and treatment of this new form of enterprise. There are in fact a wide variety of tax issues associated with series LLCs, and few of these questions currently have definitive answers. 49 Will the IRS and the taxing authorities in each of the states treat each series as a separate taxable entity? Will separate returns be required? May one series elect to be taxed as a corporation while others retain partnership tax status? When will distinct allocations of assets or earnings between series be respected by the IRS or states? How are losses to be treated and are offsets allowed between series? And, on the state level, how much of a nexus does each series have to have with a state in order to be subject to tax their? How are earnings in a series LLC to be apportioned among the states? Sales and use taxes may also be affected by organizing series LLCs. The focus of this article is not the tax consequences of utilizing the series LLC, 50 but it is hard to appropriately weigh the potential risks and benefits of this form without at least acknowledging the tax risks. Consider the first of the tax issues mentioned above. Is a series LLC one entity or is each series a distinct taxable entity? Commentators have complained that accounted for in such separate and distinct records separately from the other assets of the limited liability company, or any other series thereof... DEL. CODE ANN. tit. 6, (b) (2007). 49. It is not completely true that there are no answers to these issues. California has already acted to provide a definite answer to one of these questions. "California views series LLCs as being multiple (separate) LLCs that must pay multiple California LLC annual taxes and fees." Shop Talk: California Takes a Stand on Delaware Series LLCs but There's No News from IRS..., 104 J. TAX'N 315 (May 2006); see also CAL. FRANCHISE TAX BD., FREQUENTLY ASKED QUESTIONS-LIMITED LIABILITY COMPANIES (2006), However, the IRS has not acted to clarify this issue, and most states have taken no stand on these issues either. 50. For a more detailed consideration of the federal tax issues associated with series LLCs see Gerson, Taxing Series LLCs, 45 Tax Mgmt Memo. 75 (Mar. 8, 2004). For a more complete explanation of the state tax issues, consider Michael W. McLoughlin & Bruce P. Ely, The Series LLC Raises Serious State Tax Questions but Few Answers Are Yet Available, 16 J. MULTISTATE TAX'N 6 (Jan. 2007).

19 402 ARKANSAS LAW REVIEW [Vol. 60:385 "[c]ase and regulatory law thus far has failed to produce an adequate analytical structure for determining whether a single entity may constitute a single partnership or multiple partnerships." 5 1 Under traditional notions of partnership law, sharing of profits might be enough for the arrangement to be characterized as a single partnership. On the other hand, courts might impose the requirement that a certain percentage of profits must be shared in order to turn the enterprise into a single taxable entity. The segregation of assets for liability purposes might lead the IRS or courts in the other direction, with the result that individual series are treated as distinct partnerships. 52 California, the only state that has taken up this question, has resolved the issue in favor of finding distinct entities for tax purposes. 53 Unfortunately, California provided little in the way of reasoning or explanation as to how it reached this conclusion, and it has been noted that "[s]ome commentators surmise that because the more LLC entities or series that are doing business in California, the more tax that is generated, the Franchise Tax Board's conclusion may not have been completely objective." 54 In any event, this uncertainty could definitely complicate matters for series LLCs and persons considering this option as an alternative to multiple business entities. Nor is tax the only substantive area where uncertainty is likely to complicate matters. Yet another unintended consequence may be heightened risks associated with both federal and state securities laws. Ownership interests in LLCs may be securities under bother federal and state law, 55 and this means that any sale of such an interest may trigger substantial disclosure requirements. This is true even if the sale is exempt from registration, and if one assumes that a sale must be 51. Terence Floyd Cuff, Series LLCs and the Abolition of the Tax System, 703 PLI TAX LAW AND ESTATE PLANNING COURSE HANDBOOK SERIES 351, 358 (2006). 52. This would accord with the tax treatment afforded to the separate series of a single trust. See, e.g., National Securities Series v. Commissioner, 13 T.C. 884 (1949); Rev. Rul , C.B. 416 (regarding such senes as separate taxpayers). 53. See supra note 49, Shop Talk. 54. See supra note 50, McLoughlin & Ely. 55. See generally Carol R. Goforth, Why Limited Liability Company Membership Interests Should Not be Treated as Securities and Possible Steps to Encourage this Result, 45 HASTINGS L.J (1994); Elaine A. Welle, Limited Liability Company Interests as Securities: An Analysis of Federal and State Actions against Limited Liability Companies under the Securities Laws, 73 DENV. U. L. REV. 425 (1996).

20 2007] SERIES LLC 403 accompanied by a disclosure of material risks, making full and adequate disclosure in light of all these unanswered questions and open issues might be virtually impossible. Finally, turn away from the problems for the business owner. There is another potential constituency that might be affected by series LLC legislation: the potential creditors of the enterprise. How "fair" is the concept of a series LLC to creditors? Every existing series LLC provision specifies that inclusion of required information in the official filings will be sufficient and binding notice of the limited liability of the distinct series. The Delaware statute (and those modeled after it) specifies that: Notice in a certificate of formation of the limitation on liabilities of a series as referenced in this subsection shall be sufficient for all purposes of this subsection whether or not the, limited liability company has established any series when such notice is included in the certificate of formation, and there shall be no requirement that any specific series of the limited liability company be referenced in such notice. The fact that a certificate of formation that contains the foregoing notice of the limitation on liabilities of a series is on file in the office of the Secretary of State shall constitute notice of such limitation on liabilities of a series. 56 This seems like very minimal notice to provide creditors that series in an LLC will have limited liability. There is no requirement that names of the series be identified in the certificate of formation, or have readily distinguishable names. Moreover, if the series does have a name that is considerably different from that of the parent LLC, it might be quite hard to locate the appropriate filing. Nonetheless, these statutes provide that the single filing of the certificate of formation suffices for notice to creditors. The Illinois statute goes further and requires substantially more information to be included about each series. Illinois specifies that in addition to the notice in the articles of organization that the LLC has series with limited liability, a certificate of designation be filed for each series, which includes 56. DEL. CODE ANN. tit. 6, (b).

21 404 ARKANSAS LAW REVIEW [Vol. 60:385 not only the name of each series but also the "names of the members if the series is member managed or the names of the managers if the series is manager managed., 57 Assuming these requirements are complied with, however, the statute does state that "[t]he fact that the articles of organization contain the foregoing notice of the limitation on liabilities of a series and a certificate of designation for a series is on file in the Office of the Secretary of State shall constitute notice of such limitation on liabilities of a series." 58 However, while the effect of statutory compliance in Illinois is the same as that in the other states with series LLCs, the problem of potentially inadequate statutory notice seems to be alleviated by the requirement of additional information. The names of each series must be distinguishable; filings should be easy to access regardless of how different they are from the parent entity; and even the names of the persons with management authority will be on file for creditors. The Illinois approach, however, is the distinct minority at the current time, leaving the concern that the minimal notice of limited liability required by the Delaware-model might not be entirely fair to creditors. Finally, consider the issue of revenue, which is a practical consideration that legislators will certainly want to be apprised of. There are filing fees associated with the formation of LLCs, and these might not be an insignificant source of revenue. In fact, in most states, LLC filins have outpaced the filings associated with new corporations. In the fourteen years since LLCs were first licensed in this state, 56,305 domestic LLCs have been organized. 60 This ILL. COMP. STAT. ANN. 180/37-40(d) ILL. COMP. STAT. ANN. 180/37-40(b). 59. Howard M. Friedman, The Silent LLC Revolution-The Social Cost of Academic Neglect, 38 CREIGHTON L. REV. 35 (2004) (observing that the LLC "has become the dominant form for newly-created small businesses in a clear majority of the states, and is rivaling corporations for that distinction in several more"). 60. These figures come from an on-line search of the Arkansas Secretary of State's website, and include all domestic LLCs formed as of March 1, Arkansas Secretary of State, Business and Commercial Services, /search-corps.php (last visited Oct. 29, 2007). As discussed earlier, LLCs were first authorized in Arkansas by the Small Business Entity Tax Pass Through Act. See supra note 3. It was not possible to organize as LLCs in this state before the effective date of this legislation. In addition, a review of the filings indicates that the rate of these filings has

22 2007] SERIES LLC 405 compares with a total of 102,011 domestic, for-profit corporations formed in the entire period since the new corporate code was enacted in Regardless of how many more LLCs are being formed than corporations, the filing fees associated with the formation of more than 50,000 new entities is not insubstantial, n amounting 62 to a total of somewhere between $2.5 and $2.82 million. In addition, each LLC is required to the minimum annual franchise tax, which is currently set at $ If as few as 10,000 new businesses were set up as series rather than as distinct enterprises, this would cost the state between $450,000- $500,000 in initial filing fees, and another $1.5 million per year thereafter in franchise taxes. This is a not inconsiderable potential cost to the state. CONCLUSION The ultimate conclusion reached here is not that the series LLC is without merit, nor is it that the problems raised here are insurmountable. But at the present time, it would certainly seem advisable for the state to wait before jumping on this particular bandwagon. So long as the tax, bankruptcy and securities consequences of this form of business are uncertain, prudent advisors would have a difficult time recommending the series LLC as a preferred option to clients. In addition, the potential for unanticipated liability in the event of trans-jurisdictional injuries would need to be carefully explored, and explained in each instance, and advisors would need to be careful to explain how to minimize the risk of piercing and how to insure compliance with likely statutory record-keeping requirements. The problems of notice to potential creditors and financial loss could be minimized through careful drafting of any series LLC increased substantially, with only a few LLCs being formed in the earlier years and substantially more having been formed in the past few. 61. See 1987 Ark. Acts 958 (codified at ARK. CODE ANN to (Repl. 1999)). 62. The filing fees associated with articles of organization for a domestic LLC are $50 for articles delivered for filing in paper form and $45 for filing and processing of an electronic submission. ARK. CODE. ANN (a)(1), (d)(1) (Repl. 1999). 63. ARK. CODE. ANN (6)(B) (Repl. 1999) (establishing $150 as the minimum annual fee); ARK. CODE ANN (8) (requiring that all LLCs pay the minimum franchise tax).

23 406 ARKANSAS LAW REVIEW [Vol. 60:385 legislation, but Arkansas has typically chosen to rely very heavily on language from other jurisdictions or model acts in the case of its business statutes, and most of those do not directly address these problems. The Illinois approach does, but at the cost of avoiding some of the potential advantages associated with the series LLC in the first place. The bottom line is that this is an interesting, and potentially valuable business option, but this is not the place or time for such innovation.