SERIES LIMITED LIABILITY COMPANIES

Effective August 16, 2005, a new section of the Limited Liability Company Act (LLC Act), 805 ILCS 180/37-40 (the Series LLC Statute), made Illinois the fifth state to allow series limited liability companies, or Series LLCs. A Series LLC is a corporate limited liability structure in which a traditional LLC serves as the umbrella entity for any number of separate series, or cell, LLCs formed within the traditional LLC. Series LLCs are typically described as "protected cells within one limited liability container," because the assets of each series are protected from the liabilities of the traditional LLC and from other series, and vice versa.1 As a matter of practical application, the Series LLC Act now provides a less costly way for developers and owners of multiple parcels of real estate to achieve limited liability for each property in their portfolio.

Summary of the Series LLC Statute

Creation. According to subsection (a) of the Series LLC Statute, an operating agreement for a traditional LLC "may establish or provide for the establishment of a designated series of members, managers, or LLC interests" that have separate rights, powers, and duties concerning property and obligations of the LLC as well as any profits or losses associated with these properties or obligations. 805 ILCS 180/37-40(a). Moreover, any named series may have a different business purpose or investment objective from the LLC or any other series.

Limited Liability for Each Series. Under subsection (b) of the Series LLC Statute, for series debts, obligations and liabilities to be enforceable against only that series (i.e., achieve limited liability for the series), the series must meet the following requirements: (1) the series must be created under the traditional LLCs operating agreement; (2) the series must maintain its own records; (3) the series must hold and account for its assets apart from the assets of any other series or the traditional LLC; (4) the series must set forth a notice of the limitation of liability of the series in the operating agreement of the traditional LLC; and (5) the series must file a certificate of designation in the Office of the Secretary of State. The statute goes on to re-iterate that providing notice of the limitation of liabilities for a series in the traditional LLCs operating agreement and filing a certificate of designation for each series constitutes notice of the limited liability of that series. Further, subsection (b) of the Series LLC Statute continues by articulating that each series is to be treated as a separate business entity, and is permitted to conduct the ordinary business and exercise the powers of a limited liability company as provided under the act.

Series Name. Subsection (c) requires the name of any series to contain the entire name of the limited liability company and be distinguishable from the names of other series that are expressed in the articles of organization.

Filing Requirement. Filing the certificate of designation with the Illinois Secretary of State serves as the starting point for the existence of the particular series, as provided under subsection (d). In addition to the name of a particular series, the certificate of designation for each series must indicate the names of any managers (if the series is manager-managed) or member-managers (if the series is member-managed) of the series if they are different from those managers or member-managers of the traditional LLC.

Classes of Members. According to subsection (g), the operating agreement may provide for classes or groups of members or managers associated with a series who have such relative rights, powers and duties as provided under the operating agreement or provide for future classes or groups having such rights, powers and duties. A way a Series LLC can benefit from this provision of the act is by using classes or groups within each series to divide management duties and company operations in a way the best suits each particular series.2

Management. Further, subsection (h) permits management by members or by a manager or managers for each series, and the LLC Act governs management for all LLCs. 805 ILCS 180/15-1. Presumably the membership of a particular series would be determined like any other LLC, which is by financial contribution to the LLC, with the idea that the owners of the LLC interests are the members of the LLC. Accordingly, the LLC Act requires that a list of members, as well as their addresses and amount of financial contribution to the LLC, be kept at the principle place of business of each company and other reasonable locations. 805 ILCS 180/1-40.

Voting Rights. Subsection (i) permits an organizer to articulate in the operating agreement a division of voting rights within each series among individual members or managers or among classes or groups or members or managers, and also permits an organizer to qualify the types of issues that are voted on by particular individuals or classes of members or managers.3 Moreover, subsection (i) also allows an operating agreement to be structured so that a particular member or class or group of members associated with a series has no voting rights. Therefore, in the case of a series LLC that exercises its right to withhold voting rights from a particular member or group of members, the remaining members, or the manager(s) make decisions for the company.4

Authority. Subsection (j) says that the provisions of the LLC Act, which are applicable to LLCs and their members and managers in general, apply to each particular series concerning the operation of that series, except to the extent those rights have been modified by the Series LLC Statute. Under the LLC Act, LLCs may have a continuous life, unless a date of dissolution is otherwise specified in the Articles of Organization. 805 ILCS 180/5-5.

Dissolution. Section (m) of the Series LLC Statute provides that a particular series may be dissolved without causing the LLC or other series to also be dissolved; dissolution of the LLC, however, does dissolve any series.

Amending the Operating Agreement. An important consideration to note is that the number of series that may be spun from the operating agreement of the traditional LLC is not limited; however, under subsection (a) it appears that any subsequent series need be anticipated and named in the operating agreement. Nonetheless, under the LLC Act, a limited liability company has the power to amend its operating agreement. 805 ILCS 180/1-30, subsection (11). Therefore, if the operating agreement did not call for the existence of a particular series when it was originally drafted, it could presumably be amended to include the series. Because the operating agreement is an internal document used to regulate the affairs of the company and govern relations among managers, members and the company, the procedure for amending an operating agreement would be in the hands of the LLC it governs. 805 ILCS 180/15-5. However, note that subsection (c)(1) of Section 15-1 of the LLC Act requires unanimous consent of all of the members to amend the operating agreement of an LLC. 805 ILCS 180/15-1.

Implications for Real Estate Development

Real estate owners will certainly benefit from the enactment of the Series LLC Statute. By allowing the Series LLC form of ownership, individuals who own numerous parcels of real estate may now organize one LLC and achieve limited liability protection for each property that is held as its own separate LLC cell, and do so at a substantial cost savings over the prior method of holding each property as a stand-alone LLC.5

One of the biggest advantages provided by the new Series LLC Statute is asset protection. It is now easier for an individual, like the owner of many parcels of real estate, to provide for asset protection and bankruptcy remoteness using the Series LLC Statute. Before the effective date of this statute, to protect safer assets, like real estate, from the potential liability of riskier assets, the owner needed to retain each property as its a separate LLC, with the property as the sole asset of the LLC.6 Alternatively, an owner could hold multiple properties under one LLC and chance exposing all to the debts and obligations of one risky holding. However, with the advent of the Series LLC Statute, the owner now need only organize one LLC, then, as provided for in the operating agreement, spin off subsequent series. Following the statutory requirements, the liability of each series will be limited to the assets of that series, while the series will still enjoy the full benefits of the traditional LLC form of ownership. Also, owners of real property will be saved the time and frustrations of managing separate and distinct LLCs,7 because only one operating agreement and perhaps even one tax filing is needed for the entire Series LLC.8

Along with negating the necessity to hold each property as its own separate LLC, the Series LLC Statute saves costs for an owner or developer of real estate who would have otherwise held each property as a separate LLC.9 First, the owner will save the initial costs of organizing each property as its own LLC. Filing the articles of organization for a traditional LLC costs $500, while filing the articles of organization for a Series LLC costs $750, and filing the certificate of designation for each series costs $50. 850 ILCS 180/50-10. Furthermore, not only will the owner save up-front costs of organization, the owner will also save when filing the annual report required of LLCs. It costs $250 to file an annual report for a stand-alone LLC, while a Series LLC incurs the cost $250 for filing an annual report for the traditional LLC and $50 for each series with a certificate of designation on file. Id.

An example illustrates the savings: Suppose a property owner had five (5) properties and she would like to hold each as an LLC for asset protection purposes. If this individual organized five separate stand-alone LLCs, it would cost $2,500 (5 * $500) to file the articles of organization for each LLC, while it would cost a mere $950 [$750 + (4 * $50)] to organize a Series LLC as one traditional LLC and four series or cell LLCs. In this respect, the Series LLC form of ownership saves the property owner $1,550 over holding each property as a sole LLC. Further, to file five annual reports for each stand-alone LLC, the property owner would pay $1,250 (5 * $250), while it would cost $450 to file the annual report for the Series LLC [$250 + (4 * $50)], thus saving the owner $800 per year by using the Series LLC form of ownership. Overall, the owner would save $2,350 ($1550 + $800) in holding the properties as a Series LLC instead of five stand-alone LLCs in the first year.

Potential Limitations and Drawbacks

While creating a Series LLC for holding real property will achieve the goal of segregating assets for liability purposes at a substantial costs savings, drawbacks exist.10 First, there is a lack of case law concerning Series LLCs, so no one can say for certain how an Illinois court will rule on an issue pertaining a Series LLC. Second, the majority of states do not recognize the Series LLC, so no one can be sure of how a Series LLC will be treated with respect to the traditional LLC and other series for taxation and liability purposes in other states.

In particular, one uncertainty regards the federal taxation of Series LLCs. A question exists as to whether a Series LLC should be treated as a single entity for tax purposes, thus aggregating the profits and losses of each series and the traditional LLC onto one federal tax filing, or whether each series may be treated as a stand-alone entity for tax purposes and elect to file its own federal income tax return.

Section (b) of the Series LLC Statute provides that the traditional LLC and any of its series "may elect to consolidate their operations as a single taxpayer to the extent permitted under applicable law." Many consider this provision of the act a benefit of the Series LLC form of ownership, citing the time saved and overall simplification of having to file only one tax document that covers the traditional LLC and each series.11

Interestingly, others argue that filing one tax document for the traditional and each series LLC is merely an option and not a requirement under the statute, saying the "tax classification of each series within an Illinois series LLC is independent of that LLC itself."12 In an article titled, "An Initial Inquiry into the Federal Tax Classification of Series Limited Liability Companies," a University of Illinois Professor of Law and J.D. candidate student aver that each series in a Series LLC should be taxed as a single entity, independent of the traditional LLC or other series. Citing the language of section (b) the Illinois Series LLC act, which provides "a series with a limited liability shall be treated as a separate entity to the extent set forth in the articles of organization," and pointing to the fact that each series must file its own separate certificate of designation (as opposed to amending the certificate associated with the traditional LLC), the duo assert that because each series is treated as a separate business entity, each series should be treated as such for purposes of federal taxation.13 Finally, the pair also point to additional language in section (b) of the act that says the traditional LLC and any of its series "may elect to consolidate their operations as a single taxpayer," arguing that this language, particularly the word "elect," provides that the default taxation treatment is for the traditional LLC and any series to be taxed as separate entities, and should remain so unless and until the entities choose to be taxed as one.14

Logically, the way in which a Series LLC elects to be taxed at the federal level, either as one aggregated entity or as separate entities, is how the Series LLC would be taxed at the state level as well, but that issue also remains to be seen.

Conclusion

The Series LLC form of ownership has great potential to be an ideal ownership vehicle for individuals or groups who own multiple properties or entities. Series LLCs manage to have all of the characteristics of the customary LLC form of ownership, in particular the flow-through taxation of a partnership and the limited liability of a corporation, but offer these benefits at relatively less cost. Therefore, despite any uncertainties, the advantages of a Series LLC are likely to entice many people to venture into the Series LLC realm of ownership and reap its benefits.

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