In January 2022, Ohio will become the 15th state to adopt a Series LLC statute.
This article will examine Ohio’s new law, the tax implications, and what we know about the Series LLC structure based on how it works in other states (Delaware started the trend in 1996).
What is a Series LLC?
It is a LLC that has multiple silos (i.e., Series) inside of it. Assets and liabilities can each be segregated within these Series. Economic rights and management rights are held only by those LLC members who are “associated with” the Series, and not by the LLC’s members in general. Each Series can mostly operate as an autonomous entity, albeit with only one Secretary of State filing.
Why would I form a Series LLC?
Investors and business owners are accustomed to filing dozens of new LLC articles per year in order to insulate the assets of one investment/business from the liabilities of the others. A Series LLC allows you to erect multiple liability shields within the same entity. If properly implemented, (1) the creditors of one Series cannot reach the assets of another Series or the assets of the LLC, and (2) the creditors of the LLC cannot reach the assets of a certain Series.
How do I form a Series LLC in Ohio?
Once the new LLC Act goes into effect on January 1, 2022, a Series LLC may be created in three steps:
- The operating agreement must have two elements:
- Either or both of the following:
- Separate rights, powers, or duties with respect to specified property or obligations of the LLC or profits and losses associated with specified property or obligations;
- A separate purpose or investment objective; and
- At least one member associated with each Series.
- Either or both of the following:
- The articles of organization must contain a statement that the LLC may have one or more Series of assets.
- Separate records are kept for each Series and its assets. R.C. 1706.761.
How does Ohio’s LLC Act govern the Series LLC?
- Powers – A Series can act in its own name (that is, the Series’ name) to (1) Sue and be sued; (2) Contract; (3) Hold and convey title to assets of the Series, including real property, personal property, and intangible property; (4) Grant liens and security interests in assets of the series. R.C. 1706.05(D).
- Membership – If a LLC has multiple members, some may be “associated with” one or more Series, and some may be associated with every Series. A member may be dissociated or removed with respect to one Series, while maintaining membership in the LLC or an association with another Series. R.C. 1706.766. However, one member must always remain associated with every Series. A single-member LLC could conceivably use the Series LLC to have a separate Series for each parcel of its real estate portfolio.
- Management – Only those members who are associated with a Series have the right to manage that Series; there are no such rights for other members within the LLC who are not associated with that Series. R.C. 1706.30(A)(2). A person might be authorized to act on behalf of one Series, but not other Series or the LLC overall. R.C. 1706.18.
- Economic Rights – Only those members associated with a Series may participate in that Series’ distributions, whether ordinary distributions or liquidating distributions. R.C. 1706.29(B).
- Assets – Assets of a Series may be held pretty much any way you want: by the LLC, by the Series, by a nominee, or “otherwise.” R.C. 1706.762(A). This is in contrast to the Uniform Protected Series Act (UPSA), which states that assets should be titled with the phrase “protected series” or “P.S.” However, even without such a requirement in Ohio, the “P.S.” designation would be wise–to put the world on notice that a Series structure is in place. Such a designation might estop a person dealing with the Series from denying the Series’ existence.
- Liabilities – The liabilities of a Series do not affect those of the other Series or the LLC. Similarly, the liabilities of a Series or the LLC in general will not be enforceable against another Series. R.C. 1706.761(A). A derivative action may also be contained within the Series silo. R.C. 1701.61(B). A Series may enjoy the liability shield, regardless of whether: (A) The LLC has established any Series at the time it files/amends its articles to include the statement of limitations; (B) The statement of limitations makes reference to a specific Series of the limited liability company (Note: this second caveat is not true in every state).
- Record Keeping
- This author believes that most litigation will likely center around this question: Did the LLC adequately keep separate records, so as to authorize the use of the Series structure? The answer will have major consequence in litigation. If yes, then a Series could be judgment-proof, while other Series or the LLC could be flush with cash (but that cash is insulated). If no, then perhaps all of the Series’ and LLC’s assets are up for grabs, based on one Series’ liability. If a Series LLC loses its liability shields, it is likely a more devastating result than if there was no Series LLC at all, because the Series structure likely allowed everyone to drop their guards on liability protection.
- The ORC attempts to provide guidance as to what is adequate record-keeping: “If the records of a series are maintained in a manner so that the assets of the series can be reasonably identified by specific listing, category, type, quantity, or computational or allocational formula or procedure, including a percentage or share of any assets, or by any other method in which the identity of the assets can be objectively determined, the records are considered satisfactory.” R.C. 1706.762(B).
- Winding Up – A Series may be dissolved, without the dissolution of any other Series. R.C. 1706.767. However, the dissolution of the LLC will collapse all Series within that LLC. R.C. 1706.768.
- Choice of Laws
- Where an entity doing business in Ohio was formed in a different jurisdiction, Ohio’s LLC Act will defer to the LLC law in that state of formation. R.C. 1706.51. Of greatest interest, that would mean that an Ohio business may continue to use a Delaware LLC that has multiple Series within it.
- A different question arises where an Ohio-domiciled Series LLC conducts business in a state without a Series LLC authorization. A court could disregard the Series designation and issue judgment against the LLC as a whole. A practitioner should be cautious before launching a Series LLC with intent to conduct operations in other states.
- Registration to Do Business in Ohio – If a foreign Series LLC (i.e., one registered in Delaware) wants to do business in Ohio, that series will need to register with the Ohio Secretary of State. Within that registration, the foreign LLC must state: (1) The fact that it provides for the establishment of one or more Series of assets; (2) Whether the debts, liabilities, and obligations incurred, contracted for, or otherwise existing with respect to a particular Series, if any, shall be enforceable against the assets of that Series only, and not against the assets of the foreign limited liability company generally or any other Series thereof; (3) Whether any of the debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to the foreign limited liability company generally or any other Series thereof shall be enforceable against the assets of that series. R.C. 1706.511.
How is a Series LLC taxed?
- State Taxes – An LLC and its Series must file a Commercial Activity Tax return jointly, if the Series structure was created merely to avoid paying the CAT Tax (which kicks in at $150,000 in annual gross receipts). R.C. 5751.012(D). Otherwise, the Series would appear to be a separate taxpayer.
- Federal Income Taxes
- The IRS deems each Series to be a separate taxpayer where: (i) members of a Series have rights, powers, or duties with respect to each Series; (ii) a Series has separate rights, powers, or duties with respect to specified property or obligations; and (iii) there is a segregation of assets and liabilities such that none of the liabilities of the LLC or of any other Series are enforceable against the assets of a particular Series. Fed. Reg. 119921-09 (Proposed Reg. 2010).
- In short, this means that the check-the-box rules are in place, on a Series-by-Series basis. A single-member Series is, by default, a disregarded entity–subject to a contrary election. A multi-member Series is, by default, a partnership-subject to a contrary election. It is conceivable that the LLC, meanwhile, has nothing to report to the IRS and would not be obligated to pay taxes or file an informational return.
- Employment Taxes – The IRS contemplates a shared-servant situation where an individual works for more than one Series.
Extra care must be taken when a Series LLC seeks to purchase or sell private securities. On the sales side, who is the issuer, and does it qualify for the exemption under Reg. D? On the purchaser side, does the Series hold accredited investor or qualified purchaser status?
The horizontal liability shields between Series is untested in the bankruptcy court. Whether a Series is capable of granting a security interest under UCC Article 9 is also a subject that requires more clarity. This author believes that the provision allowing a Series LLC to hold assets via a nominee resolves many of these problems. That nominee could be an entity with all of the customary characteristics that lenders seek in making a secured loan.
Ohio’s Series LLC statute is very business-friendly, when compared to other states. However, case law is scant on Series LLCs on a national basis. Precedent is non-existent in Ohio courts. There will be instances where the practitioner will have to admit, “We don’t yet know the answer to that.”
But there are also reasons to believe that a Series LLC can become the new way of owning a business with multiple product lines, or of establishing a real-estate holding company. The comfort (or lack thereof) by the financial industry will be critical for whether the Series LLC gets off the ground. If the Series LLC is not finance-able, it will probably never catch on.
Cavitch will be advising businesses and investors on Series LLCs leading up to the 2021 launch date. Contact me at [email protected] with inquiries on articles of organization, titling of assets, and operating agreement provisions.