The series concept arose in Delaware when that state in 1988 adopted its Business Trust Act (changed to Statutory Trust Act in 2001). 12 Del. Code §3801(g). This statute provided a framework for trusts utilized for asset securitization and the organization of investment companies. In the traditional application, a series is an administrative sub-unit of an investment company.
A series company or fund is an investment company composed of separate portfolios of investments organized under the umbrella of a single corporate or trust entity. . . Each portfolio of a series company has distinct objectives and policies, and interests in each portfolio are represented by a separate class or series of shares. Shareholders of each series participate solely in the investment results of that series. In effect, each series operates as a separate investment company. Gordon Altman et al., A Practical Guide to the Investment Company Act, p. 2-3 (1996).
Section 18(f)(2) of the Investment Company Act and SEC Rule 18f-2(a) apply substantially the same analysis. Assuming that an investment company is organized as a statutory trust, only it, on behalf of the "fund family," will register with the SEC on, for example, Form N-1. Thereafter, the trust will organize a series for each of the various sponsored funds. The business trust has a single trustee, typically embodied in a board, overseeing all of the series even as, on behalf of each series organized fund, distinct fund managers are retained. Further, typically all of the series organized by a single investment company operate under a single set of service documents executed with various service providers such as transfer agents, custodians, principal underwriter(s), numerous broker-dealer firms, etc. In the securitized finance realm, under an individual business trust, distinct series are organized with respect to particular classes of securitized assets, and then securities are issued with respect to each series. Today, the series remains actively utilized in the mutual fund and asset securitization applications, and we are seeing the use of the series in other applications.
Dawn of Series LLCs
A few years after it enacted its Business Trust Act, in 1996, Delaware enacted the first statutory series LLC provisions at the same time that it added series provisions to its limited partnership statute. The apparent reason why Delaware added series provisions to its limited partnership statute was that "sophisticated, highly funded deals were commonplace for use by Delaware limited partnerships" Conaway, A Business Review of the Delaware Series: Good Practice for the Informed, at 4, http://papers.ssrn.com/so13/papers.cfm?abstract_id=1097645. Once added to the limited partnership, series provisions became part of the Delaware LLC Act the same year, presumably to maintain the Delaware LLC Act's stature as a modern, forward-looking statute. Although arguably not responding to any perceived need, lawyers quickly began seeing potential uses for series LLCs after Delaware and a few other states enacted series provisions.
The Delaware LLC Act states:
A limited liability company agreement may establish or provide for the establishment of 1 or more designated series of members, managers, limited liability company interests or assets. Any such series may have separate rights, powers or duties with respect to specified property or obligations of the limited liability company or profits and losses associated with specified property or obligations, and any such series may have a separate business purpose or investment objective. 6 Del. Code §18-215(a).
If notice and record-keeping requirements in the statute are satisfied, the Delaware statute provides:
[T]he debts, liabilities, 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, and, unless otherwise provided in the limited liability company agreement, none of the debts, liabilities, obligations and expenses incurred, contracted for or otherwise existing with respect to the limited liability company generally or any other series thereof shall be enforceable against the assets of such series. 6 Del. Code §18-215(b).
Several Potential Reasons for Using a Series LLC
Although filing fees in a few states (notably, for example, Illinois) made a series LLC attractive on that basis alone, most lawyers saw more promise in the internal liability shields of series LLCs. Thus, for example, it has been suggested that a series LLC might be used as a mechanism by which an integrated oil company could organize liability shields between different oil fields and other assets and in real estate by isolating liabilities of one parcel from the value of other parcels. As with any new, not well-understood statute, some early adopters have pushed the envelope beyond breaking by utilizing a series LLC to own a personal speedboat and to own a diamond ring and, in separate series, an automobile, and a personal residence.
Individual Series Generally not a Separate State Law Entity
Under the majority of state series LLC acts, including Delaware, the entity for state law purposes is the juridical LLC formed by a filing with the state filing office and not the series within the LLC. Stated differently, the series within the LLC is not a separate entity under the laws of the state of Delaware. Although an individual series of a Delaware series LLC has "the power and capacity to, in its own name, contract, hold title to assets (including real, personal and intangible property), grant liens and security interests, and sue and be sued" (6 Del. Code §18-215(c)), a series may not enter into a merger or conversion. Delaware permits a "domestic limited liability company" to enter into a merger or conversion. 6 Del. Code §18-209(a). Further, Delaware defines a limited liability company" and a "domestic limited liability company" as "a limited liability company formed under the laws of the State of Delaware and having 1 or more members." 6 Del. Code §18-101(6). A series within a series LLC is not "formed" under Delaware law but rather pursuant to the limited liability company agreement of the series LLC. Members are not admitted as members of an individual series but, rather, are members of the series LLC and are "associated" with one or more series and may or may not have any economic interest in the series LLC itself other than an interest in one or more series. 6 Del. Code §18-215(e)-(k). Some states, namely Kansas, Illinois, and Iowa, and the District of Columbia, have considered this issue and have permitted (but not required) that a series within a series LLC to be a separate entity. Six of the current 10 domestic series LLC statutes, however, are like Delaware, in which a series within a series LLC is not a separate entity.
Absence of Separate Entity Status Consistent with Statutory Trusts
Treatment of an individual series of a series LLC as not being a separate legal entity is consistent with the treatment of statutory trusts. The distinct series of a statutory trust is itself not a distinct legal organization. In one of the few cases to consider the matter, Batra v. Investors Research Corp., 1992 WL 278688, *1 (W.D. Mo. 1991), the court held that an individual series is not an independent legal entity. In that case, the owner of one series of an investment company, which was itself organized with 12 distinct series, filed suit with respect to one series, then transferred his investment to a different series; as such, as the lawsuit proceeded, the plaintiff no longer owned shares in the particular series with respect to which he brought the action. The defendants asserted that each series constituted a distinct investment company and that, as the plaintiff did not own shares in the series with respect to which the action was brought, he lacked standing. The court rejected this contention, noting that under the Investment Company Act of 1940, the individual series is not the issuer of securities. Ultimately, owning shares in any one series effectively granted standing to bring an action with respect to the shares in any series.
Significance of Non-separate Entity Status
This feature of series LLCs creates issues when determining how to satisfy foreign entity qualification requirements when an individual series does business outside the state of formation of the series LLC and, more importantly, whether the internal liability shields of a series LLC will be respected outside its state of formation.
Foreign Qualification Issues - Non-series State
If an individual series wishes to carry on activities in a non-series state that will constitute "doing business" in that state for purposes of the registration of foreign entities, it is likely to be unclear precisely how the series, or the juridical series LLC, should comply. That is, should the filing be in the name of the series or of the juridical series LLC? In Colorado, a non-series state, for example, the statute provides that "a foreign entity shall not transact business or conduct activities in this state . . . until its statement of foreign entity authority is filed in the records of the secretary of state." C.R.S. §7-90-801. The Colorado statute defines "foreign entity" as "a foreign corporation, . . . a foreign limited liability company, or any other organization or association that is formed under a statute or common law of a jurisdiction other than this state or as to which the law of a jurisdiction other than this state governs relations among the owners and between the owners and the organization or association and is recognized under the law of such jurisdiction as a separate legal entity." C.R.S. §7-90-102(23) (emphasis added). Because an individual series of a Delaware series LLC is not treated as a separate legal entity under Delaware law, if such an individual series began doing business in Colorado, the juridical series LLC would be required to file a statement of foreign entity authority. The records of the Colorado secretary of state disclose that in many cases an individual series has filed a statement of foreign authority in the name of the individual series. Assuming such a filing could not be characterized as a filing by the juridical series LLC, there does not appear to have been compliance with the Colorado statute.
Foreign Qualification Issues - Series State
How precisely to qualify a foreign series may also be unclear in a series state. Delaware, however, provides that if a foreign series LLC registering to do business in Delaware is governed by an operating agreement that establishes designated series of members, managers, LLC interests, or assets having separate rights, powers, or duties with respect to specified property or obligations of the foreign limited liability company or profits and losses associated with specified property or obligations of the LLC, that fact must be stated on the application for registration as a foreign LLC. In addition, the foreign LLC will state on the application whether the debts, liabilities and obligations incurred, contracted for or otherwise existing with respect to a particular series is enforceable only against the assets of that series and not against the assets of the foreign LLC generally or any other series thereof and whether any of the obligations, debts, expenses and liabilities of the limited liability company generally or another series thereof are enforceable against that series. 6 Del. C. §18-215(n). Delaware lawyers believe Section18-215(n) to be a notice statute that does not provide a substantive rule that Delaware will recognize the internal liability shield of a foreign series LLC. Conaway, A Business Review of the Delaware Series: Good Practice for the Informed, at 30, http://papers.ssrn.com/so13/papers.cfm?abstract_id=1097645.
The Texas Business Organizations Code contains a special rule for foreign series LLCs:
Sec. 9.005. SUPPLEMENTAL INFORMATION REQUIRED IN APPLICATION FOR REGISTRATION OF FOREIGN LIMITED LIABILITY COMPANY.
- This section applies only to a foreign limited liability company governed by a company agreement that establishes or provides for the establishment of a designated series of members, managers, membership interests, or assets that has any of the characteristics described by Subsection (b).
- A foreign limited liability company must state in its application for registration as a foreign limited liability company whether:
- the series has:
- separate rights, powers, or duties with respect to specified property or obligations of the foreign limited liability company; or
- separate profits and losses associated with specified property or obligations of the foreign limited liability company;
- any debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to a particular series shall be enforceable against the assets of that series only, and not against the assets of the company generally or the assets of any other series; and
- any debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to the company generally or any other series shall be enforceable against the assets of that series.
- the series has:
Note that the form the Texas secretary of state has promulgated for filing by a foreign series LLC requires that the filing will be in the name of the juridical series LLC in certain cases. The instructions to Form 313 states: "A series limited liability company that is treated as a single legal entity under the laws of its jurisdiction of organization is treated as a single legal entity for purposes of registration. The limited liability company rather than the individual series should register as the legal entity that is transacting business in Texas." Does the language of the instructions to Form 313 mean by implication that an individual foreign series that is treated as a separate legal entity by its jurisdiction of formation should file in the name of the series? If you are called on to help with such a filing, the author suggests calling the friendly folks at the Texas secretary of state's office. In all cases where the answer is not clear from the applicable statute or form, the best practice surely must be to call the particular state filing office for guidance.
Internal Liability Shields in a Non-series State
A more important question in most cases is whether a court in a non-series state will respect the internal liability shields of series LLC legislation. This concern arises most directly in tort cases - persons who contract with an individual series in a non-series state may protect themselves through appropriate contractual provisions. While the general rule is that the law of the state of formation should govern the regulation of the internal affairs of an entity, including the liability of an owner of the entity for obligations of the entity, it would appear to be a stretch for a jurisdiction without series LLCs to recognize the liability limitation function of the series within the LLC on the basis of the internal affairs doctrine - the effect of the liability limitation function applies to third-party creditors of a series, not just to the internal affairs of the entity and its members inter se, nor, unless a veil-piercing claim is involved, to the liability of a member for debts of the series or the series LLC. If the internal affairs doctrine does not apply, the next question is whether a non-series state would be required to recognize the internal liability shields of a series LLC because of the Full Faith and Credit Clause of the United States Constitution:
Full faith and credit shall be given in each state to the public acts, records, and judicial proceedings of every other state. And the Congress may by general laws prescribe the manner in which such acts, records, and proceedings shall be proved, and the effect thereof. U.S. Const. Art. IV, Sec. 1.
In other words, if an individual series of a Delaware series LLC is doing business in a non-series state, say Colorado, does the Full Faith and Credit Clause require a Colorado court to respect the internal liability shield of the Delaware series LLC legislation in a suit brought by a Colorado resident seeking to hold the juridical series LLC and all its series liable for an accident caused by the activities of one of the series in Colorado? The short answer is no. Although it is well-established that a state's statutes are "public acts" for purposes of the Full Faith and Credit Clause, Bradford Electric Light Company v. Clapper, 286 U.S. 145, 154-55 (1932), a state is not required "to substitute the statutes of other states for its own statutes dealing with a subject matter concerning which it is competent to legislate." Pacific Employers Ins. Co. v. Industrial Accident Commission, 306 U.S. 493, 501 (1939). The Court cited Pacific Employers approvingly in 1998 in Baker v. General Motors Corporation, 522 U.S. 222, 233 (1998). (Although a court may be guided by the forum state's public policy in determining the law applicable to a controversy, the Court's decisions support no roving "public policy exception" to the full faith and credit due judgments.) Further, "a rigid and literal enforcement of the full faith and credit clause, without regard to the statute of the forum, would lead to the absurd result that, whenever the conflict arises, the statute of each state must be enforced in the courts of the other, but cannot be in its own." Pacific Employers Ins. Co, 306 U.S. 493, 501-502, quoting Alaska Packers Association v. Industrial Accident Commission, 294 U.S. 532, 547 (1935). Accordingly, a court in a non-series state could, without running afoul of the Full Faith and Credit Clause, refuse to uphold the internal liability shields of a series LLC on the ground that the forum state's legislature, by not enacting series legislation, had expressed a public policy that internal liability shields within a single entity should not be recognized. By contrast, the Full Faith and Credit Clause applies quite differently to judgments of a sister state:
A valid judgment in one State of the United States will be recognized and enforced in a sister State even though the strong public policy of the latter State would have precluded recovery in its courts on the original claim. Restatement (Second) of Conflicts §117 (1971); Baker, 522 U.S. at 233.
Indeed, if a Colorado court were to render a money judgment against a Delaware series LLC because of an act of one series of the series LLC in Colorado, the Full Faith and Credit Clause would require a Delaware court to recognize and enforce that judgment. Baker, 522 U.S. at 235; Fauntleroy v. Lum, 210 U.S. 237 (1908). In Fauntleroy v. Lum, the Court required a Mississippi court to enforce a judgment of a Missouri court that, in a case brought in Missouri, enforced a contract entered into in Mississippi that was illegal under Mississippi law.
Even if you have a transaction that could go across state boundaries but remain in series jurisdictions (a real estate developer that works in Texas and Chicago), the applicable legislation is not uniform. The author suggests that until there is wider adoption of series LLC legislation, or favorable clarification of the issues discussed above, the prudent course for an attorney advising a series LLC that wants to do business in a non-series state would be to advise that the series LLC form a single-member LLC subsidiary to carry out business activity in the non-series state.