April 22, 2014

Fifth Circuit Misses Opportunity to Bring Clarity to Series LLC Questions

Allen Sparkman

As series LLC legislation has become more widespread the last several years, practitioners and others who are interested in series LLCs have been looking forward to a day when court decisions or administrative rulings will have answered some of the outstanding questions about series LLCs. Thus, it was disappointing when the Fifth Circuit Court of Appeals passed up an opportunity to bring clarity to certain questions and may also have given incorrect guidance for the district court to follow on remand. Glenn E. Alphonse, Jr. v. Arch Bay Holdings, L.L.C.; Specialized Loan Servicing, L.L.C., (5th Cir. filed December 11, 2013) (unpublished pursuant to 5th Cir. R. 47.5), involved a Louisiana resident, Mr. Alphonse, who lost his home to foreclosure. According to the district court opinion, the foreclosure action was brought in Louisiana state court by a petition filed by “Arch Bay Holdings, LLC-Series 2010B, a corporation [sic] authorized to do business in St. Tammany Parish, Louisiana.” Alphonse did not challenge the foreclosure proceeding itself or appeal the foreclosure in Louisiana state court. Instead, he sued in federal court under the Louisiana Unfair Trade Practices Act (LUTPA). The federal district for the Eastern District of Louisiana dismissed the action for lack of subject matter jurisdiction on grounds that all parties on appeal to the Fifth Circuit acknowledged were erroneous. 

Alphonse obtained his mortgage from WMC Mortgage Corporation, which later assigned the mortgage note to Arch Bay Holdings, LLC-Series 2010B. Arch Bay Holdings, LLC, is a Delaware LLC that, pursuant to Delaware’s LLC statute, had created Series 2010B as a separate series. Neither the district court opinion nor the Fifth Circuit opinion tells us anything about the basis of the separateness of Series 2010B – whether it was separate assets, separate associated members, separated management, or some other basis or combination of bases. Confusion about just how to characterize a Series LLC and one of its individual Series begins with the district court opinion, helped along by the arguments made by Alphonse. 

In his action in federal court, Alphonse did not sue Series 2010B, but sued Arch Bay Holdings, LLC and the mortgage servicer, Specialized Loan Servicing, LLC. At the district court level, Alphonse asserted “that AB-Series 2010 is a financial instrument and not a separate juridical entity.” Plaintiff also alleged “that Arch Bay Holdings, LLC controls and owns a number of trusts, including Series 2010B.” In its response to this argument, the district court observed that “a series of trusts is distinct from a series corporation [sic].” In concluding that Series 2010B was the correct party defendant, not Arch Bay Holdings, the district court noted that “Arch Bay Holdings never seized or possessed the plaintiff’s property” and that in the state court proceeding to foreclose on Alphonse’s mortgage, the petition was filed by “Arch Bay Holdings, LLC-Series 2010B, a corporation [sic] authorized to do business in St. Tammany Parish, Louisiana.” The district court then analyzed the series provisions of the Delaware LLC Act and concluded that Series 2010B was “a separate juridical entity from Arch Bay Holdings, LLC, itself.” 

The Fifth Circuit opinion added to the confusion by describing Arch Bay Holdings, LLC, as “the parent company of Series 2010B.” The defendants asserted issue preclusion and res judicata based on the state court action involving the mortgage. One ground cited by the federal district court in ruling for defendants was that “the LUTPA claims against Arch Bay should be dismissed for the additional reason that Delaware law determines Arch Bay’s liability, and under Delaware law, Series 2010B is the real party in interest and is a separate juridical entity.” In the federal appeal, defendants argued that the district court’s decision dismissing Alphonse’s claims with prejudice should be affirmed because of, inter alia, Series 2010B’s separate juridical status. 

In support of its position that Alphonse’ claims should be dismissed because of issue preclusion or res judicata, Arch Bay argued that it had “identical interests to and [was] the ‘virtual representative’ of Series 2010B in the foreclosure suit as the alter ego of Series 2010B and thus it possesses an identity of interest.” Although the court distinguished a case in which a federal district court held a parent and subsidiary to be “legally identical,” the Fifth Circuit said “we must determine whether there exists sufficient ‘identity of the parties’ between Arch Bay (the parent company) and Series 2010B (the judgment creditor) as well as between SLS (the mortgage servicer) and Series 2010B.” Moving on from its disturbing references to Arch Bay as the “parent company” of Series 2010B, the Fifth Circuit stated: “Series 2010B is a Series LLC, and Series LLCs only exist to represent the interest of the parent LLC, which in this case is Arch Bay.” (Emphasis supplied.) However, the court then observed that the legal separation of Series 2010B and “its parent, Arch Bay” was a fact-bound question and must be decided on remand. The court also stated that “the separate juridical status of a Series LLC with respect to third-party plaintiffs remains an open question. We remand because there are insufficient facts in the record to determine whether the Series LLC in this case is truly separate. The important point is that the res judicata identity of parties question – whether Series 2010B and its parent Arch Bay have identical interests – ought in fairness be considered together with the question of whether Series 2010B is in fact a distinct juridical entity.” 

In the above discussion, the Fifth Circuit appears to muddle the question whether Series 2010B was a separate legal entity with the question whether its interests and the interests of Arch Bay were identical. That is, as explained below, this author believes it is clear that an individual Series, such as Series 2010B, of a Delaware Series LLC is not a separate juridical entity, but that is, or should be, irrelevant to an analysis whether there exists an identity of interest between Series 2010B and Arch Bay. Although the court arguably forecloses any question on the identity of interest issue by its sweeping statement, completely unsupported by any part of the Delaware Series LLC statutory provisions, that “Series LLCs only exist to represent the interest of the parent LLC,” this author submits that factual analysis is required to determine if identity of interests exists, and that the better legal view is that an individual series of a Delaware Series LLC is not a separate juridical entity. The Series is not formed by a filing with the Secretary of State of Delaware, but by action pursuant to the company agreement of the Series LLC, in this case, Arch Bay Holdings. Although Series 2010B, as an individual series of a Delaware Series LLC, would have “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)), Series 2010B would not be authorized to enter into a merger or conversion in its name and capacity. Only Arch Bay Holdings, as an LLC formed by a filing with the Delaware Secretary of State, meets the Delaware definition of a “limited liability company” and a “domestic limited liability company.” (6 Del. Code § 18-101(6).) Only “limited liability companies” may enter into mergers or conversion. Members are not admitted as members of an individual series but, rather, as 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).) Although no definitive legal definition of “juridical entity” exists, the better view appears to be that an individual Series of a Delaware Series LLC is not a separate juridical entity, the Series is not created by a filing with the state, the Series cannot enter into fundamental transactions such as mergers and conversions, and termination of the Series does not occur simply because there are no members associated with the Series. In Alphonse, Series 2010B should not be considered a separate juridical entity, but that does not answer whether the owners of the economic interest in Series 2010B were identical, or to what degree, with the owners of the economic interest in Arch Bay Holdings. 

The Fifth Circuit also remanded for the district court to decide, “perhaps with . . . factual development,” whether Delaware law applied because of the internal affairs doctrine or whether liability to a third party was an external affair. 

Although it is conceivable that there might be some factual development that would be relevant, this author wishes the Fifth Circuit had taken the opportunity to declare that, as a matter of law, the internal affairs doctrine does not apply to a third-party liability claim. Failing that, the Fifth Circuit could have provided clearer guidance to the district court. It would appear to be beyond question that Delaware law should be examined and applied for the purpose of determining the relationship between a juridical LLC formed by a filing with the Delaware Secretary of State and an individual Series of that LLC. Delaware law provides that, if notice and record-keeping requirements are satisfied, an individual Series of a Series LLC is not liable for the obligations of any other Series or of the Series LLC, and the Series LLC is not liable for any obligation of any individual Series. Then, the question becomes whether the internal affairs doctrine applies to limit a third-party claim brought in a Louisiana court to the recovery available after the application of the internal liability shields of a Series LLC. Even if a court were to find that generally to be so, that would not seem to answer the identity of interest question for issue preclusion or res judicata, nor prelude in a proper case a suit claiming that the internal liability shields should be pierced on a veil piercing or alter ego theory. 

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 appears to be an inappropriate stretch to assert that the internal affairs doctrine applies here – liabilities to third-party creditors are not 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 entity. 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 U.S. Constitution (U.S. Const. Art. IV, Sec. 1.): 

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.

In other words, if, as here, an individual Series of a Delaware Series LLC is doing business in a non-Series state, Louisiana, does the Full Faith and Credit Clause require a Louisiana court to respect the internal liability shield of the Delaware Series LLC legislation in a suit brought by a Louisiana resident seeking to hold the juridical Series LLC, Arch Bay, and one of its individual Series, Series 2010B, liable for the activities just of Series 2010B in Louisiana? 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 (Restatement (Second) of Conflicts §117 (1971); Baker, 522 U.S. at 233.): 

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.

Indeed, if a Louisiana court were to render a money judgment against a Delaware Series LLC because of an act of one Series of the Series LLC in Louisiana, 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.


In Alphonse, it is unfortunate that the Fifth Circuit described Arch Bay as the “parent” of Series 2010B, and even more unfortunate that it asserted that “Series LLCs only exist to represent the interest of the parent LLC.” That might be true in a particular case but as a general proposition is plainly wrong. There need not be any identity of ownership between a Series LLC and any of its individual Series. Under Delaware law, members are “associated with a series” and the members associated with one Series may have no economic interest in the Series LLC or in any of its individual Series.

It would have been far preferable, and more useful to practitioners, if the Fifth Circuit had:

  • Held that the internal affairs doctrine does not apply to third-party liability claims;
  • Avoided inaccurate terms in describing a Series and the Series LLC of which it is a part;
  • Recognized the flexibility possible under Delaware law and remanded for specific fact findings on ownership of Arch Bay Holdings and of its Series 2010B.




Additional Resources

For other materials on this topic, please refer to the following.

Business Law Today 

Tax Aspects of Series LLCs
By Allen Sparkman
February 2013
This article explains how a series LLC navigates tax issues, especially in terms of proposed federal tax regulations.

Allen Sparkman

Allen Sparkman practices at Sparkman Foote Minor LLP in Houston and Denver.