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Limited Liability Company Update: Delaware Series LLCs

Fall 2006

Since limited liability company (LLC) statutes were enacted in all fifty states and the District of Columbia, the LLC has become the business entity of choice. Generally, LLCs provide business owners with limited liability for the debts and obligations of the business while being taxed on a pass-through basis.

In 1996, Delaware amended its LLC statute to permit an LLC agreement to provide for the establishment of one or more designated series of members, managers or LLC interests. Each series can have separate rights, powers and duties with respect to specified property or obligations of the LLC, or with respect to profits and losses associated with specified property or obligations. (A few other states have enacted or are considering enacting similar legislation.) In essence, each series is a mini-LLC or cell within the LLC itself, and the debts and obligations of a particular series would be enforceable only against the assets of such series and not against the assets of the LLC generally or the assets of any other series within the LLC.

The assets of a particular series are protected from enforcement action against the assets of the LLC or any other series if (1) the LLC agreement provides for the establishment of one or more series, (2) separate and distinct records are maintained for each series and the assets of each are accounted for separately from the other assets of the LLC or any other series (and the LLC agreement so provides), and (3) notice of such limitation of liability is set forth in the LLC’s certificate of formation. At first blush, it would appear that the use of such a vehicle would be ideal for separating assets and businesses, especially those with a high level of risk, from other assets and businesses, without having to resort to the formation and maintenance of separate legal entities and without incurring the costs and inefficiencies associated with separate entities. In addition, a Delaware series might be used to transfer assets among related businesses without incurring income or real estate transfer and recordation taxes. However, despite the ten year existence of the Delaware series LLC statute, the use of Delaware series LLCs (especially if the assets of the business are located outside Delaware and/or business operations are not confined within Delaware) has been limited for the following reasons, among others: lack of clear federal tax standards regarding income taxation of a series LLC with multiple members; untested asset protection and planning advantages of the series LLC in Delaware and foreign jurisdictions; uncertainty as to such issues as environmental contamination liability, tort liability protection, fiduciary duties, and avoidance of sales and documentary transfer taxes; and the inability to hold title in a series LLC’s own name (as it is not a separate legal entity). In light of the above-described risks and uncertainties, use of traditional business entities is recommended until the Delaware series LLC has been tested in the courts and been addressed by the Internal Revenue Service. For more information about business entity issues, contact Barry Weiskopf at 410.752.9728 or via email.

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