WHAT ARE SERIES LLCS? AN OVERVIEW OF DRAFTING AND OPERATIONAL CONSIDERATIONS

ADRIENNE RANDLE BOND Bond & Smyser, L.L.P. 5505 Jackson Houston, 77004 (713) 524-4200 voice (713) 524-1196 fax [email protected] www.bondandsmyser.com

STEVEN D. MOORE Jackson Walker, L.L.P. 100 Congress Avenue, Suite 1100 Austin, Texas 78701 (512) 236-2000 voice (512) 236-2002 fax [email protected] www.jw.com

State Bar of Texas CHOICE AND ACQUISITION OF ENTITIES IN TEXAS May 27, 2011 San Antonio

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ADRIENNE RANDLE BOND BOND & SMYSER LLP 5505 Jackson Street Houston, Texas 77004 Telephone: (713) 524-4200 Fax: (713) 524-1196 DENVER: 1616 17TH Street, Suite 564 Denver, Colorado 80202 303-502-7951 www.bondsmyser.com

Adrienne Randle Bond specializes in energy and energy finance, including complex corporate, and securities law, oil and gas finance transactions and mergers and acquisitions. Ms. Bond’s practice includes initial planning, venture capital, the formation of , and , SEC compliance issues, private placements, going private transactions, alternative energy, trademark law and licensing, corporate compliance, and acquisitions or sales of assets and other equity interests.

EDUCATION

Ms. Bond is a magna cum laude graduate of Rice University (B.A. 1980) and graduated Columbia University Law School (JD, 1980) as a Harlan Fiske Stone Scholar.

ADMITTED

 Texas  Colorado

PROFESSIONAL MEMBERSHPS

 Texas Bar Association o Business Law Section and Oil, Gas, and Energy Resources Section  Houston Bar Association o Mergers and Acquisitions Section  Colorado Bar Association  American Bar Association o Business Law Section and Environment, Energy and Resources Section o Distressed M&A Committee o International Use of U.S. Business Entities Committee o LLC, Partnership and Unincorporated Entities Committee o Mergers and Acquisitions Committee o Private Entity and Venture Capital Committee

PROFESSIONAL ACTIVITIES

Ms. Bond is a frequent author and lecturer on corporate and securities law issues, and has served as Adjunct Professor of at the University of Houston Law Center. Ms. Bond is a past President of the Women's Finance Exchange.

What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7

TABLE OF CONTENTS

I. THE SERIES LLC IN TEXAS...... 1

II. WHAT IS A SERIES LLC? ...... 1

III. HOW DO YOU CREATE A SERIES LLC? ...... 1

IV. IF YOU CREATE A SERIES LLC, WHAT ARE ITS POWERS? ...... 3

V. WHAT POWERS ARE DENIED TO THE SERIES LLC? ...... 3

VI. WHO MANAGES THE SERIES LLC? ...... 3

VII. THE MAGIC PROVISION – SECTION 101.609...... 5

VIII. WHAT ARE THE RULES ON DISTRIBUTIONS FROM THE SERIES LLC DURING OPERATIONS AND AT LIQUIDATION? ...... 5

IX. WHAT IS NOT EXPRESSLY STATED IN THE STATUTE ABOUT SERIES LLCS? QUESTIONS ABOUT MANAGEMENT STRUCTURES...... 6 A. Amendment of the Series LLC Agreement...... 7 B. Assignment of the Interests in the Series LLC...... 7 C. Withdrawal and Rights to Cash Distributions...... 8 D. Books and Records...... 8 E. Duties, including Fiduciary Duties...... 9

X. STATUTORY ISSUES OTHER THAN THE LLC STATUTE – UCC AND BANKRUPTCY...... 9

XI. OTHER STATUTORY LIMITATIONS ON SERIES LLCS...... 11

XII. WHAT ARE CIRCUMSTANCES WHERE SERIES LLCS MAY BE HELPFUL? ...... 11

XIII. TEXAS TAX CONSIDERATIONS FOR SERIES LLCS ...... 12 A. Is the Series LLC or Each Series the Texas Franchise Tax Taxpayer? ...... 12 B. Treating a Series LLC as One Taxable Entity ...... 12 C. Treating Each Series as a Separate Taxable Entity ...... 12

XIV. CONCLUSION...... 13

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What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7

WHAT ARE SERIES LLC’S? AN flexibility around the issues of ownership and operation of the assets in the series, the flexibility OVERVIEW OF DRAFTING AND should not confuse the basic nature and use of the OPERATIONAL CONSIDERATIONS vehicle: segregation of assets with common management structures. Business lawyers have always I. THE SERIES LLC IN TEXAS. split up and recombined management structures and Texas adopted new provisions permitting the economic allocations of the enterprise, and the Series creation and operation of series limited liability LLC is a permutation of that concept. companies (the “Series LLC”) under Texas law in Since the Texas statute is based on the issue of 2009. This paper is to discuss what the state of law is “commonality” among the Series LLC, that on series under the Texas statute, with some definitional concept has been imbedded in the statutory consideration of the other jurisdiction and practice formulation. The commentators have labeled the pointers for resolving the issues presented by the totality of the LLC (of which the Series within the LLC statutory formulation for the Series LLC. After is a segregated part) the “Mothership.” The entity for discussing what series are and can do, the paper will go state law purposes is the LLC itself and not the Series through points of ambiguity and development where within the LLC. Stated positively, the Series within the results of the use of the series structure may not be the LLC is not a separate entity under the laws of the perfectly clear. This vehicle for formation is still under state of Texas. An important technical point in the development, but presents an elegant solution to Texas statute is that the Series within the LLC ownership and management of closely related, but not generally is NOT a “Domestic Entity” within the identical, groups of assets. meaning of Section 1.002(18) of the TBOC. This basic concept has effects throughout the formation of the II. WHAT IS A SERIES LLC? Series LLC, the drafting of the LLC Agreement, the The Series LLC was first created in in operation of the LLC and the Series within the LLC 1996, but has only recently gained traction in and the exit strategies for the Series within the LLC. legislation in other states. Like all new formation Some states, namely and , have considered vehicles, it is an idea that is in process, and the several this issue and have permitted (but not required) that the statutory formulations are not uniform. In fact, the Series within the LLC be a separate entity. Most of the august bodies such as the American Bar Association statutory formulations, however, are like Texas where and the NCCUSL that usually draft and distribute the Series within the LLC is not a separate entity. This uniform laws, have not weighed in with draft is the most core issue that creates the ambiguity and legislation. Texas is one of the most recent thoughts mystery of forming and using this vehicle, and will be on drafting, and tends to follow the Delaware a theme through this paper. While many discuss (and formulations (and reject those state formulations that complain) about this issue, this paper will suggest have strayed from Delaware). The kernel legal concept treatments when it arises to provide certainty for the of the Series LLC is the internal segregation of assets. use of the Series LLC. The TBOC states the following: “A agreement may establish . . . one or more designated III. HOW DO YOU CREATE A SERIES LLC? series . . . that (a) has separate rights, powers or duties The TBOC has express requirements for the filing with respect to specified property or obligations of the requirements for a Series LLC, including requirements limited liability company or profits and losses for the contents of the certificate of formation, associated with specified property or obligations, or (b) requirements for the terms and conditions of the LLC has a separate business purpose or investment Agreement and requirements for specific record objective.” keeping. Section 101.602(b) of the TBOC sets forth If you consider the concept of internal asset these three express statutory requirements. Upon segregation, that means that two other issues have to formation, or by amendment, the Certificate of necessarily complement that idea: first if assets are Formation must contain a notice of the existence of a segregated, the primary reason for such segregation is Series LLC, by setting forth a notice of the limitations to allocate the economic rights to those assets (internal) caused by the segregation of the assets in the differently among the owners. Second, if the Series LLC, as specified in Section 101.602(a). Those segregation is internal, and the purpose for the Series LLC limitations are as follows: segregation is economic, then there must be some commonality within the entity, which can only be (1) The debts, liabilities, obligations and something to do with the management of the expenses incurred, contracted for, or enterprise. While the Texas statute has significant otherwise existing with respect to a particular

1 What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7

series shall be enforceable against the assets suggest that you do not have to use the mundane of that series only and shall not be “Series A” or “Series I”. If the point of the name is to enforceable against the assets of the limited help segregate assets, name the Series LLC after the liability company generally or any other assets to help the identification and notice process. series; and Next, you need to expressly deal with who the (2) None of the debts, liabilities, obligations, and governing persons of the LLC and the Series within the expenses incurred, contracted for, or LLC are or will be. Because the LLC (Mothership) is otherwise existing with respect to the limited the entity, the usual places in the Form 305 must set liability company generally or any other out governing persons for the entity, which is not the series shall be enforceable against the assets Series within the LLC Again, this is where you need of a particular series. to be thoughtful about the issue of the entity being the LLC and not the Series. Therefore, on the Form 305, The Secretary of State of the State of Texas has not you must list the governing persons of the LLC promulgated a separate form for filing a Texas Series (Mothership). That means an initial determination of LLC, although there is a form to qualify a foreign whether the LLC is manager managed or member series LLC in this state. I would recommend that you managed. The important point on this issue, is that the expressly state that the LLC is a Series LLC within the persons that you name in the Certificate of Formation meaning of Subchapter M, Sections 101.601 et seq, will be the governing persons of the LLC, and not and then quote the language of Section 101.602(a), set necessarily the governing persons of the Series within out above, out of caution. Stated directly, follow the the LLC. Please hold this thought until the discussion statutory directions and diction slavishly. below concerning the provisions on governing persons In the remaining provisions of Subchapter M on in Subchapter M on Series LLCs. If, however, you Series LLCs, there are indirect or implied requirements have managers or members that are unique to the for the Certificate of Formation in addition to the Series LLC, it would be appropriate to add that express requirements of Section 101.602(a). Looking information to the Supplemental Provisions of the at Form 305 promulgated by the Secretary of State, the Form 305 Certificate of Formation. first question about how Series LLCs function is Even though the Series within the LLC is not a presented by the issue of the name of the entity. If the separate entity, if you determine to have governing LLC is the entity, and the Series within the LLC is not persons associated with the Series within the LLC, an entity, then in the Certificate of Formation, the make sure that the Certificate of Formation designates name will be the name of the limited liability company, the managers or members associated with each specific or the LLC (Mothership), and there is not an express series. I would go so far as to recommend that you location to name a Series within the LLC. This feature amend your Certificate of Formation upon the creation has impact on the requirements for the segregation of of each series to publicly file this information. I the assets within the Series within the LLC, namely, if believe that this could be of assistance in maintaining the Series within the LLC does not have a name that the integrity of the Series within the LLC in a separately identifies it, whether or not it is an entity, debtor/creditor controversy, as I will discuss below. how can the LLC, internally or externally identify or There is not a special Secretary of State form for label the asset that are segregated in the Series within forming a series LLC. Therefore, because the old form the LLC? How can a Series within the LLC enter into does not have a space to designate members or a if it does not have a name? How can it be managers associated with the LLC, you will have to sued or sue, if it does not have a name? Obviously, the use the “catch all box” of the Supplement Provisions in Series within the LLC must have a name that must be the form to put in that information. set out, at a minimum, in the LLC Agreement. As I I do not believe that the issues of addresses, will discuss in more detail below on the section of the registered offices or present any paper concerning UCC issues, I suggest that in the significant difficulties, as long as you recognize the Supplement Provisions of the Form 305, that initially issue of the entity being the LLC. Therefore, the or by amendment, you state that the Series within the Series within the LLC cannot have a separate address LLC has a name and create a public record of that or separate registered agents or offices from the LLC name. This does not solve all of the legal issues, but it (Mothership) itself. certainly goes a long way to solve the contract and Next, in the formation process, the LLC related identification problems that could forestall the Agreement must contain provisions creating the series legal issues. A separate name that is on record in the structure. Hold this thought, because I want to discuss Certificate of Formation will give you a focal point to it more fully after we have had the opportunity to look establish the separation of the assets. I would also at and think about the remaining provisions of

2 What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7

Subchapter M on Series LLCs, and how those must V. WHAT POWERS ARE DENIED TO THE interact with the Chapter on LLCs and the remainder of SERIES LLC? the TBOC, and its hubs and spokes. Because of the structure of Subchapter M, there is You must also create internal records that a series of transactions that are not permitted to a “account for the assets associated with that series Series within the LLC. Briefly, the Series within the separately from the other assets of the company or any LLC, alone, may not merge, convert, conduct an other series.” Section 601(b)(1). Contemporaneous interest exchange, or sell substantially all of its assets records are best, and I believe this needs to include an under the terms and conditions of Chapter 10 of the identifying list of the assets, and a related balance TBOC. Thus, while a Series within the LLC may sell sheet, income statement and cash flow statements that its assets, it may not use the provisions for approval of flow from the segregated assets, whatever the precise a sale of substantially all of its business in the TBOC nature of the internal asset allocation may be. As outside of Chapter 101 on LLCs. These transactions discussed later, the IRS has issued rules that will are reserved to the LLC, or the Mothership, itself. This require the Series within the LLC to report separately, is structurally built into Chapter 101, and the so there will be a direct pressure to maintain these Subchapter M by the fact that a Series LLC is not segregated records. The nature of the segregation of within the definition of a “Domestic Entity.” the assets in the series does not change the requirement to keep records, so that if you are creative in your VI. WHO MANAGES THE SERIES LLC? series structure and accomplish matters other than asset The express rules on management provisions of segregation, you must still keep these internal records. the Series LLC are contained in four provisions, With these issues, we have covered how to file a Section 101.606, which contains provisions limiting Certificate of Formation for a Series LLC and the liability of members and managers associated with summarized the other formation requirements. Once a series, and permits the duties of the members and you have a Series LLC, what can you do with it? managers to be expanded or restricted, Section 101.607, which contains the affirmative rules on how IV. IF YOU CREATE A SERIES LLC, WHAT one may establish members and managers of the series, ARE ITS POWERS? Section 101.608 that contains the default provisions, so Texas drafters had the benefit of reviewing the that there will be governing persons if the draftsman history of drafts of Series LLC legislation, and the makes a mistake, and Section 101.610 concerning the general powers provisions contained in Section termination of the relationship between the governing 101.605 of the TBOC are well thought out. There are person and the Series LLC. four specific powers set out for a Series LLC as Section 101.607, concerning liability limitation is follows: not remarkable. It simply makes express that any members and managers associated with a Series LLC (1) To sue and be sued; are not liable for “a debt, obligation or liability of a (2) To contract; series, including a debt, obligation or liability under a (3) To hold title to assets of the series, including judgment, decree or court order.” It will be safe to real property, personal property and assume that a Series within the LLC will be subject to intangible property; and the same theories of veil piercing that are applicable to (4) To grant liens and security interests in assets LLCs in general. Section 101.607 also contains the of the series. statutory authorization to expand or restrict duties of members or managers, but I would like to discuss that This enumeration of powers is illustrative of the basic issue and practice pointers in more detail below. premise of Series LLCs being a vehicle to segregate Under Section 101.607, there is a great flexibility assets within an entity. All of these powers are the about designating members and managers, and basic functions that are required to acquire, own, allocating their respective voting rights. It is not really operate, convey or dispose of assets. The express grant clear why the drafters used the word “group,” but I of powers to a Series LLC is a helpful start in sorting would like to think that the drafters used a more out its status for statutory regimes, such as the UCC, general word to provide flexibility for creation of that will affect the operations of the Series LLC. For structures. Section 101.607 states as follows: example, if the Series within the LLC has the specific power to contract and to grant liens, then the Series (a) The company agreement may: within the LLC should be able to execute and deliver a security agreement, and a creditor should be permitted (1) establish classes or groups of one or under the UCC to file an effective financing statement. more members or managers associated

3 What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7

with a series each of which has certain the members and managers in the Series within the express relative rights, powers, and LLC are not generally governing persons of LLC duties, including voting rights; and (Mothership). Being “associated” with a Series within (2) provide for the manner of establishing the LLC gives the members or managers the rights to additional classes or groups of one or deal with the Series within the LLC under the specific more members or managers associated powers set forth in Subchapter M, but not necessarily with the series each of which has certain the full rights of members and managers generally for express rights, powers, and duties, the LLC (Mothership). including providing for voting rights and Section 101.608 contains the express back up rights, powers, and duties senior to provisions concerning the governing authority. The existing classes and groups of members first rule is that the provisions of the company or managers associated with the series. agreement concerning the governing authority for the series will trump the materials on file publicly with the (b) The company agreement may provide for the Certificate of Formation. The ability to determine the taking of an action, including the amendment persons authorized and able to enter into for of the company agreement, without the vote an LLC continue to be difficult for the Series within or approval of any member or manager or the LLC also, requiring that the company agreement class or group of members or managers, to always be produced. Next, if the company agreement create under the provisions of the company does not provide for governing persons, they will be agreement a class or group of the series of the managers or members associated with the series in membership interests that was not previously the Certificate of Formation. Hence, as set forth outstanding. earlier, if possible, it is best to have in the Certificate of (c) The company agreement may provide that: Formation an express statement of the members or managers associated with each Series within the LLC. (1) all or certain identified members or Of course, there is no back up rule for the event that managers or a specified class or group the Certificate of Formation is silent on the Series of the members or managers associated within the LLC. .It is likely to take a lawsuit to figure with a series have the right to vote on out if the managers or members designated for the LLC any matter separately or with all or any (Mothership) will be those associated with the Series class or group of the members or within the LLC in absence of a designation. managers associated with the series; Finally Section 101.610 provides rules that permit (2) any member or class or group of a manager or a member to “cease to be a manager with members associated with a series has no respect to a series” [NOTE and see below – why does voting rights; and this not say “cease to be a manager associated with a (3) voting by members or managers series”??] or “cease to be a member associated with a associated with a series is on a per series,” and the termination of the relationship does not capita, number, financial interest, class, terminate the Series within the LLC or cause either the group, or any other basis.1 manager or member to terminate the relationship with the LLC (Mothership) or another series in an LLC. Key words in the statutory formulation include With respect to the member, the fact that there is not “group” and “associated.” I believe the use of the term any member of a series will not require the series to “group” has significance, because the drafters were terminate. This means that the members of the LLC trying to indicate that a team or set of people are (Mothership) are the members of the Series within the involved, and wanted to distinguish that concept from LLC. The difference in the two statutory formulations, “series” or “class” since those words more often i.e. the use of the word “associated” with respect to connote economic rights (i.e. classes of stock have members may be important. Under this formulation, different dividends and rates of return, not different the statute uses the word “associated” with a series boards of directors). The word “associated” is with respect to members to indicate that the members significant, because that denotes a subset of rights are members of the LLC (Mothership) itself, not just under the TBOC. Because Series within the LLCs are the Series within the LLC, while managers may belong not separate entities, the drafters of the Series LLC solely to the Series within the LLC, if that is intended. statutes have used the word “associated” to signal that What does this mean for the governance of a Series within the LLC? First, the information in the Certificate of Formation will be critical to the analysis, 1 Added by Acts 2009, 81st Leg., R.S., Ch. 84, Sec. 45, eff. because if there is not a public filing, and the LLC September 1, 2009. 4 What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7

Agreement is not clear, the backup rule would indicate converse rule, so that if a provision specific to Series that the governing persons for the Series within the within the LLCs is affected by the rest of the Chapter LLC will be those members or managers designated in on LLCs, the rest of the Chapter may be applied to the the Certificate of Formation. Second, there is a Series within the LLC. Through this Section 101.609, dichotomy of authorization or agency issues that will all of the backup rules on voting requirements, election result from the LLC (Mothership) being a member or appointment of managers and officers, assignment managed or manager managed LLC. If the LLC of interests and related rights of assignees and general (Mothership) is a manager managed LLC, then by the record keeping requirements are neatly placed into the statute (and see the analysis about Section 101.609, Series within the LLC. Of course, the backup rules of below for the authority for this proposition), the Series LLCs in general are very sparse (in comparison to the within the LLC cannot be member managed, since the statutory rules available for corporations) and those Series within the LLC is not an entity separate from the back up rules are generally unpleasant, requiring LLC (Mothership) itself. A manager managed LLC unanimous approvals per capita, so Section 101.609 will not allow for a member managed Series within the perpetuates the contractual nature of LLCs and the LLC. Alternately, a member managed LLC may requirement for specific drafting. possibly have a manager managed Series within the Examples of provisions that are imported into LLC. The authority of the managers in this instance, Series within the LLCs include (1) amendment of the however, is NOT statutory, but contractual. The company agreement (requires a unanimous vote of the statute would not empower the managers to act as members), Section 101.053, (2) the prohibitions on managers within the meaning of Chapter 101 of the waiver or amendment of specific statutory provisions, TBOC. The power of the managers to act on behalf of Section 101.054, (3) the nature of a membership the Series within the LLC would derive from the interest as personal property (important in the UCC contractual rights that you may grant to those persons discussion below) Section 101.106, (4) prohibitions on as agents of the Series within the LLC under the LLC withdrawal or expulsion of members, Section 101.107, Agreement. assignment of interests, Section 101.108, (5) rights of A Series within the LLC may also designate the assignees, Section 101.110, enforceability of officers of the Series LLC by availing itself of the contribution obligations, Section 101.151, (6) rules authority to create and use officers in Section 101.254, prohibiting distribution in kind, Section 101.202, (7) though the mechanism of Section 101.609 (as transactions with interested persons, Section 101.255, discussed in detail below). Also, remember that under (7) rules concerning the appointment, term, removal, the TBOC, if the LLC (Mothership) or the Series vacancy and so forth applicable to managers, Section within the LLC is a manager managed LLC, each 101.301, et seq., and (8) general rules on meetings and manager has express agency authority for the LLC voting, Section 101.351 et seq. (Mothership) or the Series within the LLC, so that if As an by reference section, you wish the Managers to act as a group, and not Section 101.609 is very valuable, but like all individually, you must specifically provide for that incorporation by reference sections, a carefully drafted event in your LLC Agreement, and this particular LLC Agreement that will include Series within the authorization may differ between the LLC LLC will need to check each of the default rules and (Mothership) and the Series within the LLC, since it is consider how the default rule needs to apply to the also based in contract, and not statute. Series within the LLC and how the default rule will affect the relationship among each Series within the VII. THE MAGIC PROVISION – SECTION LLC and the LLC (Mothership). 101.609. This is a key provision to the Texas statute that VIII. WHAT ARE THE RULES ON grants the powers or activities permitted to the Series DISTRIBUTIONS FROM THE SERIES LLCs, as opposed to LLCs in general that are not LLC DURING OPERATIONS AND AT contained in Subchapter M specifically. This is the LIQUIDATION? provision that permits the Series LLC to avail itself of If a Series within the LLC segregates rights to the rules applicable to LLCs in general. Section assets within an LLC, it makes sense that there has to 101.609, does NOT permit the Series LLC to avail be particular rules on the distributions to the economic itself of other provisions of the TBOC (such as the owners of those segregated assets. Briefly, the statute merger sections). Section 101.609(a) states that the uses the time honored statutory rules and formulations general rules on LLCs apply to Series LLCs “to the on distributions with revisions to make the concepts extent not inconsistent” [good question – what is or is work for the Series LLC concept. This particular set of not consistent?]. Section 101.609(b) contains the rules could not be incorporated by reference because of

5 What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7 the many possible contractual permutations of a Series LLC (Mothership) must be able to contribute to the within the LLC, so the drafters tackled this issue as a Series within the LLC, and receive allocations of sui generis issue. The statute makes its way through income, gain, loss deduction and credit and distribution distribution provisions generally applicable to LLCs to of cash with respect thereto. This needs to happen with ensure that within the Series within the LLC, respect to regular operations and upon dissolution or distributions are only made with respect to the assets sale of the underlying assets. contained within the Series within the LLC. Next, you must consider the actual management of the LLC (Mothership) and the Series within it. IX. WHAT IS NOT EXPRESSLY STATED IN There are many choices, and the particular fact THE STATUTE ABOUT SERIES LLCS? situation will be an important factor. If, however, the QUESTIONS ABOUT MANAGEMENT Series within the LLC is an asset segregation device, STRUCTURES. by definition, there must be some common thread Now that we have explored the express statutory among the assets to suggest the efficacy of the use of a provisions governing the Series LLC in Texas, let’s Series, and one frequent commonalty is management. turn to what is not expressly discussed, and what you It may make more sense to have the managers at the have to arrive at by analysis and implication. First and LLC (Mothership) than at the Series, although one can foremost, and the source of much controversy about easily think of cases where there is a person unique to Series LLCs, the statute does not really contain clear one part of an entire project. Also, as stated above, if rules on the exact relationship between the LLC you have a member managed LLC, you may not have (Mothership) and the Series within the LLC. While the statutory managers of a Series in that LLC, although statute tells you what is possible to do and creates you may grant contractual agency authority. Both many alternatives and permutations, it is difficult to Member managed and Manager managed LLCs may discern exactly what you should do Because of the have officers. If your entity is manager-managed, you relative newness of this vehicle, and because the may have separate managers for the Series within the myriad of choices in the statute are confusing, you LLC, or conversely, use the managers from the LLC must consider your precise structure in the context of (Mothership) as the Managers for the Series within the your business transaction before you indulge in the LLC. This is an area where the facts and the structure potential flexibilities offered by the statute. As set out of the deal are going to guide your choices. in the beginning of the paper, the Series LLC is a If management is divided by each Series and there mechanism to segregate assets within an existing is an LLC (Mothership), in addition to thinking about structure (a management team or contract, a license or who will manage and how, you must also think about permit, a physical location, a project, etc.). If you and provide for expenses, fees and/or compensation. begin with the concept that the Series within the LLC All veil piercing arguments scrutinize very carefully is not wholly separate (or a separate entity, as you the financial arrangements between the various parts will), then some of the many choices become less where the piercing is being attempted. Series LLCs are overwhelming, and can begin to make some sense. not likely to escape this long standing case law. If If the LLC (Mothership) is the entity, and the would be wise to set out express provisions for Series within the LLC is not a separate entity, allocation and payment of fees and expenses, including management and ownership structures begin to fall into especially common or shared charges. Common or place. On the issues of ownership, if you parse the shared charges will likely include overhead, but there Texas statutory provisions, the statute provides that the may be some costs, such as expenses for maintaining a members are Members of the LLC (Mothership), not common license, that would go beyond normal actually members of the Series within the LLC. If you overhead allocation provisions, due to the nature of the study the statute, this must be the case, because a Series within the LLC. Clean and crisp financial Series within the LLC can have no members, and not separation of each Series within the LLC is going to be be required to dissolve, while an LLC without an important fact in respecting the separation of the members must dissolve, ergo, the Series within the assets. LLC does not actually have the members. That being Finally, do not forget the long standing case law said, one of the main features of the Series within the about liability of agents for entities, and the LLC is the ability to segregate assets, and therefore requirement that you identify the capacity in which an segregate the economic benefits of those assets, such as agent is serving. Once you determine your ownership allocations and distributions (and heaven help us, and management structure, make sure that the “agent” losses). This must mean that members must receive precise capacity is correctly labeled in the documents. the economic rights/obligations associated with the Once the overall structure is established, you will assets in the Series within the LLC. Members of the need to set out the two main transactions that occur

6 What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7 with respect to an “ownership interest” which would be the statute. This harkens back to the fact that the voting it and selling it. Again, the flexibility of the members are members of the LLC (Mothership), not statute is confusing at inception. Turning to voting, the the Series within the LLC. Again, you will need to first question is at what layer do you want the votes to determine what you want to do, since Section 101.609 count. This a complexity of a problem related to throws you back to the general amendment provision, analysis for class voting. If the Members are all Section 101.053, which requires the unanimous vote of members of the LLC (Mothership), are the voting the members (the LLC Agreement is a contract). You rights at that level, and/or are there matters that belong may vary the amendment provisions by agreement, and to the Series within the LLC that need to be handled at you will need to decide if the members associated with the Series level? This is an area where a formula will the Series within the LLC will be able to amend the develop, but has not yet. On voting at the LLC Series provisions, or whether all members (at some (Mothership) level, I believe that you must provide for percentage) will need to be involved, or some voting on the LLC (Mothership) level because there combination of the two possibilities that is in between. are certain transactions that require member vote that I can easily imagine some amendments that should cannot be approved by the Series within the within the remain at the level of the Series within the LLC, and LLC, such as mergers, conversions and interest some that all of the members would be affected This exchanges, so all of the equity holders need a vote, and determination will also depend on the deal and facts. you will need to figure out if “class-like” vetoes (i.e. requiring approval series by series, or approval by all B. Assignment of the Interests in the Series LLC. of the members without distinction) is appropriate for Assignment of interests is another matter that is those “extra-series” transactions. not contained in the specific provisions applicable to Next, you must think about whether there are Series within the LLC, so Section 101.609 would point matters with respect to the assets in the Series within you to the main provisions of the LLC statute, which the LLC that should be controlled by the members provisions start in Section 101.108. Once again, the associated with that Series – that would be the sale of idiosyncratic provisions of the Series within the LLC all or substantially all of the assets in the Series within must be thought through in connection with the LLC. Then, are there transactions, such as budgets, assignments of interests. First, you must consider the borrowings, capital expenditures and management of specific facts of the business deal, and whether or not lawsuits, where you must decide whether they are best the interests associated with the Series LLC will be handled centrally or in the Series within the LLC. assigned separately. Also, you must always remember Remember also, that as you get further into details of that there is a linkage between the membership management, the approval process could move from interests associated with the Series within the LLC and the equity holders to the managers (who may or may the LLC (Mothership). You must define in more detail not be centralized). Then after you decide on who you what exactly is being assigned, and the approvals to want to vote on the transactions, you need to figure out assign these new rights. Will you be able to assign just by how much. Again, the statute is flexible, which the rights associated with the Series in the LLC (even means that you have to think through your percentage Section 101.108 expressly permits an assignment in of voting structures with care. Turning to default rules, part)?? and if so, would you permit the member to you are once again governed by Section 101.609, assign the rights to allocations and distributions from which will direct you to the main LLC statutory the Series within the LLC, but not the rights to vote or provisions. The Series rules say that you can establish otherwise participate in the LLC (Mothership) in voting regimes, but the default rules for voting rules connection with the assignment? Just as in a situation are in the main LLC statute. You will further recall, with classes of interests, will there be rights of the that on all important decisions, absent agreement to the other members of the LLC (Mothership) – that means contrary in the LLC Agreement, a unanimous vote of members associated with other series, also, to purchase the members is required. or acquire the interest associated with the Series before any other outside party could enter into the Series A. Amendment of the Series LLC Agreement. within the LLC, at whatever level. Amendment of the LLC Agreement is a particular The provisions of Section 101.108 et seq, would subset of voting that needs to be covered. Again, the require you to focus on several statutory issues, after ability to amend the Series within the LLC itself is not you had thought through the business transaction. The contained in the Series LLC provisions. Therefore, if statute expressly states that an assignment of any part there are members associated with the Series within the of an interest in an LLC does not entitle the assignee to LLC, those members may not unilaterally amend the become a member of the LLC, absent approval of all provisions regarding that Series under the authority of the members (that pesky unanimous vote again!).

7 What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7

Would you want that rule, which would mean that all Series as well as the LLC (Mothership), considering of the members at the LLC (Mothership) would have to the complexities of the legal restrictions on what vote, or would you want something less. If all of the transaction the Series within the LLC is authorized to other members of the Series within the LLC must vote transact within its parameters (e.g. sale of assets) and on the admittance of an assignee, that would mean that those transactions that must be approved at the level of any member associated with another Series within the the LLC (Mothership). For example, concepts like LLC would have the right to vote on the admission of drag alongs and tag alongs would necessarily have to an assignee in a Series in which that Member is not be drafted at the level of the LLC (Mothership) in associated? Contribution obligations need to be order to operate effectively. clarified also. Section 101.108 states that assignees The withdrawal provisions of the LLC statute also that are admitted as members take on the contribution prohibit distributions in kind, Section 101.202. obligations of the assignor. While it is likely that the Because the Series within the LLC is associated with assignor’s liability for contributions is going to be specific assets in an LLC, this particular basic rule may specific to the Series within the LLC, any assignment need to be analyzed, because in the context of the must be clear on the ongoing liabilities. The Series within the LLC, it may make perfect sense to assignment provisions also state that the assignee has permit a distribution in kind of a portion of the asset rights to require “reasonable inspections or a held in the Series within the LLC to a departing reasonable account of the transactions of the member, rather than a cash distribution, and the company.” Would this mean that the assignee would structure of the Series within the LLC could facilitate only have rights to the information about the Series the resolution of that conflict or transaction, as the case within the LLC itself, or would the assignee have may be. rights to the rest of the LLC (Mothership) or other Series within that LLC? Finally, the assignor remains D. Books and Records. liable under the statute after the assignment, so you The books and records provisions of the main will need to consider how appropriate it would be to LLC statute are another section incorporated into the leave that liability in place in connection with any full Series provisions by Section 101.609. This is the first or partial assignment of interests associated with a area, however, where there has been litigation over Series within the LLC. rights of members associated with a Series within the LLC to information from the LLC. Specifically, if you C. Withdrawal and Rights to Cash Distributions. are a member associated with the Series within the The rights of a member to withdraw, and LLC, do you have rights to the books and records of consequences of withdrawal is another set of the LLC (Mothership) or the other Series within the provisions incorporated into the Series LLC provisions LLC. Not surprisingly, the holdings in the cases by Section 101.609. The basic statutory provision, set conflict, but I would maintain that the specific facts are forth in Section 101.107, states that members cannot as influential as the theoretical underpinnings of the withdraw or be expelled. This provision affects Series law on Series LLC. I would assert that if the Series LLCs in much the same manner as in a traditional within the LLC must look to the LLC (Mothership) for LLC, in that you must consider how to have an certain authorizations and related transactions, then it appropriate exit for the members, both on a friendly would be perfectly appropriate for the members basis, and on a not so friendly basis. The existence of associated with the Series to have access to the LLC the Series within the LLC raises issues on exits similar (Mothership) with respect to matters that are not within to assignments, and those issues are how separate are the authority of the Series within the LLC. The judges the rights of the members associated with the Series did not analyze the facts under that frame, however. from the LLC (Mothership) as a whole. One unique The learning from the cases is that your LLC question of a Series LLC is whether if a member is Agreement should spell out the rules applicable to the associated with a Series within the LLC, does that members associated with the Series within the LLC, so member withdraw only as the Series within the LLC, that a judge may enforce your agreement and not or also with respect to the LLC (Mothership)? The interpret the application of Section 101.609 to the answer to that question is also likely to be based on the books and records provisions of the LLC statute. deal terms, but there is again, a linkage between the Turning to the books and records provisions two that must be documented, since the Series within themselves, parsing through the information that a the LLC is not a separate entity. member has a right to receive, Section 101.501, there On the issue of friendly exits, you must consider are records applicable to the LLC (Mothership) that how rights of first refusal, preemptive rights, drag would necessarily affect each series, as for example, a along rights and tag along rights would apply to the copy of the Certificate of Formation and the LLC

8 What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7

Agreement. The more difficult question is whether a by reference, so you will have to start the analysis and member associated with a Series within the LLC drafting based on the Series provisions, Section should have access to the financial information about 101.606, and then also consider the general rules on the other Series within the LLC. On first thought, you duties in LLC. An additional consideration would be might conclude that if Series within the LLC are any type of drafting that would address the issues of supposed to be asset “silos” then the information about management stepping out of the bounds of the LLC the assets and their operations should also be agreement, and exercising authority, especially as a maintained separately. On the other hand, any manager or officer of the LLC (Mothership) that competent auditor will tell you that you cannot indirectly affects a Series in the LLC. Specifically, a determine the extent of separation or segregation governing person may not be directly a governing without access to the records to the entities related to person of a Series within an LLC, but through the the separate entity, to check all of the interparty interrelationship, make decisions that affect the Series transactions. Currently, the federal tax rules treat each within the LLC for which that governing person does Series within the LLC as a separate entity, so disputes not have direct responsibility. The long reach of over access to federal income tax records may be fiduciary duty principles makes the effort to delineate minimized. After the issues of actual ownership and duties in the LLC Agreement rather complicated. management of the Series LLC, the issues of the books and records access presents a significant area of X. STATUTORY ISSUES OTHER THAN THE controversy and thought as the law and practice on the LLC STATUTE – UCC AND BANKRUPTCY. Series LLC matures. If the Series LLC is a vehicle for asset segregation, and the Series within the LLC may E. Duties, including Fiduciary Duties. expressly enter into contracts (e.g. security A larger question, but similar analysis, is the issue agreements) and place liens on the assets of the Series of the application of duties, including fiduciary duties, within the LLC, how does the Series LLC fit into the among and between the officers, managers and existing rules of the UCC and Bankruptcy Statutes. members of the Series LLC, as their rights and powers The short answer is that the fit is not perfect, but there may be specifically delineated. Once again, a precise are current answers that are workable and hopefully analysis of the problem will be dictated by the precise statutory clarifications will come. While the express management structure, and due to the flexibility in that provisions of the TBOC are clear that the Series LLC structure, a precise analysis will have to be made on a can place a lien on the assets placed into the Series case by case basis. Several generalizations, however, within the LLC, the relationship with the Texas UCC is may be helpful in this area. Because the LLC not as seamless. Under Section 9.102(28), the Agreement may reduce or increase the duties definition of “Debtor” for purposes of the UCC is a applicable to the officers, members or managers, the “person having an interest, other than a security LLC Agreement needs to address this issue overtly, interest or other lien, in the collateral whether or not and not rely on the statute. Next, if the Series LLC is the person is an obligor.” So far so good. “Person” is truly going to function as a liability limiting vehicle, defined in Section 1.201(b) (27) as “an individual, the LLC Agreement needs to address the liabilities for , business trust, estate, trust, partnership the management team (in whatever structure or format limited liability company, associate, joint venture, you ultimately choose) across the LLC and its Series. government, governmental subdivisions, agency or Once again, if you have a Series LLC, it only makes instrumentality, public corporation or any other legal sense that the LLC Mothership will have more than or commercial entity. So “Series LLC” is not one Series, since you would not need the segregation if specifically in this definition, but it is reasonable to there was only one asset. If there are more than one cover it under “any other legal or commercial entity,” Series, and there is “management” specifically since that is precisely what the catch all provision is assigned to that Series, it makes good sense to limit for. Then turning to the next definition, Section their liability to the members associated with the other 9.102(71), a “Registered Organization” is defined as Series. Conversely, if there are “management” that are “an organization organized solely under the law of a common among all of the Series (which in fact, will be single state or the United States and as to which the likely), then it makes sense that the common state or the United States must maintain a public record management is liable to all of the Series that they can showing the organization to be have been organized.” affect. The going gets tougher as you turn to the specific This is an area where there is both a specific rule section on financing statements. Under Section 9.503, in the provisions on Series LLCs, and where Section there are rules for the name of the debtor, that are 101.609 incorporates general rules on duties in LLCs divided into rules for “Registered Organizations” and

9 What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7

“other cases.” Thus, the critical issue becomes UCC 9.503(a)(1) with the LLC (Mothership) as the whether the Series LLC is a “Registered Organization” named debtor seems the most straightforward choice, under the UCC definition. The negative view is that but one could use UCC 9.503(a)(1) with the name of since the Series LLC provisions do not make the Series within the LLC, and perhaps also comply mandatory (i.e. “MUST”) the public record about the with (a)(5). If you want to use the name of the Series, formation of the Series within the LLC, it does not another possibility is to file an assumed name qualify as a Registered Organization. The TBOC certificate for the name of the Series within the LLC, provision permits a notice to be filed, but there are no which is an alternate to directly using the name of the absolute requirements of a public record about the LLC (Mothership) as the name of the debtor. organization of the Series within the LLC itself. The Notwithstanding the criticisms of the lack of UCC counter argument is that the fact that there is a filing clarity, there is definitely a mechanism for proper and a notice is sufficient to meet the mandatory perfection under the Texas UCC provisions. requirements of the UCC, and that this argument over There is one other point to consider with the the definition of a Registered Organization is a tempest perfection process. The UCC requires that the in a teapot. The uncertainty will be with us until the collateral be described, and this part of the perfection UCC, or the TBOC is clarified, or a case points to the process is not adversely affected by the TBOC Series correct direction. provisions. It would be bad, however, if the There are several solutions to this problem. First, descriptions of the assets that are required to be under the express provisions of the UCC, the LLC maintained in the Series LLC records are markedly (or (Mothership) definitely qualifies as a “Registered even a teeny bit) different from the UCC filings. The Organization” and the filings may be made in its name, descriptions of the assets in the internal records and with a precise description of the assets. While not a external records need to match as closely as possible. perfect recognition of the Series within the LLC, this The issues about bankruptcy of a Series in an LLC procedure works. Creditors have a long track record of are also rather unclear. There are two major concerns limiting their security interests in specific assets, and about Series LLCs: (1) Who and how do you actually the relative newness of Series LLCs does not change a file bankruptcy for a Series in an LLC, and (2) will the long established UCC practice. Second, if you want to Series LLC separation of assets be respected by the include the Series within the LLC as your debtor, then Bankruptcy Code. On the first issue, we all know that I would suggest that precise information about the the Bankruptcy Code is not clear on who is authorized Series within the LLC be placed into the Certificate of to file bankruptcy for an LLC, and after a series of Formation, and that the information must contain a contested cases, rules on the issue became clearer. distinct name and listing of the purpose and governing Lawyers drafting LLC Agreement became more persons, if not the management structure. If you do not careful about expressly stating who in the management have the Series within the LLC established on the date structure of the LLC was actually authorized to file for of formation, then the Certificate of Formation needs to protection under Chapter 11. The lesson for the Series be amended to add the information to facilitate the LLC is to expressly state who and by what procedure UCC perfection process. If these two methods are not (i.e. vote) may authorize the filing of a bankruptcy satisfactory, and perhaps in addition to simply naming proceeding. Total caution would dictate that the the Series within the LLC, you may rely on the approval be made at the LLC (Mothership) level, since alternate provisions of the UCC, i.e. Section the express provisions of the Series LLC rules do not 9.503(b)(5)(A). This provision states that in “other mention bankruptcy. This problem, however, can be cases,” . . . “if the debtor has a name, only if the largely solved through careful drafting. financing statement provides the individual name or The larger question of the Bankruptcy courts organizational name of the debtor,” or under respecting the Series LLC is more difficult. It would 9.503(a)(5)(B), “if the debtor does not have a name, be wise to carefully review the statutory and case law only if the financing statement provide s the names of on substantive consolidation in bankruptcy court. the partners, members, associates or other persons While drafting can create a format that helps maintain comprising the debtor.” Thus, in the worst case, you legal separation of assets, the fact remains that the may properly perfect by providing the names of the actual practice of the managers and owners of the Members (and, to be safe, that would mean all of the assets is critical to any analysis of substantive members of the LLC (Mothership)) of the Series LLC. consolidation. While a bankruptcy judge does not have While the UCC provisions are not a perfect, they the authority to rewrite or unilaterally revise the certainly have clear provisions that may be used to express provisions of the TBOC, that judge can properly perfect under the circumstances. Until the examine how the parties behaved in connection with UCC law is clarified, compliance with filing under their respective rights and obligations, and make a

10 What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7 determination concerning the relative rights of Iowa, that treat each Series within an LLC as a separate creditors to the assets of the debtor and persons related entity. Other differences exist, particularly with thereto. This is an area where careful records and respect to Delaware, which was the first state, and concepts of “veil piercing” need to be applied to the upon which provisions other states have drafted Series LLC operations to prevent consolidation. “improvements.” Those august bodies in charge of In the preparation of documentation for Series uniform laws, such as NCCUSL and the ABA, have LLCs, other traditional concepts applied among not weighed in with uniform provisions, and have, in potential joint obligors need to be considered. In the fact, to date declined to draft such provisions. While it LLC Agreement for a Series LLC that has any debt at is not entirely clear to me how the controversy over the level of the Series within the LLC, indemnification entity/nonentity status of the Series within the LLC provisions for that debt among and between the other will work out, I do believe that the “entity” status Series and the LLC (Mothership) would be highly argument has the weaker position, since that would be advisable. In Texas, we currently have a practice of the functional equivalent of wholly owned subsidiaries, placing an indemnification provision in our LLC which we may already form. agreements for liabilities relating to Texas franchise Issues of federal and state taxation are still being taxes. This concept can be modified for obligations worked out. While the IRS has recently issued among and between the various parts of the Series proposed rules, their rules treat each series as a LLC. Similarly, there may be occasion to enter into separate entity, which frankly does not fit the statutory provisions of an intercreditor agreement with outside rules of any state, except for Illinois (which, of course, creditors in connection with the various layers or levels is the home state of the draftsman for the IRS of debt within the Series LLC. If the LLC provisions). The Texas comptroller is considering (Mothership), for example, has obligations of record rules, and should be influenced by existing rules on with respect to its several series, it would be best that consolidation of franchise tax returns. Since there are the creditors of the Series contractually recognize those other persons going to speak on tax issues, I will not relationships, much as we do now for obligations elaborate here on the proposed rules and their across subsidiaries. conundrums, but I will say that the use of indemnification provisions for taxation issues is likely XI. OTHER STATUTORY LIMITATIONS ON going to be a necessary part of an LLC Agreement for SERIES LLCS. a Series LLC. As you draft the LLC Agreement for a Series LLC have other statutory limits that must Series LLC, you will also have to pay attention to the be thought through, besides debtor/creditor issues. tension between the state law provisions that do not Most of these matters originate from the newness of treat the Series within the LLC as a separate entity and the structure, and the lack of time to adjust other the tax rules that do. At the margins, it may be that the statutes that affect the operation of a Series LLC. Only inherent flexibility of the state statutory provisions a few states have legislation that authorizes the use of a have unintended, or at least unwanted tax Series LLC. Texas is one of only about ten consequences. jurisdictions so far to enact Series LLC provisions. This raises the question about whether a jurisdiction XII. WHAT ARE CIRCUMSTANCES WHERE without Series LLC legislation would respect the SERIES LLCS MAY BE HELPFUL? Series within an LLC. While the rule that the internal Now that we know more about how to form and law of the state of formation should govern the operate a Series LLC, the next question becomes when regulation of the affairs of the entity, it still might be a you would want to consider using one. The initial use stretch for a jurisdiction without Series LLCs to for the Series LLC was in the context of regulated recognize the liability limitation function of the Series mutual funds, where the LLC (Mothership) contained within the LLC. Practically speaking, the issue of all of the SEC compliance structures and management foreign qualification of the Series within the LLC or contracts and arrangements, and the Series within the the LLC (Mothership) is quite daunting to think LLC were used as different silos of managed assets through. Major states that have legislation include under that management structure. Illinois adopted the Delaware and Illinois. States adjacent to Texas, such rules on Series LLCs because the filing fees in Illinois as Louisiana, and New Mexico, conversely, for an LLC are quite high, and the Series LLC was a do not have provisions concerning Series LLCs. mechanism that avoided the filing fee expense of Even if you have a transaction that could go wholly owned subsidiaries (don’t you wonder how across state boundaries (a real estate developer that long it will take the Illinois legislature to figure that works in Texas and Chicago), state legislation is not one out). uniform. The most extreme examples are Illinois and

11 What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7

With a little imagination, you may think of important to an all-Texas series and they could be other where there is a common management material. thread or other common business thread that makes Section 171.0002(a) of the Texas Tax Code separate subsidiaries cumbersome. A business that defines a “taxable entity” to include “a partnership, must have a license, similar to the investment company limited liability partnership, corporation, banking act rules, would be a great candidate. Real estate corporation, savings and loan association, limited transactions where separate, but contiguous parcels are liability company, . . ..” The Texas Tax Code put together for a project would be a great candidate, definition does not clearly address how Series LLCs especially if there is a business reason (which there are to be treated for franchise tax purposes, and thus often is when parcels are assembled from separate the primary issue is: owners) that the parcels cannot all be identically owned or identically managed. In any business with (i) should each series of a Series LLC be treated different operating business divisions, the Series LLC as a separate entity for franchise tax may be used to create a legal separation that is not as purposes, or difficult to manage as wholly owned subsidiaries, but (ii) should all of the series should be aggregated effective to isolate strategic or difficult assets, where and treated as one single entity for franchise the boundaries provided by the Series could provide a tax purposes? more effective solution than the black/white choice of wholly-owned subsidiary or division. In the oil and B. Treating a Series LLC as One Taxable Entity gas world, development transactions, where there are In many respects, the TBOC treats a series LLC as ongoing capital expenditure obligations and the risk of a single entity. For example a single Certificate of different ownership percentages, would be another Formation is issued to organize a series LLC. 4 And, on ideal fact pattern for Series LLCs. first look treating a Series LLC as a single taxable entity would appear to lessen an administrative burden XIII. TEXAS TAX CONSIDERATIONS FOR for the Texas Comptroller and taxpayers on the basis SERIES LLCS that a single Texas Franchise Tax Report would be A. Is the Series LLC or Each Series the Texas required rather than multiple reports schedules. This Franchise Tax Taxpayer? would probably be a false victory, though, because In an informal policy ruling, the Texas each series will already be separately calculating Comptroller has advised that, generally speaking, a revenues and deductions for federal income tax Series LLC comprised of one or more series should be purposes. treated as one taxpayer.2 It is not clear that this is the The most inconsistent result from treating a Series final word from the Comptroller on this point, but the LLC as a single entity is that Series LLCs would have seemingly innocuous finding has important tax to report as a defacto combined group, regardless of consequences. 3 ownership, nexus, or unitary status; whereas traditional While there is no question that the Texas gross separate LLCs would likely have a very different revenues an individual series generates will be subject reporting standard and resulting tax liability. to Texas franchise tax, there are issues in the way the tax should calculated, who the taxpayer should be, how C. Treating Each Series as a Separate Taxable the tax will be reported, and whether all members of Entity the series will necessarily have to be included on one In theory, each series is supposed to have its own combined Texas franchise tax report. Certain of the legitimate business purpose, capital, economics, rights, issues are only important to multi-state businesses, but obligations, and liabilities. Importantly, the owners are a at least two the computational issues will be specifically using the vehicles to independently allocate profits and losses, independent of the other series. On most Texas franchise tax issues the Texas 2 Informal email response to taxpayer inquiry dated February Comptroller does not rely on federal income tax 22, 2011. treatment to drive state tax treatment. For example, LLCs that are disregarded for federal income tax 3Subsequent to this informal ruling the Section of Taxation purposes are not disregarded for Texas franchise tax of the State Bar of Texas filed comments with Texas Legislature’s Ways and Means Committee setting forth pros and cons of treating a Series LLC as a single taxable entity or multiple taxable entities. The comments conclude that the 4 See Texas Business Organizations Code §§ 3.001, 101.601. most consistent state tax policy would result from treating See also Texas Secretary of State FAQs, Formation of Texas each separate series within an LLC as a separate taxpayer. Entities, (Nov. 23, 2010). 12 What are Series LLC’s? An Overview of Drafting and Operational Considerations Chapter 7 purposes. It is still important, though, that the U.S. real-world tax consequences. Non-unitary series Department of Treasury has issued proposed members would lose their ability to determine their regulations 5 to the effect that each series of a Series own deduction methodology (compensation vs. cost of LLC will have its own separate classification as a goods sold) and they would lose the ability to disregarded entity, partnership, corporation, etc. 6 independently apply the exemption threshold for small Reaching a result similar to the IRS position, the businesses (e.g., the $1M threshold). State of has published guidance stating that it will impose its LLC fee on each series of a series XIV. CONCLUSION. LLC.7 This may have been motivated by the fact that While the Series LLC is a new vehicle that has this was clearly a revenue-positive determination for some unanswered questions, it is a solution to California given the nature of the California tax. problems of management of assets that have common, Multiple entity treatment and conformity with but not identical features. The statute makes very clear federal income tax should reduce the tax compliance the ability to deal with assets and the transactions burden on Texas taxpayers by allowing their state surrounding assets that may be held by an entity. If franchise tax returns to more closely tie to their federal you focus on the feature of asset management and returns. commonality, but not identity, the confusion caused by Treating a Series LLC as multiple taxable entities the flexibility permitted in the TBOC provisions falls should generally benefit Texas taxpayers under the away, and you are able to focus on fact patterns that franchise tax combined reporting rules. For example, are truly facilitated by this structure. The single most the Texas apportionment numerator only includes the “common” commonality is management, but the Texas gross receipts of taxable entities independently commonality may be the nature of the asset (such as having nexus with Texas.8 Application of the “Joyce” the accumulation of one large asset from divided parts) rule generally lowers the amount of apportioned or the development of an asset over time, where income ultimately subject to Texas franchise tax. If an ownership may shift. I would like to encourage you to entire Series LLC is treated as a single taxable entity join the ranks of the optimists and urge you to study then Texas revenues from members of the series that and think about this new vehicle. Consider embracing do not have nexus with Texas will be included in the the good points of a Series LLC in transactions apportionment numerator and increase the Texas appropriate for the solutions that it provides. franchise tax base. If each series is a separate taxpayer the apportionment numerator would not include Texas sales by a series that does not have nexus here. In all other combined groups Texas sales of non- nexus affiliates are not be included in the Texas tax base, and this is arguably a state tax penalty associated with the use of series LLCs rather than separate LLCs all else (ownership, economics, and business operations) being equal. Another inconsistency would stem from the situation where some members of the Series LLC were not conducting a unitary business. If each series is a separate taxpayer then non-unitary series should not be on the combined report. If the entire Series LLC is single taxpayer then non-unitary business is included in one return, perforce. The determination has several

5 Prop. Treas. Regs. §§301.6011- 6, 301.6071-2, and 301.7701-1(a)(5), and amending §§301.7701-1(e) and (f). 6 See also, Priv. Ltr. Rul. 200803004 (Jan. 18, 2008). 7 See California FTB Informational Pub. No. 3556 (Sept. 2009). 8 This convention is often referred to as the “Joyce rule” and is in contrast to the “Finnegan” convention where Texas revenues from non-nexus affiliates would be (if adopted) included in the Texas apportionment numerator. 13