ARTICLE

Lending to Series : Subscription Credit Facility Considerations Kristin Rylko, Haukur Gudmundsson, Vincent Zuffante1

Introduction Background As the private equity asset class continues to A Series LLC is generally created pursuant to expand2 and private equity fund managers the laws of the applicable jurisdiction of respond to demand by investors for ever- formation. A defining feature of a Series LLC is more bespoke products and tailored the ability to create an unlimited number of investments, there has been an increase in the segregated subunits or series (each, a “Series”) use of alternative fund structures to under the umbrella of a single “master” LLC accommodate such demand. In addition to (or LP), permitting each Series to have the proliferation of separate accounts, funds- separate members, managers, equity interests, of-one and co-investment structures, the use assets, liabilities and objectives of vehicles that employ series, cell or other associated to it, with an internal liability shield asset and liability segregation technology has as among the Series that is intended to be increased, bringing with it opportunities and enforceable against creditors and other potential challenges when leverage at the counterparties. This is in contrast to a fund or individual series level is sought. traditional limited liability , which may have different classes of members that The use of series in a limited liability company have different rights, assets or liabilities (a “Series LLC”)3 offers many potential benefits associated with such class, but such internal to a private equity fund (a “Fund”) manager organizational structure is not intended to and its investors; however, for lenders impact the obligations and liability of the interested in advancing credit to a Series LLC limited liability company as against creditors or a series thereof, it is important to and counterparties. understand how Series LLCs differ from traditional forms of limited liability entities. At its heart, the Series structure promises the This article discusses the nature and benefits ability to segregate the assets and liabilities of of Series Entities in the private equity context4, each Series, such that the liabilities and other as well as potential issues that lenders will contractual obligations of any given Series want to take into account when considering may be enforced only against the assets of advancing credit to a series under a Series that particular Series and not the assets of any Entities secured by investor capital other Series or the “master” entity itself, so commitments.5 long as the relevant statutory formation and procedural requirements are met.6 In this respect, a Series LLC with liability segregation promises owners the personal liability protection as against third parties of a limited may also reduce legal costs associated with liability company, while also permitting the creation and negotiation of multiple fund contractual flexibility to effectively create vehicles and Operating Agreements. Aside mini-LLCs under the Series LLC umbrella, from possible savings attributable to reduced whose activities are insulated from each other long-term formation and start-up costs, use of and the Series LLC itself. Thus, in the Fund Series Entities may result in minimized filing context, each Series can have different costs, State franchise fees and compliance investors, with different investment strategies costs as well as tax savings as compared to and commitment periods associated with it, as creating separate entities instead of Series of a if each Series was an individual stand-alone Series LLC. vehicle. While there are many potential benefits to a In the context of a Fund formed as a Series Series LLC organizational structure, there may LLC, each Series may be governed by a be risks in certain circumstances as well. There common master Fund-level limited liability remains uncertainty as to the State and federal company (an “Operating Agreement”), or by income tax treatment of Series Entities and both a Series-specific Operating Agreement the Series within a Series LLC, as well as their (or supplement or addendum) and a master treatment for employment tax purposes.8 In Fund-level Operating Agreement. Each such addition, as more fully described below, it is Operating Agreement may provide different not clear whether the separate liability operational, distribution, and membership protection of a Series will be upheld by the mechanics with respect to each Series, and courts of a State that has not enacted each Series may be administered by a legislation providing for Series provisions for separate manager, although the same State law liability purposes.9 Further, manager (or general partner) is often used for accountants, lawyers and other service all Series in a Series LLC. Funds may use Series providers may not have sufficient familiarity LLC technology to facilitate establishment of with the series structure to provide adequate different Investor commitment periods for advice on the unique issues that may arise in each Series and to house separate relation to a Series LLC. investments in individual Series, thereby permitting investors to commit capital to the Facility Structure and Loan Fund for particular periods or specified uses.7 Documentation; Special Other potential benefits to implementing a Series structure include reduced formation Considerations for Series Entities and administrative cost. In some States, use of The basic loan documentation for a Facility a Series LLC allows a Fund to avoid registering advanced to a Series under a Series LLC multiple entities with the State of borrower is similar to the loan documentation organization, maintaining multiple registered typically used for a Fund that does not have a agents and filing multiple sets of annual Series construct and will usually include the reports and tax returns. Further, rather than following: (a) a credit agreement that contains requiring a Fund sponsor to form a new entity all of the terms of the loan, borrowing each time new investor capital is raised, the mechanics, conditions precedent, Fund’s Operating Agreement may provide for representations, warranties and covenants, the creation of additional Series from time to events of default and miscellaneous provisions time. Funds that use a master Fund-level typically found in a commercial credit Operating Agreement to govern each Series agreement; (b) a promissory note; (c) a pledge

2 Mayer Brown | Lending to Series Limited Liability Companies: Subscription Credit Facility Considerations or security agreement pursuant to which the of the Fund manager to issue a Capital Call to, Lender is granted a security interest in the incur indebtedness on behalf of, or grant a Collateral; (d) account control agreement(s) security interest in the assets of, one Series to over the account(s) into which investors fund repay indebtedness incurred with respect to Capital Contributions in response to a Capital another Series. As such, the borrowing base Call to perfect the Lender’s security interest for a Facility involving a Series LLC would need therein and permit the Lender to block to be established on a Series-by-Series basis, withdrawals from such account(s); (e) Uniform with several liability among the Series. As Commercial Code financing statements filed in described above, however, there are Funds respect of Article 9 collateral against the that employ Series technology for reasons applicable debtors; and (f) other customary other than asset and liability segregation, in deliverables such as officer’s certificates which case, a joint and several Series- certifying as to the relevant organizational borrower structure may be permissible, which documents, resolutions and incumbency would impact how a Lender underwrites a signatures, opinion letters and other diligence Facility. deliverables, as appropriate. While the basic loan documents required under a Facility B. STATE LAW; RECOGNITION BY COURTS; BANKRUPTCY CONSIDERATIONS. made to a Series under a Series LLC are comparable to those under a Facility made to A Lender that is considering offering a Facility a traditional commingled Fund, there are a to a Series of a Series LLC will want to number of potential issues that should be understand whether the Fund’s State of considered during the underwriting and formation, as well as the governing law of the documentation process, as more fully Facility, recognizes a Series LLC structure. The described below. Series LLC was first recognized under law in 1996, and under current A. OPERATING AGREEMENT PROVISIONS. Delaware law, a Series is authorized, in its own As with any Fund finance product, the name, to enter into , hold assets, Operating Agreement of a Series LLC will need grant liens and security interests in those to be scrutinized prior to execution of a assets, and sue and be sued.10 As of the date Facility to ensure that the Operating of publication of this article, however, only Agreement contains adequate Facility-related about a third of States recognize the Series provisions. In addition, because the assets and LLC, and among the States that do, there is no liabilities of a Series in a Series LLC are often uniformity in law.11 In order for the intended to be separate and distinct from segregation of assets and liabilities of a Series those of another Series and the Series LLC to be recognized, some States require specific itself, the Lender will need to confirm whether legal hurdles to be cleared during the the Operating Agreement adequately provides formation process, including the use of for such segregated liability. This is particularly specific language applicable to the Series in important in determining the borrower the Operating Agreement, and some States structure, understanding which Capital require certain procedures to be maintained Commitments are associated with (and thus during the life of the Fund, such as the available to) which Series, and assessing the maintenance of separate books and records potential impact on one Series of debt being with respect to each Series. Other States, such incurred by another Series. For example, in the as , require each Series to publically Operating Agreement for a Series LLC, one register with the State. Understanding the would expect to see prohibitions on the ability State’s Series LLC statutes will help a Lender

3 Mayer Brown | Lending to Series Limited Liability Companies: Subscription Credit Facility Considerations assess whether the necessary formalities have minimize the risk of substantive consolidation, been observed by the Series LLC, whether it is a Lender to a Series of a Series LLC will want possible to structure a Facility to a Series of a to ensure that the Series borrower is acting in Series LLC on a Series-by-Series basis and its own name (which is clearly identified in the whether the Facility should contain statute- Operating Agreement), is generally acting specific covenants. independently of each other Series), maintains separate books and records, does not As the Series LLC is a relatively new creature of commingle assets or prepare consolidated State law, there is limited jurisprudence financial statements, and is not cross- addressing the interrelation between States accelerated, cross-guaranteed or cross- that have statutes that provide for the collateralized with any other Series or the segregation of assets and liabilities between Series LLC. Accordingly, it may be prudent for Series and those that do not, and it is not a Lender to require that the Operating settled whether courts in States that do not Agreement of each Series and/or the Series have Series LLC statutes would recognize the LLC, and any debt instrument entered into by segregation of assets and liabilities across any Series or the Series LLC and a Lender, Series formed under the laws of another State contain provisions (i) acknowledging the with a permitting statute. Further, the segregation of assets and liabilities between treatment of a Series LLC and the Series the Series, (ii) providing that a creditor has thereof under the US Bankruptcy Code is recourse only to the assets of the particular uncertain.12 It is unclear whether Series may Series to which the debt relates and not to the constitute a “debtor” under the Bankruptcy assets of the Series LLC or any other Series, Code and thus if a Series may file bankruptcy and (iii) providing that a creditor shall not be independent of the Series LLC and other entitled to petition for the liquidation or related Series, and whether a bankruptcy court bankruptcy of any Series or the Series LLC on would uphold the segregation of assets and the basis of the failure of a borrower Series to liabilities if a Series related to a Series repay any debts or liabilities owing to a Borrower or the Series LLC itself was subject to creditor. On the other hand, assuming no a bankruptcy proceeding.13 third-party creditor has a lien on the Capital In addition, a Lender should be aware that the Commitments related to any other Series, one application of the equitable doctrine of can envision scenarios under which substantive consolidation could impact the substantive consolidation resulting in outcome of a bankruptcy case involving a elimination of the internal liability shields in a Series LLC. The substantive consolidation bankruptcy proceeding could potentially doctrine permits a Bankruptcy Court to benefit a Facility Lender by increasing the pool disregard the separate legal existence of of Investors upon which a Capital Call could entities when they are determined to operate be made to repay indebtedness. A review of more as a single entity instead of as separate the relevant State statues and case law may individual entities. Because the internal liability reveal that other State-specific provisions shield afforded by a Series LLC does not hold should also be included in the loan when a Series LLC fails to satisfy the statutory documentation for Facility to a Series. requirements for achieving separate liability, a Series LLC may be at greater risk for being C. SECURITY INTEREST AND PERFECTION substantively consolidated than individual MATTERS. limited liability companies that sit under a State law governing the formation of the parent limited liability company.14 As such, to Series LLC and the Series must be carefully

4 Mayer Brown | Lending to Series Limited Liability Companies: Subscription Credit Facility Considerations considered in connection with secured UCC filing against the Series should be in New Facilities, as such laws will inform what steps York and not in Delaware.17 should be taken by a Lender to perfect its Further, the legal name of the Series to use for security interest in the Collateral. As a purposes of filing a UCC financing statement threshold issue, a Lender will need to confirm may be uncertain given the Lender may not how the Capital Commitments are held, as be able to look to the “registered Series LLC statutes often permit multiple organization” naming rule (i.e., one looks to alternatives; for example, the Capital the registered organization’s name as stated Commitments under the Operating on the public organic record most recently Agreement may be held by the Series LLC filed with the organization’s jurisdiction of itself, through a nominee or by a particular formation (e.g., a certificate of formation for a Series of the Series LLC, and if held by a Series, Delaware limited liability company)). For it is not always clear what the name of the example, if the Operating Agreement of ABC, Series may be. A Series may or may not be a LLC provides for Series 2018-1, is the legal legal person separate from its related Series name of such Series “ABC, LLC, Series 2018-1” LLC under the laws of its jurisdiction of or “Series 2018-1 of ABC, LLC” or “Series 2018- formation; if the Series is not a separate legal 1”? In some cases, the Operating Agreement person, then the Series possibly cannot be a or certificate of formation of the Series LLC, as “debtor” for purposes of Article 9 of the applicable, may refer to a Series in multiple Uniform Commercial Code (the “UCC”). As a ways. Because of such uncertainties, it may be result, consideration should be given as to prudent for a Lender to file multiple financing whether the Series LLC, in addition to the statements and require that the Fund Series borrower itself, should be included as a specifically name each Series in the Operating grantor under the security and pledge Agreement and refer to each Series in a documentation and in the related UCC consistent way throughout the Operating financing statement filings. Agreement and in its business dealings. In light of these ambiguities, careful legal Assuming the Series can be a “debtor” under analysis will be needed in order to ensure that Article 9 of the UCC, the Series may not the Lender’s security interest in relation to a necessarily be a separate “registered Series borrower is adequately granted and organization” for Article 9 purposes, unlike the properly perfected. A Lender will also want to Series LLC itself to which the Series is consider what legal opinions are feasible in associated.15 This is relevant for the UCC light of the potential uncertainty around these Article 9 rules for determining where to file a collateral issues and what level of opinion UCC financing statement and the legal name comfort it will need in extending a Facility to a of the Series to use in a UCC filing. Under UCC Series. Article 9, a “registered organization” is “located” for Article 9 purposes in the State of its jurisdiction of formation.16 Thus, for D. Other Facility Considerations. example, a Lender would file a UCC against a As mentioned above, in connection with Delaware limited liability company in documenting a Facility, the Lender should Delaware; however, if the Delaware limited consider whether Series-specific and liability company is a Series LLC, and the statutory-related restrictions are appropriate. borrower Series has its sole place of business The parties may agree that the creation of a in New York, then it may be the case that a new Series or any change to the name or structure of an existing Series shall require

5 Mayer Brown | Lending to Series Limited Liability Companies: Subscription Credit Facility Considerations Lender approval. The parties may also agree Conclusion whether any new Series will require Lender approval as a general matter, and also prior to As more Fund sponsors consider such Series being added as a Borrower and implementing Series LLC structures because of receiving its own borrowing base under a the cost and administrative benefits they may Facility (as may be done in a legally several offer, the number of Facilities featuring a umbrella Facility structure). It is not unusual Series LLC is likely to grow in the coming for such Facilities to include ongoing years. Lenders considering advancing a Facility representations and warranties to be given by to a Series of a Series LLC should be aware the Fund to the Lender as to various that there remains uncertainty surrounding statements of fact relating to the operating of the treatment of a Series under State law and the Series to address the consideration and the Bankruptcy Code, but that there are issues described above. In conceptualizing techniques available to help mitigate the how to address some of the unique features related risks. With adequate legal and credit of a Series LLC, Lenders may look to some of and careful structuring, Lenders the technology used in credit facilities to Irish may be able to arrange credit Facilities to collective asset-management vehicles and Series that meet the needs of its Fund clients Cayman Islands-exempted segregated while also adequately protecting the Lenders’ portfolio companies, which employ downside credit risk. segregation technology not dissimilar to a Please feel free to contact the authors with Series LLC (albeit, under different legal questions regarding Facilities to Series LLCs or regimes). the various structuring alternatives and considerations attendant to such Facilities

6 Mayer Brown | Lending to Series Limited Liability Companies: Subscription Credit Facility Considerations ARTICLE mechanics to manage investment activities and annual Endnotes spending with a particular manager, using, for example, 1 Kristin Rylko is a partner in Mayer Brown’s Banking & a new Series corresponding to annual commitment Finance practice. Haukur is a partner in the firm’s periods or to cap Capital Commitments with respect to Banking & Finance practice. Vince Zuffante is an particular investments. In such cases, the need for a associate in Mayer Brown’s Banking & Finance practice. liability shield as between various Series within a

2 particular Series LLC may or may not be a primary factor See, e.g., Private Capital: Record-Setting Pace in 2017, in selecting a Series LLC organizational type. Preqin Ltd., docs.preqin.com/press/Fundraising-2017.pdf. 8 Proposed federal tax regulations have been promulgated 3 Note that some states, including Delaware, also permit but to date have not been finalized. Under Proposed both limited and trusts to elect a series Regulation §301.7701-1, 75 Fed. Reg. 55,699 (2010), each structure. See Del. Code Annotated, Title 12, §3806(b), Del. Series within a Series limited liability company Code Annotated, Title 17, §218. agreement would be treated as a separate entity for 4 This article provides a basic overview of certain federal income tax purposes and have its own potential benefits and challenges of lending to Series classification for such purposes (e.g., a , an LLCs. Specific reference to the enacting statutes of a association taxable as a or disregarded). particular jurisdiction and the terms of the constituent 9 For a comprehensive discussion of the subject, see documents of a Series LLC borrower must be Thomas E. Rutledge, “To Boldly Go Where You Have Not undertaken in assessing the suitability of lending to a Been Told You May Go: LLC, LLPs, and LLLPs in Interstate Series LLC or any Series thereof. This article is not a Transactions,” 58 Baylor L. Rev 205 (Winter 2006). comprehensive treatment of the subject. 10 See Del. Code. Sec. 18-215(c). 5 By way of background, a subscription credit facility, also known as a capital call facility (a “Facility”), is a loan or 11 At its annual conference meeting in July of 2017, the line of credit made by a bank and other credit National Conference of Commissioners on Uniform State institutions (each, a “Lender”) to a Fund that is secured Laws approved a proposed uniform state law titled the by (a) the unfunded commitments (the “Capital “Uniform Protected Series Act,” which is intended to Commitments”) of the investors to fund capital allow assets within an LLC Series to be protected from contributions (“Capital Contributions”) to the Fund when the credit and other liability risks associated with assets called from time to time by the Fund (or its general owned by such LLC or other LLC Series. It remains to be partner, managing member or manager (a “Manager”)), seen how many States will enact Series legislation based (b) the rights of the Fund or its Manager to make a call on the proposed Uniform Protected Series Act. (each, a “Capital Call”) upon the Capital Commitments of 12 For additional discussion, see ABA the investors and the right to enforce payment of the Newsletter, “Secured Lending to Series of LLCs: Beware same, and (c) the account into which investors fund What You Do Not (and Cannot) Know,” Norman M. Capital Contributions in response to a Capital Call Powell, November 16, 2015. (collectively, the “Collateral”). 13 Id. 6 See, e.g., Del. Code Annotated, Title 6, §18-215(b), which 14 In comparison, in the situation of multiple separate requires that various corporate formalities be followed in limited liability companies existing under a parent order to establish a Series LLC and achieve asset and limited liability company, a court would undertake a veil- liability segregation, including the certificate of piercing/alter-ego analysis to determine if the separate formation and Operating Agreement including notations legal existence of the limited liability companies should as to the limitation of liabilities, maintenance of proper be disregarded. The factors considered by courts under books and records, and accounting for the assets and the veil piercing/alter ego doctrine are often similar to liabilities of each Series on a separate basis. those applied in a substantive consolidation analysis. A 7 There are numerous other potential applications of the detailed discussion of the substantive consolidation Series construct in a Fund context. Series LLC technology doctrine is beyond the scope of this article. may be used to facilitate co-investments and as a means 15 For a detailed discussion of these and related issues to internally track revenue streams and asset allocations concerning the intersection of Article 9 and Series LLCs, within a Fund. A Fund-of-one may use Series LLC

7 Mayer Brown | Lending to Series Limited Liability Companies: Subscription Credit Facility Considerations 16 See UCC Official Text Section 9-307(e). “Dissonance in the Attempt to Harmonize LLC Series see 17 See UCC Official Text Sections 9-307(b)(2)-(3) . and Article 9,” Norman M. Powell, UCC Law Journal, Vol. 46 (November 2015).

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8 Mayer Brown | Lending to Series Limited Liability Companies: Subscription Credit Facility Considerations