What is an Illinois series LLC?
Several years ago, Illinois LLC members received a new tool to help them better operate and protect their business – the Series Limited Liability Company ("Series LLC"). A Series LLC is a limited liability company organized under the Illinois Limited Liability Company Act ("Act") that contains one or more "protected series" within a single limited liability company. 805 ILCS 180/37-40.
Generally, the Series LLC is intended to facilitate a multiple entity approach, such that each protected series has the benefit of similar governing documents, while also having separate liability shields for each protected series. While this concept is also present in the traditional "master" LLC/common parents approach, the Series LLC has advantages over the more traditional approach of using a common parent to hold different "child" entities to achieve limited liability protections for separate operations. In the traditional approach, while the LLCs share an administrative structure, each LLC must be formally maintained and arguably all have to be treated as standalone entities (i.e., separate tax returns, state fillings, etc…).
In contrast, the Series LLC is arguably easier to manage. According to a report published by the American Bar Association, the Series LLC provides its members with the option to resolve disputes exclusively within the confines of the Series LLC and potentially avoid litigating matters in various states of organization. This is especially beneficial when considering a multi-state approach as each protected series may be organized in its own state. The report goes on to state that the Series LLC has become increasingly prevalent as an entity form of choice for foreign businesses engaging in business in the U.S. The growth of foreign investment in the real estate market has also been instrumental in the demand for a domestic structure that allows the non-U.S. investor to operate through a single domestic legal entity as opposed to setting up a separate umbrella entity in each state where real estate is purchased.
However , one major distinction between the Series LLC and traditional LLC is the application of the Illinois series provisions, which were added to the Act in 2009. While many confuse the Series LLC with the traditional LLC provisions, the Series LLC is a unique form of entity that has its own unique set of requirements that must be adhered to. For example, while the traditional LLC has no requirements to maintain a registered office or registered agent, the Act is clear in applying these requirements to the Series LLC – an issue that seems to be even harder to impose on protected series that are incorporated into the Series LLC, instead of having a standalone entity for each protected series. On that note, even though the Act provides that each protected series has the power and capacity to sue, serve process on, and be served on behalf of the protected series, arguably serving process on the overall Series LLC instead of the particular protected series may open the door to challenges to the protection afforded to each protected series and could also potentially impact whether out of state protected series are subject to jurisdiction within the State of Illinois. 805 ILCS 180/37-45.
Worse, it is currently unclear how the Act doctrine of limited liability applies to the Series LLC. Though the Series LLC was intended to give additional liability protections to its member and managers, the statute provides little guidance on how the protections are supposed to function. Presumably, each protected series has limited liability for the debts, liabilities, and obligations of other protected series, but the issue remains as to whether the doctrine of limited liability applies to each protected series within the Series LLC against the debts of the overall Series LLC or against a protected series that is not the plaintiff.
Now that the Series LLC has been on the market for several years, it will be nice to see how the courts will apply the law and whether the law will be able to keep up with the Series LLC’s ongoing popularity.
The Importance of a Series LLC Operating Agreement
As with individual LLCs, a Series LLC will benefit from an Operating Agreement. This document establishes the rules for how the company will operate. Owning a Series LLC does involve additional responsibilities that need to be set forth in a contractual fashion. For instance, you will want to designate a Series LLC manager to make key decisions, who is an authorized bank signer, who can enter into contracts on behalf of the LLC, and how profits are to be distributed among the various series. One of the most important uses of the Series LLC operating agreement is the ability to establish hedging clauses for each separate series. A hedging clause states that the assets and liabilities of each series of the LLC are entirely separate from the company. Illinois Series LLCs are unique in that cash, property or other obligations can now be transferred from one series to another series, and hedging clauses should be addressed to allow for such transfers.
Essential Series LLC Operating Agreement Provisions
One of the most critical parts of a series LLC is its operating agreement. It sets the tone for the management of internal affairs, addresses liability and sets out how assets should be handled. There are several key elements that an Illinois series LLC operating agreement should include.
Management Structure: The operating agreement should describe how management will work. Will there be a board of managers, board of members or an individual member in charge? Will you have managers in each cell? It’s important to spell out the particulars of the management structure in order to avoid future disputes.
Liability: Even though series LLC shields may not be recognized under federal law, creditors will likely still sue the series in order to prove their claims. It’s important to include statements in the operating agreement that spell out the separation between the different cells of a series. This is particularly important if creditors of one cell will attempt to recover debts from other cells. The agreement should also address whether the series will indemnify managers, agents and members, and to what extent.
Asset Protection: The agreement should also include any language necessary to establish the separation of the series and protect assets. This includes the transfer of assets by a cell or the removal of assets. The agreement should also explain the process for appointing a new manager in case of death or disability of a current manager.
How to Create An Effective Series LLC Operating Agreement
The operating agreement of an Illinois Series LLC should be the product of careful thought and consideration. Important choices must be made regarding the structuring of the Series LLC, which must be properly reflected in the operating agreement. These choices include structuring the management in a certain way, granting decision-making authority for one or more series to a name protected manager rather than delegating that authority to a member of a series, deciding whether or not to indemnify the members and managers of a series, and determining whether or not each series should be managed by a designated manager or provide each member full rights to participate in management at any time.
Illinois law provides a great deal of flexibility in the drafting and structuring of operating agreements for Series LLC’s. However, if an Illinois Series LLC intends to have multiple series, each series should have its own separate operating agreement so the business assets, profits and liabilities between each series’ are clearly delineated. If a member of one series has an obligation to pay a creditor of the Series LLC, the member’s payment to the creditor of the Series LLC will not apply to the members of another series because each series is a separate entity under the Illinois Limited Liability Act. A contractual obligation imposed on a series will generally be limited to the assets of the series on whose behalf the contract was formed.
Series LLC Legal Requirements
The operating agreement of a Series LLC must comply with all standard Illinois business operating agreement requirements. This general business compliance includes implementing corporate formalities such as the maintenance and retention of corporate records and holding annual meetings. In addition, Series LLCs must have an operating agreement that explicitly provides for the establishment of a series and the partners, members, or shareholders of a Series LLC must be listed on the Schedule for the Series LLC. Additionally, a Series LLC must maintain separate Series registries, which document the organizational and operational issues of each Series. Both the Series LLC and each individual Series must adhere to the rules and procedures for filing names with the Illinois Secretary of State , including the use of a DBA when applicable. There are specific tax and property tax implications that apply to Series LLCs in Illinois. Series LLC tax obligations are similar to standard corporate tax obligations. Specific taxes may apply for any "foreign" Series LLC created in another state and doing business in Illinois. It’s critical to obtain adequate legal counsel and advice regarding these Center for International Business ("CIB") tax issues. Illinois Series LLCs and their respective Series that conduct real property business must adhere to Illinois property tax laws. In Illinois, most property is subject to property tax including buildings and other permanent structures on real estate as well as personal property, with the exception of motor vehicles, farm implements and equipment, and certain inventory items that fall below an assessed value limit.
Common Series LLC Operating Agreement Mistakes
As the series LLC framework continues to evolve, so does the number of mistakes made by series LLCs when creating and managing a Series LLC operating agreement. After meeting with thousands of clients, the most common mistakes we see among them are:
The LLC Member is Not a Natural Person
A multi-member Series LLC often will have a Community Trust or Revocable Trust as an LLC member. While revocable trusts are allowed to serve as LLC members, community trusts are not. Unless the revocable trust is also the individual’s living revocable trust, it cannot serve as a member of the LLC.
Using the Same Operating Agreement for Multiple Series or Minimize the Use of Series Operating Agreements
Every Series must have its own operating agreement addressing how it will be managed and what rights each Series member has. The use of one generic operating agreement will lead to inconsistencies if there are multiple series under that LLC. Likewise, some Series LLC members don’t bother with having any operating agreement for each individual Series, which can spell disaster if something goes wrong and they need to enforce a provision of the operating agreement.
Dismissing Their Fiduciary Duties
Members of Series LLCs owe fiduciary duties toward each other similar to what partners would owe to a partnership. For a standard multi-member Series LLC, members have the duty to inform others of relevant business information, not to speak on behalf of other members without their advance consent and to work towards the advancement of group goals. A member who breaches a fiduciary duty can be held liable toward other LLC members.
Failure to Keep Good, Separate Books and Records
Each Series must designate someone as its "agent," which serves similar purposes to a Registered Agent but without the administrative burdens. That agent is generally responsible for opening its own checking account, obtaining credit cards, retaining its own books, records, and bank statements, complying with applicable tax obligations, and other necessary actions to help ensure proper separation between Series for legal purposes.
Improper Separation Between Series
As mentioned above, each Series must keep its own separate records, such as financial statements, tax returns, accounting like QuickBooks, etc. They must also maintain separate bank accounts and credit cards. In addition, each Series must have its own Members and Managers separate from those of other Series. The separation of Series is absolutely critical. Otherwise, a court may find that a Series LLC is really just a single LLC with voidable liabilities for the entire LLC, not each Series separately.
Lack of Legal Compliance
This includes operating the Series LLC in the manner required by law. For example, a Series LLC must file an annual report with the Illinois Secretary of State listing out not only the principal LLC but also each of the Series, designating who their agent is, and identifying its registered agent. If the Series LLC fails to do so, the Secretary of State can administratively dissolve the LLC and cause each Series to become subject to administrative dissolution.
How to Amend an Illinois Series LLC Operating Agreement
The need to amend an operating agreement for a Series LLC may arise when there are subsequent Series with different members, the Series is to be reorganized, additional special allocations are added not originally included in the operating agreement or the operating agreement is to be amended to reflect clarity or corrections. In order to amend the operating agreement, the amendment must be signed by all members. The Illinois statute does not require the filing of such an amendment with the Secretary of State . As such, it is important to keep the amendment with the original operating agreement and any certificates of designation for each Series to allow the members to confirm the proper status of the Series and whether the intended amendment has in fact been made. Of course, such an amendment is not required if the terms of the operating agreement already provide for the amendment of the operating agreement as approved by the requisite majority.