If you are not already familiar with series LLCs or with the new Indiana series LLC statute that takes effect on January 1, 2017, you may want to read the articles at Part I, Part II, Part III, Part IV, and Part V.
In the first of these articles, I compared a series LLC to a parent LLC with subsidiary LLCs, and I stated that one difference between the two concepts is that a master LLC does not own its series in the same sense that a parent company owns its subsidiaries. Instead, the interest that makes up each series is held by persons who may or may not also hold interest in the master LLC or in other series. Although I believe that is commonly the way series LLCs are set up, I think it may be possible to set up a series LLC so that the master LLC does, in fact, hold part or all of the interest in its series. Let’s look at four possible structures, using the example of a real estate developer than develops and owns three apartment buildings.
The first structure is the one I described earlier. A master LLC is organized with one or more classes of interest held by the initial members, but for simplicity, we’ll assume there is only one class, Class M. The master LLC then issues units of a second class of interest, Class A, that make up the first series, Series A, which will own the first apartment complex. The LLC can issue Class A units of interest to some or all of the initial members who own Class M units (or to none of them), and it can also issue Class A units to other investors who are not already members of the LLC. Series A can enter into a contract with the master LLC under which the master LLC provides property management services for the apartment complex owned by Series A.
That structure can then be replicated for subsequent apartment complexes held by Series B and Series C. Units of Class B and Class C interest may be issued to some or all of members who hold Class M or Class A units, and some may be issued to new investors. The members who hold Class A, Class B, and Class C units will receive shares of the profits, losses, and distributions derived from rent, and the members who hold Class M units will receive shares of the profits, losses, and distributions derived from compensation the series pay the master LLC for property management services.
The second structure is a variation of the first. Rather than issuing Class M units that represent interest in the master LLC, the master LLC could issue Class M units as the first series, which would again contract with each of the other series to furnish property management services for the apartment buildings. The differences between this structure and the first alternative are more of form than substance because the Indiana statute (as well as the Delaware statute, the Illinois statute, and at least some of the other series LLC statutes) provide for internal limited liability between the series and between the series and the master LLC. Creditors of a series cannot reach the assets of other series or the assets of the master LLC, and creditors of the master LLC cannot reach the assets of any of the series. One minor difference under the Indiana statute (and under the Illinois statute, but not the Delaware statute) is that creation of a series requires a separate public filing. Accordingly, there will be one more public filing if the Class M units are treated as a series rather than as interest in the master LLC itself.
One potential substantive distinction lies in the possible difference between the internal liability limitation that separates two series from each other and the internal liability limitation that separates the master LLC from each of the series. One of my colleagues, a noted authority on limited liability companies, has concerns about enforcing the internal limited liability against creditors of the series, but he is even more concerned about enforcing it against creditors of the master LLC. (Concerns about the enforceability of internal limited liability are addressed in Part VIII.) If there is indeed such a distinction, the real estate developer in our example would be better off creating a separate series to run the property management business than it would running the property management business directly under the master agreement.
The third structure mimics a parent LLC that holds single-member subsidiary LLCs. It relies on the assumption that a master LLC can hold title to interest to the series formed under its umbrella. At first, that may seem counterintuitive because the interest in a series can be viewed as a class of interest in the master LLC itself and, if that view is correct, the master LLC would hold title to its own interest. Moreover, the master agreement, upon admission as a member of a series, could be viewed as being its own member. Such an arrangement would not be entirely novel because corporations commonly acquire title to their own stock by purchasing shares and, instead of retiring them, holding them as “treasury stock.” However, the corporation is generally not treated as its own shareholder. The corporation does not pay itself dividends in regard to treasury stock, and it may not vote treasury shares in meetings of shareholders.
I know of no case law in any jurisdiction that addresses the question of whether a master LLC may hold interest in a series organized under its operating agreement, and the Indiana statute does not expressly address the question. However, Ind. Code § 23‑18.1‑4‑4(a) provides, “A series with limited liability must be treated as a separate entity to the extent set forth in the articles of organization of the master limited liability company.” It seems to follow that the interest that makes up a series must not be treated as interest in the master LLC, if (as suggested in Part IV) the articles of organization of the master LLC provide, “Each series shall be treated as a separate entity to the maximum extent permitted by Ind. Code § 23‑18.1‑4‑4 and other applicable law,” and particularly if the articles specifically authorize the master LLC to hold title to interest associated with a series, to be admitted as member to a series, to receive distributions from the series, and, if the series is taxed as a pass-through entity (more about that in the next post), to be allocated a share of the series’ profits and losses.
Under this structure, then the master LLC will issue to itself Class A, Class B, and Class C units, with each of the series then being very similar to a single-member LLC, and issue additional interest in the master LLC to the investors in the two apartment buildings. Of course, under this structure, all of the economic benefits derived from the series will ultimately flow to the members of the master LLC, but with careful drafting of the master LLC operating agreement, distributions and allocations of profits and losses from the series could be directed to the members holding Class M interest to achieve the same economic and tax results that would be produced by the first or second alternatives, again assuming that the master LLC is taxed as a partnership and the series are taxed as disregarded entities.
The fourth structure is a hybrid of the first and third. Under the first structure, the persons to whom Class A, Class B, and Class C units are issued will make capital contributions to the series in exchange for those units. But what if the master LLC provides part of the capital to start a new series? One answer is that the master LLC could distribute cash to the Class M members, and those members could make capital contributions to the series in exchange for units of interest in the series issued to them in their own names. Alternatively, if it is indeed permissible for a master LLC to hold interest in and to be admitted as a member of a series organized under its own operating agreement, the master LLC could make the contribution directly in exchange for Class A, Class B, or Class C interest. The Class M members would receive the economic benefits and tax consequences of the series’ businesses through their ownership of the master LLC, as opposed to ownership of interest in the series directly. The developer can raise additional capital by issuing units of Class A, Class B, or Class C interest to other investors.
I again caution that I am unaware of any case law in any jurisdiction acknowledging that the third or fourth alternatives are permissible, but given the language of the Indiana statute, it seems likely that Indiana courts would approve such a structure. (In addition, one of my colleagues who is familiar with the use of series LLCs is confident that Structures #3 and #4 are permissible even under some state statutes that do not expressly provide that a series is a separate entity.) Whether the master LLC’s ownership of interest in a series affects other matters – particularly the enforceability of internal limited liability – is a different question that will be discussed (but unfortunately not definitively answered) later.
Note: I thank the following lawyers for their time and willingness to discuss these issues with me and for their contributions to my thinking. Any mistakes, errors, or flawed opinions are entirely mine, not theirs.
John M. Cunningham, Attorney at Law; Concord, New Hampshire
Peter G. Lawrence; Perkins Coie LLP; Chicago, Illinois
Peter Parenti; Ramirez & Parenti, PLLC; San Antonio, Texas
Ted Waggoner; Peterson Waggoner & Perkins, LLP; Rochester, Indiana
The next post discusses the federal income taxation of series LLCs.