DAVID J. WILLIS ATTORNEY
Copyright © 2014. All rights reserved worldwide.
THE TEXAS SERIES LLC
By David J. Willis, J.D., LL.M.
The traditional Texas LLC has long been a favorite of real estate investors and others, especially after limited partnerships were made subject to the Texas franchise tax January 1, 2007. Investors who formerly created investment structures based on limited partnerships (with a corporation as general partner) then shifted their focus to LLCs, which are cheaper to file and less complicated to manage and maintain. New filings at the Secretary of State reflect that formation of other types of entities is down significantly, while LLCs compose the majority of new filings. It is not an exaggeration to declare that for most smaller-scale real estate investors the LP and the corporation are all but dead, and the LLC has taken their place.
Recently, a new type of LLC–the series LLC–has become available in Texas. It is an excellent way for real estate investors to own multiple properties and businesses, allowing investors to acquire multiple assets and sort them into separate cells.
This chapter discusses structural and operational details of a series LLC as they relate to an asset management and protection program. Note that it is not necessary to implement the series aspect of a series company unless and until one is ready to do so; until then the company operates exactly the same as a traditional LLC. Accordingly, there is no downside to electing to form a series LLC rather than a traditional LLC, even if there is no immediate intention to create series.
Series LLCs began in Delaware in 1996, arrived in Texas in 2009, and are now available in thirteen states. Our preference is for Texas and Nevada, which have similar statutes. The series LLC is an idea whose time has come, particularly for real estate investors who can acquire multiple properties while avoiding complex structures with multiple entities.
What is a series company?
A series LLC allows an investor to hold assets and liabilities within separate cells or series which effectively operate as subcompanies. However, the series are not stand-alone legal entities in their own right–at least not technically (Tex. Bus. & Com. Code §101.622)–but in many respects they act as if they are. An individual series is statutorily empowered to file and defend lawsuits; enter into contracts; buy, sell and hold title to property; grant liens and security interests; and "exercise any power or privilege as necessary or appropriate to the conduct, promotion, or attainment of the business, purposes, or activities of the series." Tex. Bus. & Com. Code §101.605(5). A series can obtain its own EIN if it chooses and be treated separately for federal tax purposes. A series may (but is not required) to have its own bank account. A series can (and should) operate under its own assumed name. Given all of these characteristics, declaring that a series is not technically a stand-alone legal entity may be a distinction without a difference, at least most of the time.
Note that the Texas Comptroller, for its purposes, states that a "series LLC is treated as a single legal entity. It pays one filing fee and registers as one entity with the Texas Secretary of State. It files one franchise tax report as a single entity, not as a combined group, under its Texas taxpayer identification number."
The series LLC shares characteristics with the traditional LLC, including the benefit of informal management, an effective liability shield, and pass-through taxation; but a series LLC also has the ability to segregate and compartmentalize assets and liabilities within individual series. This offers significant protection and operational flexibility.
How does a series LLC differ from a traditional LLC? The answer is found in one word: exposure. In the case of a judgment against a traditional company, all assets of the LLC are available for purposes of satisfying that judgment. Not so with a series LLC. If a series is sued, liability is contained within that series and does not spill over to other series or the company at large.
The Texas series LLC (like traditional Texas LLCs, corporations, and limited partnerships) is governed by Business Organizations Code title 2, chapter 101. Changes to the BOC made by the 81st legislature in 2009 (including authorization of the series LLC) along with minor improvements made by the 83rd legislature in 2013 have made it a model of progressive legislation and improved Texas’ already deserved reputation as an excellent place to do business and engage in asset protection. There is no longer any good reason to go to another state to form an LLC unless one is specifically looking for an extra layer of protection by virtue of physical and jurisdictional distance.
BOC sections 101.601 and 101.602 read:
Sec. 101.601. SERIES OF MEMBERS, MANAGERS, MEMBERSHIP INTERESTS, OR ASSETS.
(a) A company agreement may establish or provide for the establishment of one or more designated series of members, managers, membership interests, or assets that:
(1) has separate rights, powers, or duties with respect to specified property or obligations of the limited liability company or profits and losses associated with specified property or obligations; or
(b) A series established in accordance with Subsection (a) may carry on any business, purpose, or activity, whether or not for profit, that is not prohibited by Section 2.003.
(2) has a separate business purpose or investment objective.
Sec. 101.602. ENFORCEABILITY OF OBLIGATIONS AND EXPENSES OF SERIES AGAINST ASSETS.
(a) Notwithstanding any other provision of this chapter or any other law, but subject to Subsection (b) and any other provision of this subchapter:
Added by Acts 2009, 81st Leg., R.S., Ch. 84, Sec. 45, eff. September 1, 2009.
(1) the debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to a particular series shall be enforceable against the assets of that series only, and shall not be enforceable against the assets of the limited liability company generally or any other series; and
(b) Subsection (a) applies only if:
(2) none of the debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to the limited liability company generally or any other series shall be enforceable against the assets of a particular series.
(1) the records maintained for that particular series account for the assets associated with that series separately from the other assets of the company or any other series;
(2) the company agreement contains a statement to the effect of the limitations provided in Subsection (a); and
(3) the company’s certificate of formation contains a notice of the limitations provided in Subsection (a).
Benefits of Simplicity and Economy
Lawyers are frequently asked "How many LLCs do I need, and how many properties can I safely hold in one LLC?" The series LLC eliminates these issues, at least up to a point. Our answer to the first question is most often "One LLC or perhaps two if you choose a two-company structure in order to separate assets from activities." Our response to the second question is "No more than 20 or 25 properties should be held in a single LLC, even a series LLC." This is our arbitrary, but informed, opinion. The statute permits an infinite number of series, but prudence suggests that even a series company should have some limit on the number of properties it owns. When an investor has filled Series A through Series Z–that’s 26 properties–it is time to consider forming another holding entity. Asset protection should be a cautious enterprise.
What if an investor has only one property or business to put into the company? Should he or she still consider a series LLC? Perhaps the question should be "Why not?" since there are no significant additional up-front costs and one can delay implementation or activation of series until an appropriate time. Until series are created or made operational, the company behaves exactly the same as a traditional LLC. It is not necessary that one already have multiple properties or businesses in order to form a series LLC. If real estate investment or multiple businesses are in one’s future, it may be wise to go ahead and establish a series LLC early, so that leases, contracts, accounts, and so forth can all be established in a way that is consistent with a series structure. Otherwise, it will be necessary later to use assignments or bills of sale to move these items into individual series.
Those averse to the idea of multiple series may elect to form a traditional LLC, which continues to be useful for a single investment or business purpose. A traditional LLC is also suitable to act as a management company.
Series LLC Formation and Conversion of Traditional LLCs
In order to establish a series LLC, BOC section 101.604 requires that specific wording be included in the Certificate of Formation. The filing of the COF is an excellent opportunity to put the public on notice that the company has a serious asset protection firewall in place. Accordingly, minimalist filings, in particular Internet forms, should be avoided. These are seldom adequate for any serious asset protection purpose, and they certainly fall short in the context of a series LLC.
It is possible to convert an existing traditional LLC to a series LLC by means of a Certificate of Amendment. Unfortunately, nearly all of the company documentation of the traditional company (organizational minutes, company agreement, etc.) will need to be replaced so there is little in the way of cost savings, except for a lower filing fee. Note that this approach is not recommended unless the existing traditional company is free of baggage such as debts, tax liabilities, contractual obligations, pending or threatened litigation, and the like. Otherwise, it is advisable to start a new entity that is unencumbered by such burdens.
Insulation of Each Series
A series LLC contains individual series in which properties or businesses can be held separately and apart from the assets held by other series and by the company at large. In other words, each series may contain a separate rental property (a common arrangement); or, alternatively, by way of example, Series A could contain a rental fourplex; Series B could contain a strip center; Series C could contain a business that buys and sells real estate notes; series D could contain a general contracting business; and so on. The important point is that each series is insulated from the other as well as from assets and liabilities held by the company at large.
A point of clarification here: A series LLC can still own property without a series designation, as an asset of the company at large. For example, property transferred into "ABC LLC" would become a general company asset, even if the company is a series LLC, because no specific series is named in the transfer.
Let’s return to the main distinction between a traditional LLC and a series LLC. Suppose there is a foreclosure on a property contained in Series A, and there is a deficiency at the foreclosure sale (i.e., the property sold for less than the amount owed the lender). The lender then sues and obtains a deficiency judgment. Assuming that the series company and its transactions were properly structured, the judgment would be enforceable only against Series A assets, not against the assets of Series B, Series C, or the assets of the company at large. This is not true of a traditional LLC which holds its properties in a collectively vulnerable pool. All by itself, this is a compelling reason to establish a series LLC rather than a traditional LLC.
Good record keeping is both important and required. In fact, series insulation is preserved only so long as "records maintained for that particular series account for the assets associated with that series separated from the other assets of the company or any other series." Tex. Bus. Orgs. Code § 101.601(b)(1). In other words, records must be maintained "in a manner so that the assets of the series can be reasonably identified by specific listing, category, type, quantity, or computational or allocational formula or procedure." Tex. Bus. Orgs. Code § 101.603(b). Implicit in the statute is the idea that assets and liabilities of a series can and should be separate both from the assets and liabilities of other series and those of the company at large. Commingling among these categories should be avoided.
Series record keeping is not as daunting as it may sound. A simple coding system for company assets and expenditures (all within a single checking account) would satisfy the statutory requirement of reasonableness. It is not necessary to establish a bank account for each series in order to comply with section 101.603(b)–although a real estate investor may decide to take this step if the properties held by each series are significantly and substantively different, either operationally or in terms of tax treatment. One account for the entire company is more common.
As always, records should be kept in anticipation of litigation, particularly litigation that includes piercing allegations, since such allegations (abusive though they may be) are nearly automatic in contemporary business litigation. Internal documents that reasonably identify the activities of each series are therefore important from the standpoint of anticipating and preparing for litigation.
An investor should think carefully before mixing and matching entirely different businesses within the same company. Generally speaking, one should not place an asset or enterprise in one series that:
(1) creates a much higher level of liability or potential for legal action than businesses in other series;
(2) has a significantly different debt structure (involving development loans, personal guarantees, and the like) than that in other series;
(3) receives significantly different tax treatment from other series or is involved in a payment plan with the IRS;
(4) serves as a management entity with exposure to the public (tenants, vendors, contractors, and the like) since this function is better placed in a separate LLC altogether.
Entities with any of the foregoing characteristics should be placed in separate, stand-alone LLCs (either traditional or series), referred to among asset protection advisors as "single purpose entities" or "SPEs." Examples are restaurants, retail stores, and apartment complexes. Merely because the BOC permits entirely different enterprises to be contained within the same entity does not mean that one actually should do so.
Title Insurance and Assumed Names
Both title companies and lenders are new to transactions involving specific series, so this is an evolving area at the level of practice. For instance, title companies typically require a certificate of good standing for an LLC, whether traditional or series. Title companies can be obsessive about this. We have even encountered title companies that demand a certificate of good standing for specific series. This reflects a misunderstanding of the law and the series concept. Since series are created privately, without necessity for public notice or state filing, no official method exists for establishing that a series (as opposed to the company at large) is in good standing. Some lawyers argue that the statute should be amended to provide for registration of series and therefore the ability of the state to determine if a particular series is in good standing or not. We oppose this idea on anonymity and asset protection grounds. As much company activity as possible, including the creation of series, should be kept out of the public records. Amending the statute to require series registration and good standing would only serve to make Texas a less attractive asset protection destination.
One should also expect that a title company will require that an assumed name certificate be filed indicating that the company is doing business by and through one of its series–e.g., "ABC LLC DBA Series A." See Part VI, ch. 33: Assumed Names.
Anticipate that a title company will also require a company resolution evidencing both the creation of a series and its authority to enter into the subject transaction. This is not a problem since these are simple documents to prepare. It may also be necessary to educate the title company (and possibly its attorney) as to the fact that series are empowered by statute to hold title to real property and grant liens. Tex. Bus. Orgs. Code § 101.605(3), (4), although this has become less common as use of series entities has spread and title companies become more comfortable insuring title held by individual series.
Title companies often demand a copy of the company agreement, a demand we resist whenever feasible. Company agreements are private, proprietary documents that are not usually the business of anyone but members of the company.
Separating Assets from Activities: The Two-Company Structure
Our recommended asset protection structure for serious, long-term real estate investors involves two LLCs, a shell management company (which can be a traditional LLC) and a holding company (a series LLC). The fact that the holding company (formed in either Texas or Nevada) does not enter into contracts or business dealings makes its assets beyond reach in most cases. Few investors or business persons need anything more complex than a two-company structure, although there may be good reasons to vary or customize this model as circumstances require.
Information in this article is proved for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes and any statutes or cases referred to should be checked for updates. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. Although we will respect your confidentiality, this firm does not represent you unless and until it is retained and agrees in writing to do so.
THIS DOCUMENT IS NOT INTENDED TO BE USED, NOR CAN IT BE RELIED UPON, BY ANY TAXPAYER FOR THE PURPOSE OF AVOIDING PENALTIES IMPOSED UNDER UNITED STATE FEDERAL TAX LAWS. THIS DOCUMENT DOES NOT CONSTITUTE DOES NOT CONSTITUTE A TAX OPINION OR OTHER ADVICE TO WHICH CIRCULAR 230 IS RELATED.
Copyright © 2014 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, http://www.LoneStarLandLaw.com.