The following explores the concept of Series LLCs, their creation, benefits, risks, and legal considerations. Series LLCs offer an attractive structure for businesses with multiple assets, providing the advantages of separate liabilities without the complexities of maintaining multiple entities.
Introduction
The rise in popularity of Series LLCs has piqued the interest of many clients and potential investors, triggering the need for a closer examination of this unique corporate legal entity. Series LLCs offer a rather novel approach, enabling a single entity to create multiple series, each with its own assets and liabilities, resembling independent entities without the administrative burdens of multiple business formations.
For example, Series LLCs can be a useful tool for real estate investors who own multiple properties. Under this scenario, each property can be associated with a separate series within the Series LLC. If one series is involved in litigation, the assets of the series associated with the remaining properties will not be used to pay off any liabilities.
The legal basis that allows for the creation of Series LLCs in Puerto Rico is found in Article 19.17 of the Puerto Rico General Corporations Act, as amended (the “Corporations Act”). This article provides the legal framework and provisions that empower the establishment and organization of individual series within a Limited Liability Company. According to this article of the Corporations Act, the Operating Agreement of a Series LLC can establish a separate series of members, managers, or LLC interests. Each series can have specific rights, powers, duties, and responsibilities related to specific properties or obligations of the LLC, as well as its own profits or losses associated with those properties or obligations. Additionally, each series can have a distinct business purpose or investment objective, which, in and of itself, results in a more dynamic corporate vehicle.
The assets of a particular series are protected from enforcement against the other assets of a Series LLC if: (i) the limited liability company agreement provides for the establishment of one or more series; (ii) separate and distinct records are maintained for each series and its assets are accounted for separately from the other assets of the Series LLC or any other series (and the limited liability company agreement so provides); and (iii) notice of such limitation of liability is set forth in the Series LLC’s certificate of formation filed with the Puerto Rico State Department. Note that each series must maintain meticulous records, segregating its assets from those of the series LLC and other series.
Tax treatment
The Puerto Rico Department of Treasury has not yet issued any guidance to determine the tax treatment of Series LLCs. Nevertheless, in Puerto Rico, Series LLCs are treated as corporations for tax purposes unless the option to be taxed as a pass-through entity is chosen. From a federal tax perspective, the IRS released regulation REG-119921-09, suggesting that Series LLCs should be treated the same way as regular LLCs, as they qualify for either classification.
Benefits
Operational Efficiency: Series LLCs facilitate multiple business activities within a single entity, granting each series its own set of assets and liabilities, safeguarded from other series' creditors. This consolidation reduces expenses and administrative responsibilities compared to establishing and managing multiple LLCs. Moreover, the series LLC model proves cost-effective when operating a parent-sub structure in conjunction with multiple LLCs.
Cost Savings: Incorporation costs are reduced as there are no additional fees for forming a Series LLC. In Puerto Rico, only one annual report to the Department of State is required, and a single agent or representative for the entire Series LLC can be maintained.
Asset Protection: One of the salient benefits offered by Series LLCs is the ability to separate assets and liabilities among entities, preventing the application of the principal entity doctrine. Additionally, Series LLCs provide asset protection similar to, or even better than, multiple traditional LLCs, as they can segregate debts within each series. This is possible because Series LLCs can hold properties in their own names and generate interests within that group without affecting properties outside the Series LLC. Furthermore, Series LLCs enable the safeguarding of a specific asset from the general liabilities of the entire entity, eliminating the need to create a new entity solely for property ownership. In summary, Series LLCs allow a single entity to own multiple properties and treat them as if each were owned by a separate LLC.
Structure Flexibility of Series LLCs: Like standard LLCs, Series LLCs offer significant flexibility in terms of management and ownership arrangements. Each series may have distinct managers, members, and assets, and distribution provisions can be customized on a series-by-series basis.
Risks and Considerations
While Series LLCs present numerous benefits, one must also consider its associated risks:
Limited Legal Precedent: Due to the novelty of Series LLCs, an absence of interpretive case law exists, leading to uncertainty in certain scenarios. This form of business organization has not been widely tested in federal or state courts. No court has considered or established what constitutes “separate and distinct records” in the context of a Series LLC, nor has a court determined what asset or other restrictions, if any, are necessary to comply with such requirement.
Bankruptcy Implications: The treatment of Series LLCs in bankruptcy remains relatively untested, and the process for a series to file for bankruptcy independently from other series or the Series LLC requires further examination. It is unclear whether a federal bankruptcy court would treat each series as a separate bankruptcy estate or whether it would disregard each series and pool all the assets and liabilities of the Series LLC as a whole.
State Legislation: Most U.S. jurisdictions have yet to enact similar state laws providing for the formation of Series LLCs. This reality may affect the ability of a Series LLC to conduct business in such jurisdictions.
Insight regarding the PR Incentives Code
As an additional consideration, if both a Series LLC and its individual Series intend to submit a tax exemption application to export services under section 2031.01 of the PR Incentives Code, a crucial condition applies. Specifically, within the framework of a Series LLC structure, every individual Series, along with the LLC itself, must share a 20% common ultimate ownership.
Consequently, when dealing with tax exemption scenarios under the PR Incentives Code that involve a Series LLC, it becomes imperative for all the series to possess a shared common ultimate ownership. The "common ultimate ownership" principle will be thoroughly scrutinized by the Puerto Rico Incentives Office in cases pertaining to this matter, focusing on the ultimate individuals who hold membership ownership within the series. Nonetheless, situations may arise where the member of the Series LLC assumes the role of the controlling member, thereby wielding authority over all decisions. In such instances, when the members of the series within the Series LLC function as passive investors devoid of voting rights, a case-by-case evaluation might be conducted by the Puerto Rico Incentives Office. However, note that any final determination on the matter rests with the Incentives Office.
Conclusion
Series LLCs offer significant advantages as an efficient and cost-effective business structure, particularly for businesses with multiple assets seeking to maintain separate liabilities. Nevertheless, potential users must carefully consider the inherent risks stemming from the relative novelty of Series LLCs, the varying degrees of state recognition, and its tax implications. Seeking professional legal counsel and performing a thorough due diligence review are imperative first steps when contemplating using Series LLCs to conduct your business.
Written by: Lic. María Gabriela Diez
If you have any questions or need additional information regarding the contents of this Newsletter, please don’t hesitate to reach us at:
Plaza 273, Suite 900
273 Ponce de Leon Ave.
San Juan, PR 00917
Phone: 787-710-8262
This Newsletter has been prepared for information purposes only. It is not intended as, and does not constitute, or should be construed, as legal advice or solicitation of any prospective client. An attorney-client relationship with BIO Counselors at Law LLC (BIO) cannot be formed by reading or responding to this Newsletter. Such a relationship may be formed only by express engagement with BIO.
