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Nov
3 • 2017
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Does a Series LLC Provide Extra Protection Against Piercing the Corporate Veil?

In a recent article (Why Roll the Dice with Series LLCs), we discussed why we don’t form series LLCs in light of the risks and as-yet unanswered questions surrounding this relatively new business form. One of the uncertainties concerns the extent to which a series LLC may protect against piercing the corporate veil to shield the members’ personal assets from the reach of third-party creditors. We fielded that very question soon after we posted our first article on series LLCs, so we will address that specific issue with greater depth here.

To reiterate briefly, a series LLC is like a holding company made up of internal units, or series. The series are somewhat akin to unincorporated divisions within a corporation, with one big difference. While unincorporated divisions may be treated as separate entities by the corporation, they are not recognized as such by the law. Accordingly, even if a corporate obligation is assigned internally to a particular division, the corporation is ultimately responsible for the division’s performance of the obligation, with the corporation’s shareholders being on the hook only if the exacting standards for piercing the corporate veil are met.[1]

By contrast, series LLC statutes recognize a legal separation among the individual series within the LLC, for liability purposes at least. Delaware, which gave birth to the series LLC in 1996, provides in its Limited Liability Company Act that

in the event that a limited liability company agreement establishes or provides for the establishment of 1 or more series, and if the records maintained for any such series account for the assets associated with such series separately from the other assets of the limited liability company, or any other series thereof, and if the limited liability company agreement so provides, and if notice of the limitation on liabilities of a series as referenced in this subsection is set forth in the certificate of formation of the limited liability company, then 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 such series only, and not against the assets of the limited liability company generally or any other series thereof, and, unless otherwise provided in the limited liability company agreement, 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 thereof shall be enforceable against the assets of such series.[2]

This provision states both the effect of establishing series within an LLC, and the prerequisites for achieving that effect.

As we discussed previously, the effect of creating a series LLC is the erection of an internal liability shield—“i.e., the partitions confining the assets and liabilities of each series to that series alone”—so that the other series and the LLC as a whole cannot be liable for the debts and obligations of one unit within the LLC and vice versa.[3] The prerequisites for achieving that effect are: (1) the LLC agreement provides for the establishment of one or more series and for the limitation of liabilities among the series and the LLC; (2) a notice of the limitation on liabilities of a series is set forth in the LLC’s certificate of formation; and (3) the records maintained for any such series account for the assets associated with such series separately from the other assets of the LLC or any other series. Satisfaction of these prerequisites is, in essence, intended to provide a “safe harbor” against courts’ piercing the veil and holding the LLC or other series liable for debts incurred by one of the units within the LLC, whereas “[a]lternative structures” such as related corporations or regular LLCs may “present a potentially open-ended risk that a court will consider related entities to be part of a single firm” and pierce the corporate veil to hold a related entity liable for another entity’s debts.[4]

That is all well and good, but the entrepreneur just starting her own business is more interested in the external liability shield provided by forming a corporation or LLC, which ordinarily prevents her personal assets from being held liable for the business’s debts and obligations by third-party creditors. Does a series LLC provide any more protection than a regular LLC against a court piercing the LLC’s veil to reach members’ personal assets? That is one of the open questions surrounding series LLCs at this point,[5] but we don’t think so.

In Delaware and the other jurisdictions that have enacted series LLC provisions, those provisions are part of the jurisdiction’s limited liability company statutes. As a result, while the series LLC provision deals specifically with the internal liability shield, the series LLC’s external liability shield is based on the same provisions applicable to regular LLCs.[6] In Delaware, for example, the Limited Liability Company Act provides that,

[e]xcept as otherwise provided by this chapter, the debts, obligations and liabilities of a limited liability company, whether arising in contract, tort or otherwise, shall be solely the debts, obligations and liabilities of the limited liability company, and no member or manager of a limited liability company shall be obligated personally for any such debt, obligation or liability of the limited liability company solely by reason of being a member or acting as a manager of the limited liability company.[7]

The word “solely” in this provision “indicates that a member or manager will not be liable for the debts, obligations, or liabilities of a Delaware LLC only by reason of being a member or manager; however, other acts or events could result in the imposition of liability upon or assumption of liability by a member or manager.”[8] As such, courts have concluded that the veil of a Delaware LLC can be pierced to visit liability on LLC members under circumstances similar to those permitting a corporation’s veil to be pierced.[9]

In Delaware, the factors considered by a court in deciding whether or not to pierce an LLC’s veil include whether: (1) the LLC was undercapitalized; (2) the LLC failed to observe corporate formalities; (3) the LLC paid a dividend; (4) the LLC was insolvent; (5) the dominant member siphoned funds from the LLC; (6) there was an absence of corporate records; and (7) the LLC was a façade for the member’s operations.[10] Maintaining the records required to satisfy one of the prerequisites for a series LLC might tip one or two, but by no means all, of these factors in the members’ favor when the piercing analysis is conducted. In any event, members who are inclined to keep up with the greater recordkeeping requirements imposed on a series LLC are unlikely to have any problem with maintaining the lesser records and formalities required of a regular LLC. Therefore, there seems to be little reason to think that doing business as a series LLC, rather than a regular LLC, provides any extra protection against a court piercing the LLC’s external liability shield to hold members personally liable for the LLC’s debts and obligations, if the factors justifying veil piercing are present in a particular case.[11]

[1] See, e.g., Reducing Risk of Alter Ego with Some Simple Things.

[2] Del. Code Ann. tit. 6, § 18-215(b).

[3] Carter G. Bishop & Daniel S. Kleinberger, Limited Liability Companies: Tax and Business Law ¶ 14.03[1][b][ii] (Thomson Reuters 2017).

[4] Larry E. Ribstein & Robert R. Keatinge, Ribstein and Keatinge on Limited Liability Companies § 4:17 (Westlaw updated June 2017).

[5] In researching this article, we examined a number of scholarly papers, including two focusing solely on Texas law relating to series LLCs. The authors of one of the articles opined that series LLCs “may be more susceptible to courts piercing the corporate veil,” Jennifer Avery et al., Series LLCs: Nuts and Bolts, Benefits and Risks, and the Uncertainties That Remain, 45 Tex. J. Bus. L. 9, 15 (Fall 2012), while the other concluded that, properly construed, the Texas LLC statutes would leave series LLCs “virtually immune to veil piercing under existing law,” Bernie R. Kray, Respecting the Concept and Limited Liability of a Series LLC in Texas, 42 St. Mary’s L.J. 501, 544-45 (2011). Part of the problem may be that it is not always clear whether the authors are discussing veil piercing with respect to a series LLC’s internal or external liability shields, but it still demonstrates just how unsettled the law is in an area where business owners want to be as certain as possible that their personal assets are protected.

[6] See Alberto R. Gonzales & J. Leigh Griffith, Challenges of Multi-State Series and Framework for Judicial Analysis, 42 J. Corp. L. 653, 710 (2017) (“[T]he members associated with each Protected Series and/or the Series LLC itself should have the limited liability protection of an LLC, as all of the Series LLC statutes are found within the general LLC statutes and generally are overlay provisions to the general LLC statutes. A failure of the internal liability shields should not lead to a failure of the external liability shields for the members, but will rather place the Series LLC in the same position as a regular LLC.”).

[7] Del. Code Ann. tit. 6, § 18-303(a) (emphasis added).

[8] Pepsi-Cola Bottling Co. of Salisbury, Md. v. Handy, No. 1973-S, 2000 WL 364199, at *3 (Del. Ch. Mar. 15, 2000) (quoting R. Franklin Balotti & Jesse A. Finkelstein, The Delaware Law of Corporations & Business Organizations 20-6 (3rd ed. 1998)).

[9] See, e.g., In re Opus E., LLC, 528 B.R. 30, 57-58 (Bankr. D. Del. 2015), aff’d, 2016 WL 1298965 (D. Del. Mar. 31, 2016), aff’d, No. 16-2202, 2017 WL 4310367 (3d Cir. Sept. 28, 2017); see generally Justin T. Fezzi, Comment, Third Time’s a Charm: How the Uniform Law Commission Can Fit Series LLCs into the Uniform Limited Liability Company Act, 58 St. Louis U. L.J. 911, 924 (2014) (most courts allow veil piercing in the LLC context, using corporate standards).

[10] Opus E., LLC, 528 B.R. at 58. Those are factors considered in determining whether the LLC operated as a single economic entity, which is part of the test for piercing the LLC’s veil. The other part requires the creditor to establish that “an overall element of injustice or unfairness is present.” Trevino v. Merscorp, Inc., 583 F. Supp. 2d 521, 528 (D. Del. 2008).

[11] See Gonzales & Griffith, supra note 6, 42 J. Corp. L. at 704 (“[T]here is no reason to believe that the external shields of the Series LLC and the associated Protected Series as a group will be any different in that respect from that of a regular LLC.”).