Brief Background and Introduction
As a Texas commercial litigation and business lawyer, and clinical professor of business law, I am consistently advising clients and educating students as to the vast depth and complexities of the Texas Business Organizations Code and Texas Business and Commerce Code. However, business laws, both statutory and common law in nature, have far-reaching effects into many other areas of law such as family law, banking and securities law, and estate planning to name but a few. Likewise, while my cases primarily involve federal and state litigation between business entities, both as plaintiff and defense, I have learned well that the truly illuminated counselor understands the polymathic nature of theoretical business law and how it impacts not only the business-entity clients but their individual equity holders as well.
Narrowing down the topic of this article a bit more, it should not come as a shock to Texas lawyers that the LLC has long surpassed the C-corporation and S-corporation models of the past in many significant ways.(1). This is simply nothing more than the continued evolution of business models and the law, which began as nothing more than a sole proprietorship or general partnership many years ago.
However, as this evolution continues to manifest itself in new and exotic ways Texans are now faced with an interesting, and still novel, concept of choice-of-entity selection: What is a series LLC? And what are the inherent risks of a series LLC? As to the first question proposed above, a series LLC, or SLLC, is conceptually nothing more than a series of subsidiary “members, managers, membership interests, or assets” corralled under a single, parent LLC. (See Tex. Bus. Orgs. Code subch. M, §§ 101.601(a)-b)). As much of U.S. business law history begins, the esoteric coterie within Delaware launched the first version of this concept in 1996.(2). And, of the roughly 14 states who have adopted this type of entity formation,(3) each has its own particular laws governing such an enterprise. While this article will primarily consider SLLCs within Texas, it is worth nothing that California among few other states, while not allowing for a domestic version of the SLLC, will still permit foreign SLLCs to operate as such within their borders. Hence, it is key for business lawyers to check the particular state’s code(s) in which you or your clients intend to operate in this capacity. As to the second question proposed above, the rest of this article will humbly attempt to focus upon the more, foreseeable, likely, and somewhat latent risks as they apply generally to SLLCs within Texas and the U.S. Court of Appeals for the 5th Circuit.
Texas SLLCs in Application
The Statutory Lens. In Texas, SLLCs are codified formally by Tex. Bus. Orgs. Code, subch. M, § 101.601. As such this currently sparse, though direct, code states generally that a “company agreement may establish or provide for … series of members, managers, membership interests, or assets” that have “separate rights, powers, or duties” or “a separate business purpose or investment objective.” Furthermore, the statute provides that an SLLC “may carry on any business, purpose, or activity” that is not generally prohibited by the Texas Business Organizations Code.(4). As to the elephant in the room—enforceability of obligations—the code provides as follows: (1) Debts, liabilities, obligations, etc. of any series shall be enforceable as to that series only; and (2) None of the aforementioned shall be enforceable against the parent LLC, or any other series. (See Tex. Bus. Orgs. Code, Ch. 2, § 101.602). However, there are some formal steps that must be closely complied with in order to invoke the express limited liability. While each is de jure necessary to invoke such limited liability the steps are simple in nature: (1) Records must be properly maintained for each series, separately; (2) the parent LLC’s company agreement must grant both the ability of the parent company to operate series and expressly grant such series their own limited liability protections; and (3) the parent LLC’s certificate of formation must contain an express notice of such limited liability protections.(5). Other than that, the various series are allowed to act and conduct themselves as any other limited liability entity, such as to sue and be sued, contract, sell and hold title, etc.(6). As to the federal aspect we have IRS guidance prescribed within their fairly recent regulations, in that series of an LLC are to be taxes as either a disregard filing entity, a partnership, or a corporation.(7). This verification by a major federal agency only further strengthens the argument, both theoretically and practically, that SLLCs are to be considered prima facie as drafted by the legislatures of the several states.
The Caselaw Lens. As it likely comes as no surprise to the reader, the first question I am always asked with regard to SLLCs is but how do courts view SLLCs? This is the logical next-step inquiry into the nature of any business entity. Yet, with the sparse caselaw on the subject, and many lawyers’ hesitance to recommend the SLLC as a result, this lack of juridical input from the bench has left many lawyers and businesses without this practical tool in their framework. Within Alphonse v. Arch Bay Holdings, LLC,(8) Texas business lawyers have great, historical lines of logic from which to gain valuable insights as to how courts within the 5th Circuit conceptualize the application of the SLLC. In Alphonse, a mortgagor brought suit against a parent LLC, even though the facts at bar indicated the damages arose between Alphonse and a series of the parent LLC. This, of course, is every business lawyer’s greatest fear in this regard—vicarious liability/piercing the veil—which leads them to advise against the SLLC. This line of logical history is created by Alphonse’s volatile procedural history.(9). As to the question of whether or not a series only exists to represent the interests of the parent LLC, the court illustrated its view on this point at being of the fact-based nature.(10) Through the 5th Circuit managed to largely avoid these novel arguments by stating these SLLC issues were “extremely novel, complex and fluid issues of [state] law … [and are] more appropriately addressed to a[state’s] court”, this clear direction to counselors notwithstanding, we are able to glean great insights nonetheless.(11). The court, opining as to whether a parent LLC was merited, states such an argument rests simply upon fact-intensive questions of the relationship between a parent LLC and its series.(12). Ultimately, the courts relied on a two-fold system, (Texas and Louisiana series LLC laws were modeled after the Delaware Code; the 5th Circuit will use this lens for interpretation, although Texas appellate courts and Supreme Court of Texas remain to be seen) of analysis in this regard: (1) Delaware Code(13) and (2) Louisiana State Code.(14). Under the first prong, to wit, the Delaware Code, the court stated “unless otherwise provided in a limited liability company agreement, a protected series shall have the power and capacity to, in its own name, contract, hold title to assets … and sue or be sued.” So the 5th Circuit has held that (1) State law of formation governs the legality and limited liability protections of SLLCs and (2) 5th Circuit courts are likely to draw heavily upon Delaware Code as a guiding muse of intent and purpose. In Texas, though courts have not directly dealt with SLLCs and vicarious liability, respondeat superior, or piercing the corporate veil, at least one recent case(15) considered an SLLC as a separate “person” of the parent LLC, holding that a contract between a plaintiff and a series was valid and enforceable. Finally, the same court recognized the long-held Texas business principles that partnership and company agreements, along with contracts, are to be construed as according to their plain and unambiguous language as such language stands to, prima facie, represent the parties’ intent.(16).
So, where does that leave us as Texas business lawyers? It is very clear from the statutory framework of the Texas Business Organizations Code that different series of LLCs are intended to be treated as an incorporated or duly formed entity, even though the series are not actually required to be registered with the Texas secretary of state. Additionally, it is fairly clear that the highest courts in the 5th Circuit likewise interpret these state codes as written, so much so that our federal courts are hesitant to consider these arguments at all. Likewise, the IRS has for some time now taxed series as separate entities, and therefore does not view them as simply nothing more than subsidiary extensions or DBAs of a parent entity. Thus, the only dark matter left in this regard relates to secondary, though highly important questions of business law. These secondary questions include issues such as (1) How are SLLCs viewed during bankruptcy proceedings?; (2) Can secured or unsecured creditors be barred from collection against an LLC if their claims are against a series, or vice versa?; (3) How will Texas SLLCs be interpreted in foreign jurisdictions?; (4) How do securities laws and regulations, both state and federal, apply to SLLCs?; and (5) The glaring theoretical question regarding SLLCs—if the SLLC is considered a separate entity, without having to register as such with the Texas secretary of state, how can it be viewed as a separate entity given that it is just part of a single, duly registered legal entity?
First, the statutory language regarding SLLCs in Texas is both plain and unambiguous with regard to how the Legislature intended for series to be applied and interpreted, to wit, that while not a separately incorporated entity the series of an LLC are to be treated as separate entities notwithstanding. Second, both Texas courts and the 5th Circuit have likewise continued to hold that partnership or company agreements should be construed as any other written contract, to wit, by utilizing the Four Corners Doctrine.(17) Thus, as to the point of limited liability and piercing the veil it is overwhelmingly likely that a court sitting within the 5th Circuit will find a series is due all applicable limited liability and powers equal to a formally incorporated and formed domestic entity; but, this will be exemplified only if the company agreement(s) and certificate of formation contain the required notices and language, and if the records and books of each series are maintained appropriately and separate from any other series, or the parent LLC itself. With regard to how securities, IRS, and other regulations may apply to SLLC, we already have some guidance from the IRS as aforementioned, and it is highly doubtful that the Texas State Securities Board will venture far, if at all, from the IRS and the Securities and Exchange Commission which have thus far considered SLLCs as equal to any other incorporated limited liability entity, to wit, as a standalone separate legal entity. Therefore, while belt-and-suspenders barristers may be hesitant to dive in headfirst when it comes to trying an SLLC case, this author encourages his fellow Texans to boldly embody the spirit of our Texan forefathers as pioneers of a new and mysterious land and begin establishing SLLCs across this great state and nation.
B. BLAZE TAYLOR
is a shareholder of The Moster Law Firm and operates as chief of civil litigation for the firm. He is also a clinical professor of law at Lubbock Christian University. Taylor’s practice includes complex commercial litigation, intellectual property, business formations and governance, and construction law.
1. See Choice of Entity Update, 13th Annual Adv. Real Estate CLE, State Bar of Texas (2019)(citing Tex. Sec. of State—No. of Domestic For-Prof. C-Corps/S-Corps in 2019 = 366,017; No. of Domestic LLCs in 2019 = 1,042,532).
2. See Del. Code Ann. Tit. 6, §§ 17-218, 18-215.
3. See Ala. Code § 10A-5A-11.01; Del. Code Ann. Tit. 6, §§ 18-215, 805); D.C. Code § 29-802.06; Ill. Comp. Stat. 180/37-40; Ind. Code § 23-18.1; Iowa Code § 489.1201; Kan. Stat. Ann. §§ 17-76, 143; Mo. Ann. State §§ 347.039, -.153, -.186; Mont. Code Ann. §§ 35-8-102, -107, -108, -202, -208, -304, -307, -503, -803, -804, -901, -902; 2018 Neb. Laws L.B. 1121; Nev. Rev. Stat. § 82.296; Okla. Stat. tit. 18 § 2054.4; P.R. Laws Ann. Tit. 14 § 3967; Tenn. Code Ann. § 48-249-309; Tex. Bus. Orgs. Code §§ 101.601, -.622; Utah Code Ann. § 48-3a-1201.
4. See Tex. Bus. Orgs. Code, ch. 2, § 2.002.
5. See Tex. Bus. Orgs. Code, ch. 101, subch. M, § 101.602(b)(1)-(3).
6. See Tex. Bus. Org. Code, Ch. 101, Subch. M, §101.605.
7. See IRS Reg. §§ 301.7701-1.
8. See Alphonse v. Arch Bay Holdings, L.L.C., 548 Fed. Appx. 979, 984 (5th Cir. 2013).
9. See Alphonse v. Arch Bay Holdings, LLC, CIV.A. 12-330, 2013 WL 55911, at *1 (E.D. La. Jan 3, 2013), rev’d sub nom. Alphonse v. Arch Bay Holdings, L.L.C., 548 Fed. Appx. 979 (5th Cir. 2013); Alphonse v. Arch Bay Holdings, L.L.C, 2:12-CV-330, 2014 WL 6674029 (E.D. La. Nov. 24, 2014), aff’d sub nom. Alphonse v. Arch Bay Holdings, L.L.C, 618 Fed. Appx. 765 (5th Cir. 2015).
10. Alphonse v. Arch Bay Holdings at 984 (looking at how management was structured, how disbursements were paid, whether books were kept separately, and how assets were allocated and held).
11. See Alphonse at 2:12-CV-330 (2014).
12. See Alphonse 548 at 979 (2013).
13. Del. Code Ann. tit. 6, § 18-215 (2012).
14. La. Rev. Stat. Ann. § 12:1342.
15. Great Sw. Reg’l Ctr., LLC v. ACSWD, LP, 14-18-00679-CV, 2020 WL 205993, at *10 (Tex. App.—Houston [14th Dist.] Jan. 14, 2020, no pet. h.).
16. Id. at 4-7.
17. See Grt. Sw., WL 205993, at 10 (2020).