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Lending to Series of LLCs: Navigating UCC and Bankruptcy Code Risks and Providing Closing Opinions

Identifying Potential Pitfalls for Lenders and Mitigating Risks in Finance Transactions

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific WEDNESDAY, AUGUST 26, 2015

Presenting a live 90-minute webinar with interactive Q&A Norman M. Powell, Partner, Young Conaway Stargatt & Taylor, Wilmington, Del. Jonathan R.C. Arkins, Partner, Kaye Scholer, New York

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Lending to Series LLCs

Jonathan Arkins Kaye Scholer LLP, New York jonathan.arkins@kayescholer.com Norman M. Powell Young Conaway Stargatt & Taylor, LLP, Wilmington npowell@ycst.com

Overview

• Series LLC: an LLC with one or more series.
• A series is like, yet unlike, a subsidiary or,

perhaps, a division.

• Most series have their own assets and

liabilities “associated” with the series.

• Internal liability shields: series assets are

available only to creditors of that series.

• Most series can act in their own names.

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Overview

• Series might not be organizations, entities, or

persons.

• Most statutes don’t define “series.”
• They provide that an operating agreement

may establish (or provide for the establishment of) one or more series of members, managers, assets, and economic rights.

• Many current statutes do not require any

publicly available notice of series.

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Establishing Internal Shields

• Where public notice and additional

conditions are satisfied, the debts,

• bligations, and other liabilities of a series

are enforceable only against the assets associated with that series.

• Internal shields are important to lenders.

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Establishing Internal Shields

• Conditions include public notice.
• Some statutes require general notice filing

with the Secretary of State.

• e.g., Delaware – notice can indicate that the

series LLC has or may in the future have one or more series.

• Some require specific notice filing with the

Secretary of State.

• (e.g., Illinois - notice must be filed with respect to

and specifically referencing each series by name).

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Establishing Internal Shields

• Records for any series must account for the

assets associated with such series separately from the other assets of the series LLC or its

• ther series.
• The LLC agreement must adequately provide

for all relevant series.

• Establishment of series is facilitated by the

enabling statutes, but accomplished by or pursuant to the LLC agreement.

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Establishing Internal Shields

• Internal shields requires satisfaction of both

static and ongoing requirements.

• Static - e.g., the requisite filing and LLC

agreement language.

• Ongoing - e.g., maintaining separate records.
• Failure to maintain separate records results in

loss of internal shields.

• But the series continues to exist as a series

despite the loss of internal shields.

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Internal Shields in States Other Than Delaware

• Will internal shields be respected in states

that don’t offer shielded series?

• Some say yes - law of the formation state.
• Implicitly assumes shields are internal affairs.
• Others take a contrary view.
• Alphonse v. Arch Bay Holdings, L.L.C., 548 F.

App’x 979 (5th Cir. 2013) offers insights.

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Internal Shields in States Other Than Delaware

• The Alphonse dispute arose in a residential

foreclosure.

• Plaintiff was a series of a Delaware series LLC.
• The homeowner did not defend, but later

brought an action against the series LLC alleging robo-signing and fraud.

• Trial court dismissed: the series and the

series LLC were separate from each other.

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Internal Shields in States Other Than Delaware

• On appeal, the court acknowledged the law
• f the state of formation normally determines

issues relating to internal affairs.

• But different conflict-of-laws principles apply

where the rights of third parties (i.e., strangers to the LLC agreement) are involved.

• Internal affairs “does not apply to disputes

that include people or entities that are not part of the LLC.”

• How apply intra-series

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Series Might Not Be Entities

• Most series have a great many entity

characteristics.

• Series can sue.
• Series can contract.
• Series can hold property.
• But most series are denied certain entity

characteristics – cannot exist except during the life of the series LLC, cannot merge.

• Are series separate entities?
• Most statutes are silent (e.g., Delaware).

14

Series Might Not Be Entities

• Under some statutes, an LLC agreement may

provide that series are to be treated as separate entities (e.g., District of Columbia).

• Thus, entity status can be a matter of contract.
• Other statutes also require internal shields for

entity status (e.g., Illinois).

• Still others explicitly disclaim separate entity

status (e.g., Texas).

15

Series Might Not Be Entities

• Complicating matters, a series may be an

entity for some purposes, but not for others.

• Under the Treasury Department’s proposed

regulations, a series is treated as an entity formed under state law, regardless of whether the series is a juridical person for state law purposes.

16

Series Governance

• General default rule is governance by

associated members in proportion to their interests.

• Most permit other governance as agreed.
• Thus, a series can have most any governance

structure.

• Governance of a series can differ from that of

the series LLC, and governance of one series can differ from that of another series.

17

Series Purpose

• Generally, series may have any lawful

purpose.

• Some statutes authorize series both for profit

and not for profit.

• Many statutes exclude regulated activities

such as banking.

• Some provide that a series’ purpose may

differ from that of the series LLC.

• It is less clear whether a series can have a

purpose inconsistent with the purpose of the related series LLC.

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Series Purpose

• Statutes differ in explicitness as to holding

title to property, granting security interests, and suing and being sued.

• Most statutes provide options for holding of

property:

• in the name of the series LLC,
• in the name of the series, and
• in the name of a nominee.
• The statute tells us what’s possible.
• Documents tell us what’s been chosen.

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Series and UCC Article 9

• By definition, the “debtor” is the person

having an “interest” in the collateral.

• LLCs are “registered organizations” (i.e., filing

required)

• Thus LLCs are “located” in their formation

jurisdictions, and their names are ascertainable with certainty.

• But things may be different for assets

associated with a series.

• Secured parties must determine what, in fact,

is the debtor within the meaning of RA9.

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Series LLC as Article 9 Debtor

• If a series LLC is the debtor, make an ordinary

filing against and naming the series LLC as debtor, in the series LLC’s location.

• Matters unique to the series can be

addressed in the collateral description, or in box 17 (miscellaneous) of a financing statement addendum on form UCC1Ad, as appropriate.

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Nominee as Article 9 Debtor

• If a nominee is the debtor, determine

whether the nominee is an organization, a registered organization, or an individual.

• File in the nominee’s location and name.
• Note that a nominee’s location may differ

from that of the series LLC or a given series.

22

Series as Article 9 Debtor

• If a series purports to be the debtor, first

consider whether the series is an

• rganization.
• UCC Article 1 § 1-201(b)(25) - “organization” is “a

person other than an individual.”

• UCC Article 1 § 1-201(b)(27) “person” means an

individual, corporation, business trust, estate, trust, partnership, limited liability company, association, joint venture, government, governmental subdivision, agency, or instrumentality, public corporation, or any other legal or commercial entity.

23

Series as UCC Article 9 Debtor

• Is a series a legal or commercial entity?
• If it’s neither, it may not be a possible Article

9 debtor.

• Series likely are not registered organizations

(compare Illinois series with internal shields).

• By definition, a registered organization must

be “formed or organized” by the filing or issuance of a public organic record.

24

Series as UCC Article 9 Debtor

• Under “general notice” statutes, the State need

not receive any record showing a series to have been formed or organized.

• Even “specific notice” statutes, the filing is not a

condition to establishment of a series, but only to its having internal shields.

• Thus, series likely are not registered
• rganizations (except Illinois series with internal

shields).

• Series analogous to limited liability partnerships?
• LLP is not a registered organization.
• See PEB COMMENTARY NO. 17.

25

Series and the Bankruptcy Code

• Treatment of series under the Bankruptcy

Code is still more uncertain.

• Because many series are not entities, they

may be ineligible to become Bankruptcy “debtors.”

• A debtor is “a person. . . concerning which a

case … has been commenced.”

• “Person” includes individuals, partnerships,

and corporations.

• If series is a “person,” is it a partnership or a

corporation?

26

Series and the Bankruptcy Code

• The Bankruptcy Code does not define

“partnership.”

• It provides an illustrative, but not exclusive or

exhaustive, definition of “corporation.”

• Corporation “(A) includes— (i) [an] association

having a power or privilege that a private corporation . . .possesses; (ii) [a] partnership association [in which] … only the capital subscribed [is] responsible for the debts of such association; (iii) [a] joint-stock company; (iv) [an] unincorporated company or association; or (v) [a] business trust; but (B) does not include [a] limited partnership.”

27

Series and the Bankruptcy Code

• LLCs generally fit the Bankruptcy Code’s

definition of “corporation.”

• But its unclear whether series do.
• Similarly, its unclear whether internal shields

would be respected in a bankruptcy proceeding.

28

Closing Opinions for Series

• Lenders to series have the same concerns as

lenders to traditional borrowers.

• Lenders to series may have additional concerns

unique to series.

• Even a status opinion is based in contract law.
• A closing opinion isn’t a good way to address the

viability of internal shields.

• Where a series LLC has one series, it will likely

eventually have additional series.

• If any series is amenable to suit in a jurisdiction that

may not respect internal liability shields, a lender to any series may find its expectations frustrated.

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