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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, obligations, 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 other 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 of 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).

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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.

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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.

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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. 19

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.

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Series as Article 9 Debtor

● If a series purports to be the debtor, first consider whether the series is an organization. ● 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.

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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.

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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 organizations (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?

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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.”

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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.

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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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