To diversify risk, someone with multiple rental properties or other investment properties would likely be advised to place each property in a separate entity. This was traditionally accomplished with the use of a corporation or limited partnership in earlier years. Recently, however, the limited liability company has quickly become the entity of choice for real estate.
Placing high-risk assets in separate entities, far from each other, and especially separate from low-risk assets, defines asset protection. For example, someone who operates a demolition business through the use of a corporation or LLC should not place an investment rental property in the same LLC or corporation. Similarly, someone with a large amount of low-risk assets such as cash, securities, etc. you should not be advised to place those assets in the same entity as an ongoing business. However, compliance with the basic principles of asset protection can be costly. Placing each parcel of real estate into separate entities includes separate filing fees and includes additional legal and accounting fees in most cases.
However, there is a solution to the increased fees associated with multiple filings: Series LLC. The Delaware LLC Law for the first time authorized the creation of separate series within the same LLC. Under the Act, debts and other liabilities under Delaware Law are enforceable only against the segregated assets in the particular series to which such assets have been attached. (Delaware Limited Liability Company Law, Section 18-215). Delaware Law also provides that each series can have different members, or the same members with different percentages than in other series besides the parent LLC, which provides flexibility for multi-investor projects.
This combination allows a series to be treated in many ways as a separate and distinct LLC. The Act also authorizes the LLC Operating Agreement to designate a number of members, managers, or other interests who have separate rights and duties with respect to the specific property of the LLC.
The Illinois General Assembly recently adopted an amendment to the Illinois LLC Law authorizing the creation of the series LLC. (805 ILCS 180/37-40). Similar to Delaware Law, Illinois Law provides that “debts, liabilities, and obligations incurred, contracted, or otherwise existing with respect to a particular series shall be enforceable against the assets of such series only, and not against the series of the same,… …”. (805 ILCS 180/37-40(b)). In real estate investment terms, this means you can create a multi-series parent LLC to protect your assets, avoiding multiple state filing fees, legal fees, and other professional costs associated with creating each separate LLC.
To create a series LLC, special language must be included in the Articles of Organization, which is filed with the Illinois Secretary of State. A Certificate of Designation must also be filed for each series other than the LLC with the Articles of Organization.
Note that obtaining and preserving separate liability status requires each series to be operated as a separate entity. This means that separate records must be maintained for each series, with the assets in each series identified. Unfortunately, the case law is largely undeveloped for the series LLC structure. This is especially true in Illinois. Without the benefit of a court decision, many facets of the new series LLC law may be subject to reasonable differences in interpretation. For example, some professionals have argued that it is safe practice to provide each series with a separate bank account.
Additionally, an entity formed in one state may not do business in another state unless it is first “qualified” to do business in the foreign state. This is accomplished by filing an application with the secretary or department of state of the foreign state and paying some type of foreign filing fee. Without qualifying to do business in the foreign state, the entity may subsequently incur fines and other charges for not doing so. Once an entity qualifies to do business in the foreign state, it essentially becomes subject to the laws of that state, which presents a problem for the series LLC structure.
If an LLC is formed in Illinois and qualifies to do business in another state so that it can own real estate in that state, then that LLC becomes subject to that state’s law. The exception is internal affairs and the management of the LLC itself. The state of non-formation will normally apply the law designated in the LLC’s Operating Agreement or the laws of the state of formation. But typically this involves disputes between members about how the LLC is owned or operated and does not include disputes with creditors or third parties who are not party to the operating agreement. It is highly unlikely that any state without Series LLC legislation will apply the Series legislation to creditors, claimants and other third parties who have not agreed to be bound by the Series legislation.
This issue is why corporations, LLCs, and other entities formed in other jurisdictions are unlikely to offer any advantage over those formed in the state where ownership will be held.
Regardless of the perceived drawbacks, this structure is quickly becoming the vehicle of choice for Illinois investors with multiple properties.
