Lending to a Series LLC
by Gordon Russell and Michael Attaway
The Series LLC is a relatively new form of business entity in Texas. It was added to the Texas Business Organizations Code in 2009. Because the Series LLC is new, many attorneys and bank officers are unfamiliar with the opportunity and risks a Series LLC presents.
A “Series LLC” is literally different constituent “Series” within the structure of a single LLC. The Series LLC itself is the “Parent”, which is formed by filing a certificate of formation. After the Parent is formed, members of the Parent can create the individual Series with no additional public filing. Instead, the individual Series can be automatically created under the operating agreement when a new asset is purchased.
Each Series is treated as a separate legal entity with its own assets and liabilities. Accordingly, it functions in the same manner as a number of traditional, single asset LLCs created by the same members. Individual Series may separately enter into contracts, buy and sell property, borrow money, and do anything else a traditional LLC can do. Most importantly for lenders, creditors of one Series may not reach the assets of any other Series or the Parent. Series LLCs often take advantage of their structure by making the Parent a shell management company with no assets.
A Series LLC limits a creditor’s access to a borrower’s assets and credit by placing assets in a separate Series, therefore, lending to a Series LLC can be perilous. Accordingly, a lender must take steps to protect itself. Those steps are (a) careful due diligence, (b) appropriate representations and warranties regarding corporate structure, (c) where appropriate, a legal opinion of borrower’s counsel, and (d) guaranties of the Parent and its principals or sponsors.
A lender should ensure all loan documents are entered into with the specific Series with which the lender intends to contract. In doing so, the lender must determine which Series actually owns the collateral that will secure the debt and whether that Series has sufficient assets and cash flow to repay the loan.
Determining the assets of a specific Series may be difficult. There is no required public filing when the Parent creates a Series, therefore, there are no public records that can be used to determine the existence of a Series. Accordingly, the lender must look to the borrower or borrower’s counsel for this information.
The lender must be diligent in obtaining and analyzing objective proof of ownership. The best proof of ownership is a contract, bill of sale, or deed. In order for the asset to be protected from creditors, the bill of sale or deed must transfer the asset to a specified Series. If it does not, it becomes a general asset of the Parent as a whole and may be reached by a creditor of any Series.
The lender should obtain representations and warranties designed to protect against the risks posed by the Series LLC. It should require the borrowing Series to warrant it is the owner of the collateral and any other assets that will secure repayment of the loan. Further, the loan documents should include clear restrictions on transfer of any property between the Series.
The risks inherent in lending to a Series LLC described above also emphasize the importance of guaranties from the sponsor or principals of the borrower and of the Series LLC Parent of all extensions of credit to a Series LLC and to individual Series.
The challenges of lending to a Series LLC are compounded because the lender will be negotiating with the Parent. Because the Parent generally has no assets, contracting with it can be fatal. Accordingly, it is fundamental that the lender require actual proof of ownership of assets before making a loan. If the lender does not ascertain proof and the Parent management does not understand how a Series LLC works with respect to ownership of the collateral and other assets and obligations to repay debt, a lender could have a claim against an entity with no assets.
There is fashion in the law as elsewhere. The Series LLC is the next big thing in business entity selection. But beware of new shiny things: a Series LLC can become a Trojan horse for lenders.