Series LLC: The Rise (and Risks) of a New Limited Liability Entity | Post 3
This post continues the discussion of series LLCs and bankruptcy. There are still unanswered questions in this area of law. Today we’ll explore a second possible option for how bankruptcy court should treat series LLCs: entity law with exceptions approach.
Option Two: Entity Law with Some Exceptions
Recall that to file for bankruptcy, a series must be a “person” under the Bankruptcy Code (the “Code”). Typically, LLCs are treated as a “person” by bankruptcy courts even though they aren’t mentioned in the definition in the Code. At this point, no court has determined a cell’s “personhood” for bankruptcy purposes.
Entity law is the general starting point for corporate groups in bankruptcy. Entity law is the body of law that creates formal legal boundaries so that each corporation within a corporate group has independent legal rights and duties with separate liability from the other corporations in the group. These boundaries protect the assets of one corporation from the creditors of other corporations in the corporate group. In the case of series LLCs, entity law would prevent creditors of one series from collecting the assets of a related series, or the whole LLC. Courts generally do not question an entity’s separateness unless creditors can show a lack of formal separation between affiliates of a corporate group, then they “pierce the corporate veil” and the presumption of separateness dissolves.
Courts may find the entity law framework an attractive approach for dealing with series LLCs in bankruptcy proceedings. Under this approach, each series, or cell, would be a separate “person” under the Code, and its liabilities would not affect the other cells of the series. Bankruptcy law is driven by equitable principles. A bankruptcy court’s goal is to facilitate an orderly reorganization or dissolution for the debtor while ensuring that creditors are treated fairly. If the court finds that there are no actual boundaries between series, the presumption of separateness is rebutted, and the liabilities of the debtor series are imputed to the other series in the LLC. Courts would likely examine whether:
- Each series is financially independent or interdependent;
- The series LLC is economically integrated;
- The holding company participates in the decision-making of each of the cells; and
- The series LLC holds itself out to the public as a single integrated enterprise.
If these boundaries between series are not present, the court could allow a creditor to reach the assets of the other cells or the series LLC as a whole.
Bankruptcy courts try to preserve the pre-bankruptcy rights, remedies, and legitimate expectations of creditors, and these expectations are based on state corporate and collection laws. Most series LLC statutes provide that the debts, liabilities, obligations, and expenses of one series are not enforceable against the assets of another series, which emphasizes a preference for separate entity treatment. This would likely support a bankruptcy’s court’s use of entity law for series LLCs, unless a state law is inconsistent with bankruptcy law.
However, some observers argue that companies are more consolidated in actuality than on paper, and that entity law may no longer be the favored approach. Ultimately, courts will choose the body of law that best reflects the customary industry practices and the creditors’ expectations.
Stay tuned for our next post discussing two other alternatives courts have for series LLCs in bankruptcy.
Thanks to Danielle Flatt for her work on this post.