Types of Texas Series LLC
In the state of Texas, an LLC is allowed to be formed with multiple series (after which the name could be something like ABC, LLC, Series A). The series of a Texas Series LLC are not separate entities, but rather separate "divisions" under one legal umbrella. Each series may own its own assets, enter into contracts, own bank accounts, and much more, just like a corporation. Members entered into contracts with one of the series , and creditors who decide to enter into contracts with one of the series do so as well. The owners and the creditors of one series of the series LLC will hold no right or claim to the assets, liabilities, or obligations of other series at law or in equity. As a result, the creditors of one series may not pursue the assets of other series to pay debts owed by the series they entered into contract with. Series LLCs contain statutory "charging order" protection (Section 101.601.) which allows the creditor of a series to collect on a judgment entered against the series.
Why an Operating Agreement?
The importance of a Texas Series LLC Operating Agreement cannot be overstated. In fact, not only is it crucial for governing LLCs, but it’s almost always even more important than a typical LLC Operating Agreement. That’s because, with a series LLC, not only does the holder of the limited liability company interest need to know what the rules are, but so does every series of the LLC.
Now, a standard LLC Operating Agreement will list what the rights and responsibilities are for all members and managers alike in the LLC. For a series LLC operating agreement, that’s doubly true…that is, the rights and responsibilities of the members and managers have to be spelled out, period. But for the entire LLC, list out what requirements each series must follow to be compliant with its operating agreement.
To say nothing of how series LLCs should clearly define what kind of assets are owned by each series in the LLC. After all, if the first series in the series LLC owns a dozen complex rental properties, we need to know the insurance requirements for those various properties. Likewise, if the second series in the series LLC offers consulting services, we need to know how knowledge is protected (client lists, for example), just like we need to know what the entire LLC needs to do to protect those assets, as well.
In addition to the aforementioned requirements, there are more elements that go into an operating agreement: what happens if members come in or out of the series, how the series LLC taxes itself (that is, do the series need to file separately with the IRS), what sorts of voting requirements the series LLC needs to have to pass a resolution (majority? majority of each series? etc.), whether any of the series need to post a bond for certain activities (this is a niche activity but it may be called for), and that we’ve made any necessary filings with the State Secretary of Texas.
Key Features of a Texas Series LLC Operating Agreement
Although the Texas Series LLC is still relatively new, the fundamentals of a series LLC operating agreement are not really any different than that of an ordinary LLC operating agreement.
For example, you want to ensure that you clarify how profits and losses are allocated amongst the LLC members, what events will cause dissolution, what happens when a member wants to sell its membership interest or dies (succession and buy-sell provisions), and how voting is conducted.
However, with a Texas Series LLC, you have some very important differences. First of all, you have to make sure that the LLC is properly organized, i.e. files the name reservation application, articles of organization, and designates a registered agent. Secondly, you need to make sure that you comply with all the notice requirements of having a registered agent under Texas law.
In addition, simply because a series LLC under Texas law allows for segregation of debts, assets, and liabilities amongst each series within a series LLC, does not mean that you do not have to be hyper-sensitive to the fact that courts (not law firms or lay people) may still want to look behind the veil and see if you have treated each separate series like a separate entity. Otherwise you may find that your series LLC is treated like an alter ego.
Some other important items on which the LLC operating agreement should focus are:
Tips for Drafting Texas Series LLC Operating Agreement
A Texas Series LLC Operating Agreement must include provisions addressing the governance, rights and duties of each Series and the Parent. For example, the agreement should contain provisions that describe the following: best practices also dictate that the agreement be written such that it is applicable to each Series LLC being formed. So employ a series approach to provide for simpler and easier amendments, instead of preparing a new agreement for each new Series or investment. The agreement should also include a checklist of items that each Series must follow and use that list for each new Series and update the Operating Agreement accordingly. The agreement should also contain a list of documents relating to the LLC and each Series, in order to assist in the ongoing record-keeping of the LLC and each Series.
What’s important to note here is that each Series or Departments could have Specific Provisions included in the Operating Agreement to meet the needs of the Department. Also, an Operating Agreement is meant as a living document, so it is meant to be revised, added to, and amended as circumstances require. Again, the key is distinguish between the Parent and the Series creating many of the same provisions just segregating the treatment of them for each.
Series LLC Legal Benefits
A Texas Series LLC provides its members with liability protection for the debts and obligations that are unique to their series. Each series has its own assets, its own members, and its own management structure. For instance, if Series A enters into a contract with another person, and Series A breaches the contract, the creditor can only pursue remedy against Series A’s assets. The creditor cannot pursue Series B’s assets to remedy Series A’s default. Therefore , a creditor who obtains a judgment against Series A will have to collect it solely from Series A’s assets. This is one way in which one Series is protected from the creditors of another Series within the same Texas Series LLC.
In addition, under current Texas law, a single filing fee with the Texas Secretary of State is all that is needed to create and organize multiple Series within a single Series LLC.
Possible Pitfalls of Texas Series LLC
While Texas law is generally favorable to the Series LLC and the benefits for certain businesses are undeniable, the Series LLC has some potential challenges and pitfalls. First, as the Series LLC concept grows in acceptance for use concerning the entire enterprise, as opposed to use concerning a single project or property, there is always the risk that one or more governmental authorities, or perhaps an activist state Attorney General, may seek to challenge the validity of an entire Series LLC with the hope of first causing expensive litigation and then victory as the series LLC is attacked as a corporation but with the limited liability of an individual LLC. Until and unless that happens, there is no impetus for litigation and those who will spend money on this issue will have an incentive to make significant changes to their practice to be noncompliant and create the attractor for litigation that is necessary to have the issue be decided. Second, Series LLCs have not been the subject of substantial litigation in Texas. Therefore, as the concept grows in Texas, it is likely that undefined areas will become the basis for litigation. For example, recent case law does not recognize the debtor-credits of one series being collectible from the assets of another series. See, e.g., In re Bock Energy Corp., 480 B.R. 558 (Bankr. W.D. Tex. 2013). Thus, there is a potential for creditors who have judgments, to incur additional judgments in similar or identical amounts against separate series for the same obligation thereby making the administrative burden of complying with the separate entity principles a troubling issue.
Conclusion and Suggestions
A Texas Series LLC’s operating agreement should be customized to fit the needs of a business’ owners. This will help ensure that its operating agreement: (a) avoids ambiguity (b) provides clear sailing on matters of intent, and (c) complies with Texas law.
Here’s what every entrepreneur considering a Texas Series LLC should know about a Texas Series LLC’s operating agreement: (a) it should list the series that will be established; (b) it should govern the managers for the series in question as it will form them (with the understanding that if the managers change, their power and authority do not shift to other managers unless the document states otherwise), (c) it should be clear about which assets are, and are not, going into a series; (d) it must be consistent with other documents that are relevant to its operation (including articles of organization for the LLC, name of the entity, how other entities address the assets in question, etc.), (e) it should designate which members will get what amount of profits (and losses, if applicable),(f) it must cover re-inventories, (g) it should cover how interests in a series will be transferred (i.e. sold, gifted, conveyed, without adequate consideration, etc.), (h) it should cover how series interests may be entered into evidence, (i) it should specify if assessments can be made, (j) it should designate when a member is to be expelled , (k) it should designate whether the company will be dissolved in the event a member is expelled (l) it should cover capital contributions, (m) it should be clear on which members are liable for debts, (n) it should cover how to amend its terms, (o) it should detail the voting process, (p) it should set forth the governing law (i.e. Texas law), (q) it should demonstrate the intention to protect only the series (and not the parent LLC) and (r) it should be clear how members may dissolve a series.
Therefore, if you have a Texas Series LLC (or are considering forming one), it’s in your best interest to draft an operating agreement that satisfies the aforementioned requirements. Doing so will not only assist you in meeting your Texas LLC obligations, but will also provide you with the type of liability protection you need to achieve your business goals.
Inherent in this type of document is the danger of drafting a series LLC operating agreement that isn’t tailored to your business. Not only can this lead to unintended liability, it can result in unwanted legal battles between you and your fellow members or managers; any of which could lead to substantial costs.
In short, you should consult with an experienced Texas business lawyer as soon as possible if you think a Texas Series LLC is right for your business. Not only will your lawyer be able to structure and draft an operating agreement that fits your particular business needs, he or she will also be able to answer any questions you may have about related matters.
