The certificate of designation states (1) the LLC’s name, (2) whether the LLC is established in Illinois or in another state, (3) the name of the series, and (3) a statement that the LLC’s registered agent and office shall be the agent and office for the series.
805 ILCS §180/37-40(d). The name of the series must contain the entire name of the LLC and be distinguishable from the names of the LLC’s other series. Id. If the management of the series is different from the management of the LLC, the certificate of designation must state the names and address of the managers or the members who will manage the series. Id. A series of an LLC will be deemed to be in good standing as long as the LLC is in good standing.
805 ILCS §180/37-40(e). However, the series will not have the additional limited liability protection that series LLCs afford unless a certificate of designation has been filed by the series. 805 ILCS §180/37-40(b).
Operating Agreement
The series in a series LLC must be established in the LLC’s operating agreement.
805 ILCS §180/37-40(a). A series can be defined in many different ways. The LLC Act states that a series may provide for different members, managers, or LLC interests having separate rights, powers, or duties with respect to specified property or obligations of the LLC or profits and losses associated with specified property or obligations. Id. A series also may have a separate business purpose or investment objective. Id. Rather than establishing specific series from the LLC’s inception, a series LLC’s operating agreement may provide for the establishment of series or additional series in the future. Id.
With respect to the management of the series LLC, the operating agreement may provide that a series will be managed by either the member or members associated with the series or by a manager or managers chosen by the members of the series. 805 ILCS §180/37-40(h). If the operating agreement does not specify the management of the series, the series’ management is vested in the members associated with the particular series. Id. The operating agreement may grant to all or certain of the members or managers of the series the right to vote separately or with any group of the members or managers associated with the series on any matter.
805 ILCS §180/37-40(i). In the alternative, the operating agreement may provide that a member or the members of the series have no voting rights. Id.
In order for each series to have limited liability, the operating agreement of the series LLC must specifically provide for this. 805 ILCS §180/37-40(b). The operating agreement should
explicitly state that the debts, liabilities, and obligations incurred, contracted for, or otherwise existing with respect to a particular series shall be enforceable against the assets of such series only, and not against the assets of the LLC generally or any other series of the LLC. In
addition, the operating agreement should state that none of the debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to the LLC generally or any other series of the LLC shall be enforceable against the assets of such series. Id.
B. CONVERSION
A standard LLC can be converted into a series LLC without first dissolving the standard LLC.
The conversion is accomplished by amending the standard LLC’s articles of organization to provide for a series LLC. The members of the standard LLC must authorize the conversion by unanimous vote. 805 ILCS §180/15-1(c)(2). Once authorized, the standard LLC should file an articles of amendment on Form LLC-5.25 with the Secretary of State to amend its articles of organization. The articles of amendment should be drafted so as to cause the final articles of organization to contain the provisions stated on the articles of organization Form LLC-5.5(S), which is the form used to form a series LLC initially. In particular, the articles of amendment must contain a provision stating that series exist and that they have limited liability if the series LLC desires this limited liability.
The filing fee for articles of amendment that convert a standard LLC to a series LLC is $400.
The Secretary of State calculates this fee as the $150 fee regularly charged for filing an articles of amendment plus $250 representing the difference in the fee for filing an articles of
organization for a series LLC as compared to a standard LLC. Despite the Secretary of State’s method for calculating the filing fees, only the articles of amendment is filed to accomplish the conversion and not a new articles of organization.
C. REPORTS
Like a standard LLC, a series LLC must file an annual report with the Secretary of State. A domestic standard LLC files its annual report on Form LLC-50.1(D). The Secretary of State has not created the form that will be used for a series LLC to file its annual report. However, the Secretary of State has indicated that the annual report will be one document rather than a separate document for each series. The filing fee for an LLC’s annual report is $250 plus $50 for each series if the LLC is a series LLC. 805 ILCS §180/50-10(11). These filing fees are fixed and apply regardless of the amount of capital of the LLC. Id.
D. CONDITIONS FOR LIMITED LIABILITY
The limited liability protection that series LLCs offer for the assets of each series of the LLC is not automatic. Rather, certain conditions must be satisfied in order for the series LLC to obtain this limited liability protection. 805 ILCS §180/37-40(b). These conditions are the following:
1) The LLC’s operating agreement must create series and explicitly provide for limited liability for the series;
2) Separate and distinct records must be maintained for each series;
3) Each series’ assets must be held (directly or indirectly, including through a nominee or otherwise) separately;
4) Each series’ assets must be accounted for separately;
5) Notice of the limited liability must be contained in the LLC’s articles of organization;
and
6) The series must file a certificate of designation with the Secretary of State.
Id.
The LLC Act also specifies circumstances that will not cause a series LLC to lose its additional limited liability protection. 805 ILCS §180/37-40(b). A series LLC does not lose its limited liability if the LLC and any of its series consolidate their operations as a single taxpayer or are treated as a single business for purposes of qualifying to do business in Illinois or another state. Id. In addition, the LLC Act states that the LLC and any of its series may work cooperatively or contract jointly without losing their limited liability protection. Id.
E. OPERATING
A series with limited liability is generally treated like a separate legal entity in conducting its business. 805 ILCS §180/37-40(b). A series should use its own name to contract, hold title to assets, grant security interests, sue and be sued, and otherwise conduct its business. Id. The provisions in the LLC Act will apply to each separate series in the same manner that they apply to a standard LLC as a whole. 805 ILCS §180/37-40(j). Any event in the LLC’s operating agreement or the LLC Act that causes a manager or member to cease being a manager or member of a series will not cause the manager or member to cease being a manager or member of the LLC in general. 805 ILCS §180/37-40(k).
The business of a series can be wound up and the series can be dissolved without causing the dissolution of the limited liability company as a whole. 805 ILCS §180/37-40(m).
F. TAXATION
Series LLCs may be taxed as one entity or multiple entities. Federal tax law rather than state business law determines the existence of an entity for tax purposes. Whether a series LLC is taxed as one or more entities will depend on the characteristics of the series. A series LLC likely will be taxed as one entity if its series have common economic interests and activities, ownership, and decision making. However, if the series differ substantially with respect to these items, then the LLC likely will be taxed as multiple entities.
The IRS has held in a private letter ruling that each series of a Delaware business trust would constitute a separate entity for tax purposes. IRS Private Letter Ruling, No. 9435015, 1994 WL 474303 (Sept. 2, 1994.) In this situation, each series was to have a distinct investment objective and invest in a portfolio of securities in which no other series would have an interest.
Each holder of an interest in the trust was to invest in one or more series and his rights and economic interests were limited to, and determined only with respect to, the particular series in which he invested. Id.
The IRS has not issued any specific guidance on the taxation of series LLCs, and therefore, there is a great deal of uncertainty in this area. What is certain is that the tax consequences of a series LLC being taxed as one entity as compared to multiple entities are substantial. This aspect of the series LLC provides the tax planner with many opportunities and challenges.
VI. ETHICS IN DEALING WITH LLCs
A. ETHICAL STANDARDS AND CIVIL LIABILITY
As with any engagement, a professional must not only comply with the ethical standards set by his profession, but also ensure that he is not negligent in performing his services.
Professionals who are not lawyers also should be particularly careful not to engage in the unauthorized practice of law.
Professionals who are not attorneys may attempt to advise individuals on the formation and maintenance of an LLC. The danger of doing this is that the professional could be deemed to be engaged in the unauthorized practice of law. Illinois courts have defined the practice of law broadly to be the giving of advice or the rendition of any sort of service which requires the use of any degree of legal knowledge or skill. If the advice offered or service provided requires more than ordinary business intelligence, it constitutes the practice of law.
In general, if a person is merely filling out forms for a company, this is not considered the practice of law. However, if the person performs a legal analysis of the facts relating to the company and advises the company on how to proceed, this constitutes the unauthorized practice of law.
B. THE ROLE OF THE ATTORNEY AS ADVISOR IN LLC FORMATION
The procedures that an attorney should follow in forming an LLC for a client are extensive. The attorney should first determine whether the LLC is the most appropriate entity for the client’s operations, considering the differences among the different entity types. (See the section above Factors to Consider in Choosing the Right Entity.) The attorney also should ensure that the LLC Act and any other applicable statutes governing the client’s industry allow for the client to operate as an LLC. In addition, the attorney should ensure that all of the specific
requirements for the client to be allowed to operate as an LLC are satisfied. (See the section above on Special Rules for Regulated Professionals.)
Once the attorney has determined that an LLC is desirable and permissible, the attorney should draft the articles of organization for the LLC. (See section above on Drafting the Articles of Organization.) Most importantly, the attorney should draft the operating agreement for the LLC. (See section above on Drafting the Operating Agreement and Statutory Limitations.) Although an attorney may wish to start the drafting process by using a standard form operating agreement, an attorney should not allow the form to substitute for the attorney’s good
independent analysis and advice, considering fully the nature of the LLC’s business and its structure.
During the drafting process, the attorney should meet several times with the key members of the LLC to determine how the LLC will be structured and operated. For example, the attorney should discuss what each member will contribute to the LLC, how decisions for the LLC will be made, what each member will receive from the LLC, and how a member will withdraw from the LLC. The attorney should ensure that the operating agreement is consistent with the member’s understanding as to how the LLC will be structured and operated. If an attorney skips this important step, the members often operate the LLC in a manner that is independent of – and often inconsistent with – the operating agreement. This creates a situation in which it becomes nearly impossible to sort out the legal rights and obligations of those involved in the event that a conflict arises in the future. The attorney may also need to draft employment and/or
independent contractor agreements for the members and/or managers who will be providing services to the LLC. Finally, the attorney should ensure that the LLC complies with all applicable securities laws.
An attorney often forms an LLC and then stops providing services to the client relating the LLC’s setup. By doing so, the attorney not only fails to serve his client well, but also misses the opportunity for earning additional fees for providing essential services for the ongoing maintenance of the LLC. At a minimum, an attorney should ensure that either the attorney or the LLC files its annual report when due every year. The attorney may also wish to consult with
his LLC clients to ensure that the LLC is in compliance with its other ongoing legal obligations and to determine if anything has changed with the LLC that would require changes to the LLC’s filings with the Secretary of State or to the LLC’s internal documents. For example, the
attorney should ensure that the LLC has maintained its registered agent in Illinois and has the records that it is required to keep on file. In addition, the attorney may inquire as to whether the LLC’s name, members and/or managers, registered agent, principal place of business, operations or governance has changed. If so, the attorney may inform the LLC that certain of these changes may require changes to the LLC’s filings and internal documents and offer to provide services to make any required changes.
Many businesses exist that provide standard forms to the public for forming LLCs or that provide services to fill out these forms for the LLC without the involvement of an attorney.
These businesses often charge very small amounts to their customers for providing these documents and services. For example, many companies charge only several hundred dollars for forming an LLC. An attorney may face an uphill battle to convince a client that it is not in the client’s best interest to form an LLC solely by using standard forms. Instead, the attorney may elect to cut his fees and to provide fewer services to his client to tailor the LLC’s
documents to the LLC’s business. However, the attorney should remember that regardless of the amount of the fee charged, the attorney still has unlimited personal liability for any
malpractice claim that arises from his services. The attorney should think carefully about whether providing bad service and incurring substantial risk is worth the small fee. An attorney may determine that a client who is not willing to pay for the attorney doing all of the tasks necessary to properly form and maintain an LLC should make other arrangements for forming his LLC.
C. AVOIDING CONFLICTS OF INTEREST
When dealing with an LLC, an attorney may represent the LLC itself and/or one or more of the LLC’s members individually. If the attorney represents only one person or entity, then no issues arise as to a potential conflict of interest by the attorney. Thus, if an attorney is retained to form an LLC, the attorney may wish to represent only the LLC to avoid potential conflicts of interests. The attorney also should take steps to protect himself against any potential claims of an improper conflict of interest. For example, the attorney should send an engagement letter to his client stating precisely the identity of his client and also stating that the attorney is not representing any other entity or persons involved. The attorney also may send an appropriate letter to any others involved in the situation to avoid any inference by them that the attorney is representing them, especially if they are not represented by an attorney. In providing his services, the attorney should ensure that he at all times is acting for his client and not for any other entity or person. Finally, the attorney should ensure that he is paid by his client and not from any other entity or person.
If the attorney chooses to represent two or more persons or entities in dealing with an LLC, then potential conflicts of interest may arise. The Rules of Professional Conduct state that an attorney cannot represent a client if the representation of that client will be directly adverse to another client or be materially limited by the attorney’s responsibilities to another client unless (1) the attorney reasonably believes that his representation of the client will not be adversely affected and that there will be no adverse effect on his relationship with the other client; and (2) each client consents after disclosure. In addition, when the attorney’s representation of
multiple clients in a single matter is undertaken, the disclosure must include an explanation of the implications of the common representation and the advantages and risks involved. Thus, if the attorney chooses to represent multiple clients in forming an LLC or otherwise dealing with an LLC, the attorney should ensure that he complies with these rules.
D. CONFIDENTIAL INFORMATION FROM A REPRESENTATION
In dealing with an LLC, attorneys and accountants also should be careful not violate the duties of confidentiality that they owe to their clients. The Illinois Rules of Professional Conduct prohibit a lawyer, during or after termination of a professional relationship with a client, to use or reveal a confidence or secret of the client known to the lawyer unless the client consents after disclosure. Accountants owe their clients a similar duty.
Thus, a lawyer or accountant who deals with LLCs first should ensure that he or she has clarified who his or her client is. It is possible that the lawyer’s or accountant’s client is the LLC entity, the LLC’s members or both, provided that the representation is not prohibited by the rules on conflicts of interest. Only by identifying his client, can the lawyer or accountant ensure that he or she is not disclosing information improperly to individuals and/or entities other than his or her client.
VII. MASTERING ESTATE PLANNING ISSUES
A. USING AN LLC TO HOLD AND TRANSFER REAL PROPERTY
LLCs are used frequently to hold real property and to carryout like-kind exchanges of real property.