To diversify risk, someone with multiple rental properties or other investment properties would likely be advised to put each property into 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 company 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 number 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 in 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 first authorized the creation of separate series within the same LLC. Under the Act, debts and other liabilities under Delaware Law are due only against segregated assets in the particular series to which those assets have been placed. (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 series other than the parent LLC, providing flexibility for projects with multiple investors.
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 that have separate rights and duties with respect to the specific property of the LLC.
Recently, the Illinois General Assembly adopted an amendment to the Illinois LLC Law that authorizes 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 for, 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 parent LLC with multiple series to protect your assets while 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.
Please 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 kept for each series, with the assets of 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 judicial decision, many facets of the New Series LLC legislation may be subject to reasonable differences in interpretation. For example, some practitioners have argued that it is safe practice to provide each series with a separate bank account.
Also, an entity formed in one state cannot 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 foreign state’s secretary or department of 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 failing to do 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 is subject to the law of that state. 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 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 a party to the operating agreement. It is highly unlikely that any state without a Series LLC law would apply the Series law to creditors, claimants and other third parties who did not agree to be bound by the Series law.
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 multi-property Illinois investors.