Series LLC’s: When Things Go South
There is no business model that provides complete immunity from market reversals, natural disasters, or changes in laws and regulations. Stuff happens. To everyone, in every business. And when even the best-laid plans of talented and successful business people go awry, the polygamous marriage among companies, creditors, or customers often end up in court. Unlike holy matrimony or other business models, Series LLCs can protect all parties in advance. Most often, with the right lawyer as “Best Man” or “Maid of Honor” chaperoning the courtship, the headaches and heartache of divorce court can be avoided altogether.
Space limitations only allow for “bare bone” treatments of two examples. For those interested in more information, further research is available on the Internet or consultation with our firm (devoted exclusively to Series LLCs and real estate investment) at no charge.
When The Series LLC Saves The Day: Two Examples
The first comes from real life: the premier, if not only, case in which a federal bankruptcy court upheld the concept and validity of SLLCs and denied a creditor’s attempt to game the system in their favor. The second is hypothetical, but has real-life implications. After all, “happily ever after fairy tale marriages” are exactly that: fairy tales.
Regardless, all levels of state, local and federal government (courts, legislatures, regulatory agencies, the I.R.S. itself) are interpreting and enforcing myth as reality. Judges, politicians, and bureaucrats don’t like change. They love inertia, momentum and precedent–campaign speeches notwithstanding.
Example 1: In re Dominion Ventures, LLC, No. 11-12282 (Bankr. D. Del.)
Now, it’s impossible to get two lawyers together without getting lost in a gigantic bowl of word salad or a maze of rabbit holes. Put them in a courtroom in front of a judge (who’s also a lawyer) and things actually get simpler. The focus and facts are limited to a relevant Reader’s Digest version. Legalese will be kept to minimum.
Dominion, a legitimate and reputable group of businessmen, established an SLLC in full compliance with state law. Both the “parent” company and each of the “children” cells operated independently, maintained separate accounting, and did everything “by the book.” That included using sound business practices. One thing led to another and Dominion needed some help on credit and cash flow. “Creditor X” to the rescue!
All that was required was a change in the original Operating Agreement and absolute veto power over all operations and decision making. Well, the bailout didn’t prevent the boat from sinking and ultimately everyone ended up in Bankruptcy Court. Now remember, the issues had nothing to do with SLLC legislation. Things just didn’t work out. “Creditor X” claimed that its after-the-fact position prevented SLLC protection and that all assets of all “children” should be consolidated to satisfy the debt.
Maybe “Creditor X” should have retained a lawyer who had the experience and expertise to advise against the unenforceable loan at the altar. At the end of the day, the assets of Dominion, its members (owners), and all other respective creditors of the individual “parents” and “children” were protected.
Example 2: Moldy Mary vs. Larry Landlord, (S) LLC
Larry Landlord bought his first duplex just after his graduation from high school. The property wasn’t much to look at, but it was cheap and he was handy with his hands. Four years later, a complete repainting of the exterior, and a brand new roof had improved the curb appeal. The kitchens were remodeled. The flooring, plumbing, and paneling were upgraded. Weeds and dirt had been replaced with immaculate landscaping. Prospective tenants had to get in line on a waiting list.
So, he bought another rental property. And another. And another. All under the protection, as independent series, of an SLLC. Tenants clamored for a space in his well-maintained, well-managed rental properties. As many investors were knocking on the door to participate in the next project.
Eventually, Larry had expanded operations to include 14 properties (and 14 segregated series), to include 5 apartment complexes and 10 members (owners). Each was fully compliant with state law requirements for documentation, maintaining separate bank accounts, tax filings, and accounting. Some participants were members of a dozen common projects. Some had invested in only one. According to sound business practice, common sense, and the exercise of due diligence, the group hired a a highly reputable building inspector. He gave the building a comprehensive evaluation for each unit.
A sixth property, a high-rise apartment complex costing as much as all other holdings combined, came onto the market and Buster Bankroll contacted Larry. Knowing nothing about real estate or property management, Buster wanted to invest as an absentee landlord. Negotiations went well. Occupancy was at 94% after the first month.
Moldy Mary was one of Larry Landlord’s very first tenants. She’d been living in the same apartment, owned by a different series, for about 8 years. A few years previously, after a particularly heavy rainstorm, she’d noticed water spots on her walls and a peculiar smell in her bedroom. The next day, Larry Landlord’s maintenance crew arrived, replaced a section of roofing shingles as well as some interior sheet rock.
Fast forward to 6 months later. Mary got sick. Really sick. So did her husband and three kids. Medical bills exceeded insurance limits. Neither spouse could work and lost their jobs. The entire family was forced to leave the apartment and move in with relatives.
But to prove a point, when the family contacted Louie Litigator, lawsuits were filed the same day. Multiple, massive lawsuits. Fortunately for Larry and Buster and all other members (including those who owned Mary’s series), the SLLC was on their side.
Based on every legal regardinge protections provided to the Delaware SLLC structure only one of the choices below are NOT true. Let us know which you chose:
- Larry Litigator did an hour’s worth of research and determined that liability lies with only the series that owns Mary’s apartment. He has withdrawn from the case and the “blood-from-a-turnip” strategy.
- The members of the series who own Mary’s apartment have no exposure beyond their investment.
- The very specific language of statutes and growing legal precedent will not threaten the assets Buster or Larry or all other members of any and all other series (or Larry Landlords, (S)LLC).
Guess in the comments section below.
Learn More About the Series LLC
Learn more about the Series LLC here on the Royal Legal Solutions website. We’ve written extensively about the benefits of the Series LLC, and given much more information about how the Series LLC works. We offer many more educational materials on this subject because we believe all real estate investors have the right to be informed. If you’re considering forming a Series LLC, contact us for your consultation today. We’ll get the job done right, and keep your head above water if things go South!