[This post was authored by Smith Rayl’s newest member, Rose Shingledecker.]

Last week, the Seventh Circuit Court of Appeals decided Doermer v. Callen, No. 15-3734 (7th Cir. Feb. 1, 2017), a case that illustrates and implicates several important aspects of Indiana nonprofit corporation law. Over the next few posts, we’ll explore some of the key aspects of the case and what it has to say about Indiana nonprofit law.  First up: the board of directors and directors’ terms.

At the center of the case is the Doermer Family Foundation, Inc., a nonprofit corporation formed under the Indiana Nonprofit Corporation Act of 1991 (the “Act”). The initial board of directors consisted of a father; a mother; their son, Richard Doermer; and daughter, Kathryn Callen. Each initial director had a lifetime appointment.

Mother died in 2000. In 2010, Phyllis Alberts was elected to the board of directors for a three-year term expiring in January 2013. Later in 2010, Father died, leaving the board with three directors: Richard, Kathryn, and Phyllis. In September 2013, over Richard’s objection, Kathryn and Phyllis voted to reelect Phyllis for a second term. The board then took several actions that Richard opposed, including making gifts to the University of Saint Francis of Fort Wayne, Indiana, Inc. (Kathryn sat on their board of directors), and electing Kathryn’s son, John, to the board.

Unhappy with the board’s actions, Richard brought suit in federal court on behalf of himself and the corporation, naming Kathryn, Phyllis, John, and Saint Francis as defendants. Specifically, Richard sought the recovery of certain charitable contributions made by the board (including the gift to St. Francis), Kathryn’s removal from the board, an injunction barring Phyllis and John from acting as directors, and the appointment of new directors.

Central to this case is the effect of Phyllis’s term on the board’s actions. You may have noticed in reading the facts above that Phyllis’s term as a director expired in January 2013, nine months before she and Kathryn voted to reelect her to a second term. In his suit, Richard argued that any board actions taken after Phyllis’s first term expired (including her reelection to a second term) were invalid because Phyllis was not a properly-elected director.

Under Indiana law, a nonprofit corporation must have a board of directors. Ind. Code § 23-17-12-1. Just as in a for-profit corporation, the corporation’s business and affairs are managed under the board’s direction and authority. I.C. § 23-17-12-1. The board of an Indiana nonprofit corporation must consist of at least three directors. I.C. § 23-17-12-3.

As to the term of the directors’ service, a nonprofit’s articles of incorporation or bylaws must specify the length of the directors’ terms. I.C. § 23-17-12-5. However, if a term is not specified in the organizing documents, the statutory default term is one year. I.C. § 23-17-12-5. Directors may be elected for successive terms. I.C. § 23-17-12-5.

In Doermer, Phyllis was elected to a three-year term pursuant to the Foundation’s bylaws, which stated that any director other than a surviving founder shall serve for three years. But the Foundation’s bylaws also provided that a director shall serve “until her or his successor is elected and qualified.” This language is consistent with the Act, which provides a safety net when a director’s term expires before the election or appointment of a new director. Despite the expiration, the Act states that “the director continues to serve until . . . a successor is elected, designated, or appointed and qualifies[.]” I.C. § 23-17-12-5(d).

In essence, the Foundation’s bylaws adopted the statutory safety net, and the board resolution first appointing Phyllis to the board in 2010 also used that language. Thus, when Phyllis’s term expired in January 2013, under the statute, bylaws, and board resolution, she continued to serve until her successor (Phyllis herself) was elected in September 2013. As a result, the court held that the expiration of Phyllis’s term prior to her reelection did not automatically render the board’s subsequent actions invalid.

This case illustrates how the Act’s provisions come into play when drafting an organization’s articles of incorporation and bylaws. The Act provides a nonprofit corporation with flexibility in some matters, minimum standards in others, and certain default provisions when the articles or bylaws are silent. A thorough knowledge and understanding of the Act is critical to drafting a nonprofit corporation’s organizing documents so that they both conform with the law and help the organization meet its goals.

If you are considering forming an Indiana nonprofit corporation, please let the attorneys in the Business Law Department of Smith Rayl Law Office, LLC know how we can help.

gavel-1238036Last July, the Indiana Court of Appeals decided Rogers v. State, 60 N.E.3d 256 (Ind. Ct. App. 2016), in which the attorney for a criminal defendant had deposed an employee of a charitable organization who held a degree in social work from an accredited university but not a license from the Behavioral Health and Human Services Licensing Board of the Indiana Professional Licensing Agency. The attorney for the organization advised the social worker not to answer certain questions on the grounds that the information was subject to the privilege for communications between a social worker and her client.  The defendant filed a motion to compel the social worker to answer the questions, and the court denied the motion. The court gave the defendant permission to file an interlocutory appeal with the Indiana Court of Appeals, which reversed the trial court’s decision, holding that the privilege does not apply to unlicensed social workers. The State sought transfer to the Indiana Supreme Court, which held oral argument before denying transfer.  Because transfer was denied, the decision of the Court of Appeals is now final.

Ind. Code 23‑25.6‑6-1 provides that, with some exceptions, a “counselor” cannot be compelled to disclose communications with a client.  Counselor is defined by Ind. Code 25‑23.6‑1‑3.8 as “a social worker, a clinical social worker, a marriage and family therapist, a mental health counselor, an addiction counselor, or a clinical addiction counselor who is licensed under this article.”  The question put to the Court of Appeals was one of statutory interpretation:  Does the phrase “who is licensed under this article” apply to all six professions in the list, or does it apply only to the last one, clinical addition counselors?

In arguing that the modifying phrase applied only to the last item in the list, the State relied in part on a canon of statutory construction (i.e., a rule a court sometimes uses as a guideline for interpreting statutes) called the doctrine of the last antecedent, which says that when a list of nouns is followed by a modifier, the modifier is presumed to apply only to the last one in the list (i.e., the “last antecedent”) unless there is a comma between the last item and the modifier.  Because there is no comma between “clinical addiction counselor” and “who is licensed under this article,” the State argued, the phrase does not apply to “social worker.” Therefore, an unlicensed social worker is within the definition of “counselor;” and the privilege applies.

However, canons of statutory construction are not ironclad rules, and courts will disregard them when there are other indications that the legislature had a different intent.  In deciding the question, the Court of Appeals rejected the application of the last antecedent doctrine, in part by examining the history of the statute and finding evidence that the general assembly did not intend for the modifier to apply only to the last item in the list.  Thus, the Court concluded, the phrase “who is licensed under this article” applied to every item in the list.  Therefore, an unlicensed social worker is not in the definition of “counselor;” and the privilege does not apply.

In asking the Supreme Court to take up the case, the State argued primarily that the Court of Appeals had not given sufficient weight to the fact that the social worker in this case fell within a licensing exemption for employees and volunteers of charitable organizations.  The State argued that exemption reflected a policy decision by the General Assembly to make it easier for charitable organizations to provide social work services to their clients and that denying the privilege to an unlicensed social worker employed by a charitable organization would undermine that policy.  The State argued that, by doing so, the Court of Appeals had relegated clients of charitable organizations to the status of “second class citizens.”

In response, Rogers argued, among other things, that the Court of Appeals decision did not create a second class of citizens and, indeed, assured clients of charitable organizations the same benefit that the licensing requirement extends to clients of other social workers, i.e., a safeguard against qualified, competent, or ethical social workers.  Rogers also argued that Indiana courts interpret statutes to establish harmonious statutory schemes, and that a privilege for unlicensed social workers was inconsistent not only with the statutory history but also with several other statutory provisions.  Finally, Rogers pointed out, if the Supreme Court were to overrule the Court of Appeals, Indiana would stand alone because no other state has extended a privilege to unlicensed social workers merely because they work for charitable organizations.

In keeping with its usual practice, the Supreme Court did not explain why it decided to deny transfer, so we do not know exactly what the court thought of the relative merits of the opposing arguments, only that it decided to allow the Court of Appeals decision to stand. During oral argument, the Justices asked the lawyers for both sides several questions that were not directly answered by the Court of Appeals, but again we do not know whether the Justices agreed with the lawyers’ answers. Because some of those questions may be helpful to charitable organizations, we’ll take them up in Part II, along with some other ramifications of the decision.


  1. This article replaces a more abbreviated one posted last year before the Supreme Court had taken action.
  2. Rogers is represented at trial by Susan Rayl of Smith Rayl Law Office, LLC and by Jonathan Little of Saeed and Little LLP. They were joined in the appeal by Michael Smith of Smith Rayl and by Jessica Wegg of Saeed and Little.

100_3698-300x225.jpgTwo provisions commonly found in commercial contracts, particularly contracts between parties that reside in different states, are a choice of law section and a designation of forum section. The  choice of law section specifies which state’s laws govern the contract, and the designation of forum section specifies the court in which lawsuits that arise from the contract are to be filed and litigated. Examples:

The laws of the state of _______ (without giving effect to its conflicts of law principles) govern all matters arising out of or relating to this Agreement, including, without limitation, its validity, interpretation, construction, performance, and enforcement.

Any party bringing a legal action or proceeding against any other party arising out of or relating to this Agreement shall bring the legal action or proceeding only in the United States District Court for the ______ District of ________ or, if that court does not have subject matter jurisdiction, in a state court of general jurisdiction sitting in ___________ County, __________.

When a lawsuit is filed and a question is raised as to which state’s law applies, the court first looks to its own state’s principles for deciding which law applies to a particular lawsuit. In most states, those principle will, with some exceptions or conditions, defer to the parties’ agreement on choice of law as set forth in the contract. Similarly, most states will give effect to the parties’ agreement that lawsuits must be filed and litigated in a particular court, again with some exceptions or conditions. A bill proposed in the current session of the Indiana General Assembly seeks to change that for contracts in which one party is a resident of Indiana or has a place of business in Indiana, for which the performance of the contract is to occur in Indiana, or for which a substantial part of the subject matter of the contract is located in Indiana.

Senate Bill 171 would invalidate contract provisions designating a forum outside of Indiana for a claim that arises within Indiana or requiring the contract to be governed by Indiana law for a controversy that arises within Indiana. Although that may, on first blush, appear to be favorable to Indiana businesses, it will actually make it more difficult for Indiana companies to do business with companies in other states.

There are good reasons to include choice of law and designation of forum provisions in contracts. They are not merely boilerplate clauses that the party who drafts the contract inserts to gain an advantage over the other party. Instead, both clauses reduce the likelihood and expense of litigation, and parties to contracts often negotiate them very carefully.

A choice of law provision has consequences that begin well before a lawsuit is filed or even if a lawsuit is never filed. Different states have slightly different laws regarding contracts, and the answer to a question regarding the meaning of a particular contract term, or the consequences if that term is breached, depends on which state’s laws govern. Unfortunately, the answer to that question may depend on where the lawsuit is ultimately filed because the court will first look to its own principles to decide what state’s law controls. Although those principles are relatively consistent from state to state, they are not identical. As a result, the lawyer asked for an opinion about the parties’ rights or obligations under a contract may have to give more than one answer, one for each state in which a lawsuit may be brought. Including a choice of law provision in a contract reduces the uncertainty in predicting how a particular lawsuit may come out, and it reduces the cost of litigation by removing a threshold question the court must answer.

When parties negotiate a choice of law provision, they are usually not trying to gain an advantage over the other side because it is impossible to predict in advance which state’s laws may favor which particular party should a dispute arise. Instead, most lawyers want a choice of law provision that designates the laws of a state with which they are familiar, reducing the chances of unexpected surprises.

In contrast, a designation of forum clause can favor one party over the other through “home court advantage.” Some people believe that juries are likely to favor home-state litigants, and there may be some truth to that. In any event, the location of the litigation can affect the cost. It will likely cost an Indiana resident less to litigate a case in Indiana than to litigate the same case in, say, New Mexico, and vice versa. If nothing else, travel expenses can be considerable. For that reason, contracts sometimes require litigation to be brought in a state in which neither party resides in order to keep a more level playing field.

Designation of forum clauses also reduce the likelihood of litigation because, without one, the party who files the lawsuit picks the court in which the case is filed. That can create a “race to the courthouse” in which each party tries to sue the other first. An advance agreement on the location of the litigation reduces the incentive to file a lawsuit quickly, giving the parties more time to negotiate a resolution of a dispute without going to court.

Senate Bill 171 seeks to deny Indiana companies the freedom to contractually specify which law will apply to a contract and where disputes will be litigated, making it less attractive for companies in other states to do business in Indiana. Hoosiers and Hoosier companies are perfectly capable of looking after their own interests when negotiating contracts, and they don’t need the General Assembly to interfere with those agreements, especially when that interference will ultimately work to the detriment of Indiana residents and businesses. We hope Senate Bill 171 dies a quiet death in committee.

Fair disclosure:  I am entirely unqualified to answer the above question.  In fact, I had never heard of blockchain technology until this morning when I read a blog entry by my friend, John Cunningham, with a link to an article discussing four technological innovations that may affect the legal profession. One of them is blockchain, part of the technology that makes bitcoins possible.  Not only that, but I don’t know a lot more about bitcoins than I know about blockchain.  I do, however, know a little about real property records.

Now that you’ve been warned, if you’re still interested, read on.

What is Blockchain?

As already mentioned, blockchain is the technology that makes bitcoin possible. A particular bitcoin is created through a process known as mining. Thereafter, every transaction involving the bitcoin, each transfer of ownership, is recorded in a “block,” with each block containing a reference to the block that records the last transaction involving the same bitcoin.  A block, once created, cannot be changed.  The result is a permanent, immutable ledger of linked records that permit the history of each bitcoin to be traced from its current owner back to its inception.

Using Blockchain for Land Records.

The first thing that came to my mind in reading about the bitcoin blockchain is the similarity to the records of ownership of real property that, at least in the United States, are commonly maintained by county officials, usually called recorders. Those recording systems provide some degree of assurance to a purchaser of real property that seller actually owns the property, and the immutability of blockchain technology makes it more potentially more suitable than other forms of electronic records as a replacement for paper recording systems.

Not surprisingly, I’m far from the first person to recognize that similarity.  In fact, the Cook County (Illinois) Recorder of Deeds is already testing the concept under an arrangement with Velox RE Tech, Inc.  As Deputy Recorder of Deeds John Mirkovic put it, “A blockchain-based public record is where you would start if you were to create a public land record from scratch.”

Although some differences between land records and bitcoin records (at least in my limited understanding of bitcoins and blockchain) come to mind, I doubt that they present insurmountable barriers to adapting blockchain technology to replace current land recording systems.

Analog Versus Digital

The first distinction between bitcoin records and land records doesn’t appear to present any problems at all.  Although bitcoins are divisible, they are not infinitely divisible. The smallest bitcoin denomination, known as a “satoshi,” is equivalent to 0.00000001 bitcoin. Therefore bitcoin blockchains track discrete quanta of virtual money. Although land cannot, as a practical matter, be infinitely subdivided into smaller and smaller parcels, recording systems are not inherently restricted to tracking discrete quanta of land.  In other words, land records are analog, and bitcoin records are digital. Given that digital systems have been replacing analog systems for decades, that distinction alone is barely worth mentioning.

Types of Ownership Interest

There are other differences between ownership of bitcoins and ownership of land that may present problems to be solved.  As far as I can tell, these things are true about bitcoins and ownership of bitcoins, but none of them is true about real property rights.

  • Bitcoins are created by only one process.
  • Once mined, bitcoins never disappear.
  • Bitcoins always have one, and only one, owner.
  • Bitcoins cannot be transferred to another person without some action (or at least acquiescence) by the owner.

Those factors make the historical record of bitcoin ownership relatively simple compared to the records of land ownership.

For example, unlike ownership records for bitcoin, land records must accommodate any number of owners and several different types of joint ownership, including joint tenancy, tenancy in common, and tenancy by the entireties. Land records must be able to deal with the possibility that one, some, or all of the joint owners may transfer their interest to one or more other persons, either with or without a change in the type of tenancy (e.g., joint tenancy to tenancy in common).

In addition, land records must accommodate conditional ownership, such as life estates (ownership lasts only as long as a specified person lives) and fee simple determinable (ownership terminates upon a specified event), and other temporary property rights, such as leases.  Unlike bitcoins, these types of property rights, once created, do not last forever.

Moreover, real property records must deal with property rights, such as easements, that represent something less than “ownership.” Some such property rights have characteristics that are, as far as I know, nonexistent in bitcoin blockchains.  For example, some of them, such as mechanics’ liens and tax liens, can arise from outside the historical chain of ownership, even without any action by the property owner. Compared to bitcoins, those rights seem to spring out of nowhere. Similarly, many of these limited rights, once created, can also disappear. For example, the release of a mortgage exterminates the right to foreclose on the property. The right is not transferred to anyone; it just disappears.

As mentioned earlier, I doubt that any of these observations represent insurmountable obstacles to adapting blockchain technology to real property records, but I think they may make the task more difficult than it may appear on first blush.  Maybe the transition will occur while I’m still practicing law, or maybe not.  I hope so.

Family Cabin

It might come as a surprise to non-Hoosiers that several parts of Indiana are popular locations for vacation cabins.  The best known are probably Brown County and the area around the Indiana Dunes.  Other locales include Lake Maxinkuckee, Lake Monroe, and Lake Patoka; the Amish country and the smaller lakes of northern Indiana; the wooded hills in other parts of southern Indiana; and the small towns on the northern bank of the Ohio River.  Saving the Family Cottage:  A Guide to Succession Planning for your Cottage, Cabin, or Vacation Home, by Stuart J. Hollander, David S. Fry, and Rose Hollander, 4th ed., 2013, is an excellent resource for owners of family vacation homes or other property to be preserved for shared use by future generations.  However, the principles are not restricted to leisure property.  For example, owners of family farms will also find useful advice for keeping the farm in the family for generation after generation.

One of the central concepts of Saving the Family Cottage is to avoid problems of real property owned jointly by several individuals — a situation that, of course, can arise when property is passed from one generation to the next. When property has multiple owners, disagreements between them can result in the property being partitioned. For some types of property, such as undeveloped land, the partitioning may mean that the property is divided into multiple parcels, like cutting a pie into pieces, with each owner receiving a piece of the whole.  In other cases, such as a vacation cottage, a dispute may result in the property being sold and the proceeds divided among the owners.

The authors’ primary solution to that problem — one that we and many estate planning attorneys heartily endorse — is to create a limited liability company to be owned by the family members and to transfer ownership of the property to the LLC. One reason is that transferring ownership of LLC interest from one person to another, unlike transferring ownership of real property, is generally not a matter of public record. A more compelling reason is that the law provides very few rules to govern the relationship between multiple owners of real property (or most personal property, for that matter) and very few mechanisms for resolving disputes that do not result in the termination of the joint ownership.  In contrast, the flexibility of LLCs (which we have touted in this blog multiple times) permits the owners to decide in advance who will make decisions concerning the property and how they will be made and how disputes among heirs will be resolved while keeping the property in the family.

However, simply filing articles of organization with the Indiana Secretary of State and recording a deed transferring ownership of the property to the LLC is not enough. The LLC operating agreement is the key, and a form downloaded from the internet will almost certainly be woefully inadequate.  The family members setting up the LLC must ponder and answer some difficult questions.  They must anticipate future problems that are almost unimaginable today and decide how they will be solved.  That’s where Saving the Family Cottage comes in. It presents the issues to consider, beginning with the fundamental question, Why do we want this property to stay the family after we’re gone?  The authors suggest four categories of reasons:

  • Emotional attachment. The fondness that family members feel toward the property exceeds the property’s economic value.
  • Wealth accumulation. The property is a good investment.
  • Family unity. The property is a focal point for family get togethers, and keeping it in the family will make it more likely that future generations stay connected.
  • Family heritage. The property represents traditions that the owners want their descendants to understand and to carry on.

Different reasons for keeping the property in the family will lead to different decisions about the details of the LLCs operating agreement.

The authors also point to obstacles to keeping the property in the family that may arise and provide advice for dealing with them.  They include:

  • Ownership passing to the spouse or ex-spouse of a child or grandchild, either as a result of death or divorce, rather than to the original owners’ lineal descendants.
  • The inability or unwillingness of a future heir to meet financial obligations with respect to the property.
  • The bankruptcy of an heir.
  • The desire of an heir to cash out, either to liquidate an asset or simply from lack of interest.
  • Disagreement over operation or maintenance of the property or improvements to the property.
  • The collective financial inability of heirs to keep the property.

The advice of an estate planning attorney experienced in drafting LLC operating agreements is, in our admittedly biased opinion, indispensable in ensuring that the wishes of the owner are carried out.  Even so, your lawyer cannot make all the decisions for you. As with any aspect of an estate plan, the decisions are difficult and intensely personal, and making them can be hard work. Saving the Family Cottage is a good place to start.

At Smith Rayl Law Office, LLC, we know that many small business owners are looking for affordable resources, information, and strategies to help expand their businesses and reach new customers.

This week, the Martindale Brightwood Community Development Corporation, in partnership with the U.S. Small Business Administration and the Community Resurrection Partnership, is hosting a FREE Business Opportunity Fair.

This event is a great chance to learn about opportunities to grow your small business and how to market your products and services to customers.

  • Date – Thursday, October 20, 2016
  • Time – 3:00 pm – 7:30 pm
  • Location – Overcoming Recreational Center, 2203 Columbia Avenue, Indianapolis, IN 46205

The agenda includes presentations from the following:

  • 3:30 pm – Indiana Department of Transportation Economic Opportunity Division
  • 4:30 pm – Ivan Baird, Mid-States Minority Supplier Development Council
  • 5:30 pm – Woolridge Impact Marketing Group

Please register here to reserve your space!

ReportsIndiana nonprofit corporations are being converted to a new schedule for filing business entity reports with the Indiana Secretary of State.  In the past, a business entity report has been due every year in the same month in which the organization was incorporated. Nonprofit corporations will now file business entity reports every other year, the same schedule that applies to business corporations and LLCs. The filing fee will double from $10 to $20 for reports filed on paper.  Online filings will cost $22.

The transition began on July 1, 2016, when existing organizations began filing biannual reports and paying the $20 filing fee. Organizations that file a business entity report in July through December 2016 will file their next business entity reports in 2018 and then will continue to file reports in every even numbered year (still in the same month in which they were incorporated). Organizations that file their first biannual report in January through June of 2017 will file their next reports in 2019 and then in every odd numbered year.

New organizations incorporated in an even numbered year will file business entity reports in the same month of every even numbered year thereafter. New organizations incorporated in an odd numbered years will file business entity reports in the same month of every odd numbered year.

Click here to download the business entity report form in PDF format.  Click here to file online.

This is the last of eight articles on series LLCs and the new Indiana series LLC statute that will take effect on January 1, 2017.  Earlier articles are:

Part I, Basic concepts and terminology
Part II, Is a series an entity?
Part III, What constitutes a series?
Part IV, Setting up an Indiana series LLC
Part V, Operating agreements for Indiana series LLCs
Part VI, Alternatives for ownership structure
Part VII, Federal income taxation of series LLCs

Ever since Delaware adopted the first series LLC statute in 1995, commentators and practitioners have expressed concerns about the structure.  The proposed Treasury Regulation published in 2010 (discussed in Part VII) answers some of those questions, but the near absence of court decisions dealing with series LLCs leaves many others unanswered.

The most common concern is whether courts will recognize internal limited liability (see Part II for a discussion of that concept), particularly courts in states other than the one in which the series LLC is organized, and especially in states that do not have their own series LLC statute.  An analysis of the choice of law principles that govern such a decision is far beyond the scope of these articles, but the concern will remain until it is addressed in published court decisions.  As a result, many practitioners appear to be avoiding series LLCs altogether or restricting their use to organizations that conduct business or own property only within the state of organization.

Even if courts recognize internal limited liability in principle, they will likely apply the same principles of veil-piercing to master LLCs and their series that they apply to traditional LLCs.  The usual form of veil-piercing holds the members of a limited liability company liable for the obligations of the company, allowing the creditors of the company to reach the assets of the members.  Veil-piercing is an extreme remedy, but it happens.  Courts consider several factors in deciding whether to disregard the liability shield, one of which – the failure to observe required corporate formalities – is discussed here and here. (I am surprised to discover that the Indiana Business Law Blog has never discussed all the factors in veil-piercing. Perhaps we will.)

A subset of veil-piercing, known as the alter ego doctrine, allows creditors of one company to reach the assets of a related company.  Under the Indiana version of the alter ego doctrine, four additional factors are added to the usual factors that favor piercing the veil.  They are:

  • The two entities have similar names
  • The entities have similar business purposes
  • The entities share common owners, managers, and employees
  • The entities share common offices, telephone numbers, and business cards

Each of those factors affect how easily it may be for people to mistakenly believe that the business with which they are doing business is one and the same as another entity.  All four of the above factors are likely to be present in many series LLCs. Moreover, if the master LLC owns interest in one of its series, or if a series holds interest in another series, there will be two avenues to veil-piercing, traditional veil-piercing to allow the creditors of a series to reach the assets of its members and alter ego veil-piercing to allow the creditors of a series to reach the assets of a related entity.

Whether Indiana courts will apply the alter ego doctrine to series LLCs, in either the same form or a modified form, is an open question. In the absence of an answer to the question, anyone who uses a series LLC should minimize the presence of the four factors listed above. Some of them may be difficult to eliminate entirely without significant adverse effect on the company’s business purposes, but others can be eliminated or at least minimized with relatively litte expense or effort (for example, by providing separate mailing addresses, telephone numbers, and business cards for each series).

Even so, the Indiana series statute practically requires that series LLCs will satisfy one of the above factors, that of similar names.  The name of the master LLC must include the suffix “-S” after the corporate designation (e.g., “LLC-S”), and the name of each series must include the entire name of the master LLC and the word “series.” A possible way of eliminating that factor is for the series to adopt dissimilar assumed business names, but whether that is permissible is, itself, an open question because the series LLC statute does not expressly authorize a series or a series LLC to adopt an assumed business name. Given that a traditional LLC can adopt an assumed business name, and given that each series must be treated as a separate entity, one would think a series should be able to adopt an assumed business name — if it were not for the fact that Indiana series LLC statute is so specific about the names of master LLCs and series.  Would the use of assumed business names undermine the General Assembly’s obvious intent that the entities within a series LLC be unmistakably identified as such?  On the other hand, would Indiana courts conclude that the policy reasons for including that factor in the alter ego analysis are satisfied by the use of names prescribed by the statute? There is currently no answer to those questions.

The proposed Treasury Regulation that clarifies that each series is to be treated as a separate entity (see Part VII) expressly leaves open at least two other questions of federal taxation:

  • Is each series to be treated as a separate entity for federal employment tax purposes?
  • Is each series to be treated as a separate entity for employee benefit purposes, such as qualified plans?

We do not attempt to answer those questions or even to examine all their ramifications.

The mention of employee benefits raises a host of other legal questions involving the identification of the “employer.” For example, are all the series considered a single “employer” for determining whether they are subject to the Family Medical Leave Act? There are similar questions under the Fair Labor Standards Act, the Occupational Safety and Health Act, and other regulatory schemes.  It is conceivable that most or all state law questions can be answered by the statutory provision that, if certain conditions are satisfied, each series must be treated as a separate entity (see Part II), but it is unlikely that all questions of federal law can be answered so easily.

Perhaps the largest set of unanswered questions lies in the applicability of the Bankruptcy Code to series LLCs. As we discussed in a recent set of articles beginning here, bankruptcy courts have not even developed a uniform approach to the bankruptcy of a member of a traditional LLC, much less a series LLC. The extent to which bankruptcy courts will recognize the parts of a series LLC as entities separate from each other and separate from their owners is, in my view, a wide open question.

Secretary of Defense Donald Rumsfeld once said that there are “known knowns” (things that we know), “known unknowns” (things that we know we do not know), and “unknown unknowns” (things that we do not know that we do not know); and it is the latter category that often causes the most trouble. As my colleague John M. Cunningham observed in his book Drafting Limited Liability Company Operating Agreements, Rumsfeld could have been talking about series LLCs.

Earlier articles on the topic of Indiana series LLCs are here:

Part I, Basic concepts and terminology
Part II, Is a series an entity?
Part III, What constitutes a series?
Part IV, Setting up an Indiana series LLC
Part V, Operating agreements for Indiana series LLCs
Part VI, Alternatives for ownership structure

In this one, we look at federal income taxation of series LLCs.

For several years after the first series LLC statute, it was an open question whether a series LLC is to be taxed as a single, consolidated entity or each series is to be taxed separately.  In 2010, the Internal Revenue Service answered the question through a proposed rule, 75 Fed. Reg. 55,699 (Sept. 14, 2010), 2010-45 I.R.B., that can be relied on even though it has yet to be finalized.

At the time the IRS issued its proposed rule, series LLC statutes had been enacted in eight states plus Puerto Rico.  In analyzing the statutes, the IRS concluded that under all the statutes series have some, but not all, of the attributes of a separate entity and noted that only two (those of Illinois and Iowa) expressly provide that a series is to be treated as a separate entity.  However, the IRS is not prohibited from treating a series as an entity distinct from its owners for federal tax purposes, even if it is not treated as a separate entity under state law.  As explained in the preamble to the proposed rule,

[Treasury Regulation] Section 301.7701–1(a)(1) provides that the determination of whether an entity is separate from its owners for Federal tax purposes is a matter of Federal tax law and does not depend on whether the organization is recognized as an entity under local law.

75 Fed. Reg. at 55,699-700.  Similarly, the IRS is not obligated to treat every organization that is a separate entity under state law as an entity distinct from its owns for federal tax purposes.

Although entities that are recognized under local law generally are also recognized for Federal tax purposes, a State law entity may be disregarded if it lacks business purpose or any business activity other than tax avoidance.

75 Fed. Reg. at 55,700. Accordingly, Prop. Treas. Reg. § 377.7701-1(a)(5)(viii) contains a set of definitions that determine whether a series as defined by state law is to be treated as an entity distinct from its owners for federal tax purposes.

First, Prop. Treas. Reg. § 377.7701-1(a)(5)(viii)(B) defines a “series statute.”

A series statute is a statute of a State or foreign jurisdiction that explicitly provides for the organization or establishment of a series of a juridical person and explicitly permits—

(1) Members or participants of a series organization to have rights, powers, or duties with respect to the series;

(2) A series to have separate rights, powers, or duties with respect to specified property or obligations; and

(3) The segregation of assets and liabilities such that none of the debts and liabilities of the series organization (other than liabilities to the State or foreign jurisdiction related to the organization or operation of the series organization, such as franchise fees or administrative costs) or of any other series of the series organization are enforceable against the assets of a particular series of the series organization.

Second, “series organization” is defined by Prop. Treas. Reg. § 377.7701-1(a)(5)(viii)(A).

A series organization is a juridical entity that establishes and maintains, or under which is established and maintained, a series (as defined [below]). A series organization includes a series limited liability company, series partnership, series trust, protected cell company, segregated cell company, segregated portfolio company, or segregated account company.

Finally, Prop. Treas. Reg. § 377.7701-1(a)(5)(viii)(C) provides the federal definition of “series.”

A series is a segregated group of assets and liabilities that is established pursuant to a series statute…by agreement of a series organization…. An election, agreement, or other arrangement that permits debts and liabilities of other series or the series organization to be enforceable against the assets of a particular series, or a failure to comply with the record keeping requirements for the limitation on liability available under the relevant series statute, will be disregarded for purposes of this [definition].

The proposed rule provides that each series, as defined above,

  • Is treated as an entity apart from its owners for federal tax purposes;
  • Makes its own, independent election of tax status under the “check-the-box” regulation; and
  • Is not responsible for the federal income tax obligations associated with any other series.

The “check-the-box” regulation means that each series with more than one member can elect to be taxed as a partnership, as a corporation under Subchapter C, or as a corporation under Subchapter S (if the members of the series satisfy the restrictions on S-corp shareholders).  If the series has only one member, the choices are disregarded entity, C-corp, or S-corp.  Although the proposed rule does not specifically address the issue, it seems that each series needs its own tax identification number and that each series that does not accept the default classification of partnership (or disregarded entity) must file its own Form 8832 (to elect C-corp status) or Form 2553 (to elect S-Corp status).

It is apparent from the above definitions and discussion that the Indiana series LLC statute is a “series statute,” that a master LLC under Indiana law is a “series organization,” and that a series as defined by the Indiana statute is also a “series” for federal tax purposes.  According, the above principles apply to each series in an Indiana series LLC.

Nonetheless, the proposed rule leaves other questions unanswered.  Although it provides that a series is to be treated as an entity distinct from its owners, it does not address the status of the series organization itself. However, the preamble recognizes that series organizations are generally considered to be separate entities under both state law and federal tax law. Accordingly, it appears likely that a master LLC is to be treated as an entity separate from its owners and separate from its series.  Note, however, that under some structures, such as Structure #2 described in Part VI, the master LLC will have no income, deductions, or credits. If so, and if the master LLC is taxed as a partnership (the default status for LLCs), it will have no obligation to file tax returns.   75 Fed. Reg. at 55,704.

The final post on Indiana series LLCs will discuss other unanswered questions and uncertainties.

[Revised 9/15/2016 to include information on obtaining tax identification numbers and filing forms to elect S-corp or C-corp status.]

If you are not already familiar with series LLCs or with the new Indiana series LLC statute that takes effect on January 1, 2017, you may want to read the articles at Part I, Part II, Part III, Part IV, and Part V.

In the first of these articles, I compared a series LLC to a parent LLC with subsidiary LLCs, and I stated that one difference between the two concepts is that a master LLC does not own its series in the same sense that a parent company owns its subsidiaries. Instead, the interest that makes up each series is held by persons who may or may not also hold interest in the master LLC or in other series. Although I believe that is commonly the way series LLCs are set up, I think it may be possible to set up a series LLC so that the master LLC does, in fact, hold part or all of the interest in its series. Let’s look at four possible structures, using the example of a real estate developer than develops and owns three apartment buildings.

Structure #1

The first structure is the one I described earlier. A master LLC is organized with one or more classes of interest held by the initial members, but for simplicity, we’ll assume there is only one class, Class M. The master LLC then issues units of a second class of interest, Class A, that make up the first series, Series A, which will own the first apartment complex. The LLC can issue Class A units of interest to some or all of the initial members who own Class M units (or to none of them), and it can also issue Class A units to other investors who are not already members of the LLC. Series A can enter into a contract with the master LLC under which the master LLC provides property management services for the apartment complex owned by Series A.

That structure can then be replicated for subsequent apartment complexes held by Series B and Series C. Units of Class B and Class C interest may be issued to some or all of members who hold Class M or Class A units, and some may be issued to new investors. The members who hold Class A, Class B, and Class C units will receive shares of the profits, losses, and distributions derived from rent, and the members who hold Class M units will receive shares of the profits, losses, and distributions derived from compensation the series pay the master LLC for property management services.

Structure #2

The second structure is a variation of the first. Rather than issuing Class M units that represent interest in the master LLC, the master LLC could issue Class M units as the first series, which would again contract with each of the other series to furnish property management services for the apartment buildings. The differences between this structure and the first alternative are more of form than substance because the Indiana statute (as well as the Delaware statute, the Illinois statute, and at least some of the other series LLC statutes) provide for internal limited liability between the series and between the series and the master LLC. Creditors of a series cannot reach the assets of other series or the assets of the master LLC, and creditors of the master LLC cannot reach the assets of any of the series. One minor difference under the Indiana statute (and under the Illinois statute, but not the Delaware statute) is that creation of a series requires a separate public filing. Accordingly, there will be one more public filing if the Class M units are treated as a series rather than as interest in the master LLC itself.

One potential substantive distinction lies in the possible difference between the internal liability limitation that separates two series from each other and the internal liability limitation that separates the master LLC from each of the series. One of my colleagues, a noted authority on limited liability companies, has concerns about enforcing the internal limited liability against creditors of the series, but he is even more concerned about enforcing it against creditors of the master LLC. (Concerns about the enforceability of internal limited liability are addressed in Part VIII.) If there is indeed such a distinction, the real estate developer in our example would be better off creating a separate series to run the property management business than it would running the property management business directly under the master agreement.

Structure #3

The third structure mimics a parent LLC that holds single-member subsidiary LLCs. It relies on the assumption that a master LLC can hold title to interest to the series formed under its umbrella. At first, that may seem counterintuitive because the interest in a series can be viewed as a class of interest in the master LLC itself and, if that view is correct, the master LLC would hold title to its own interest. Moreover, the master agreement, upon admission as a member of a series, could be viewed as being its own member.  Such an arrangement would not be entirely novel because corporations commonly acquire title to their own stock by purchasing shares and, instead of retiring them, holding them as “treasury stock.” However, the corporation is generally not treated as its own shareholder. The corporation does not pay itself dividends in regard to treasury stock, and it may not vote treasury shares in meetings of shareholders.

I know of no case law in any jurisdiction that addresses the question of whether a master LLC may hold interest in a series organized under its operating agreement, and the Indiana statute does not expressly address the question. However, Ind. Code § 23‑18.1‑4‑4(a) provides, “A series with limited liability must be treated as a separate entity to the extent set forth in the articles of organization of the master limited liability company.” It seems to follow that the interest that makes up a series must not be treated as interest in the master LLC, if (as suggested in Part IV) the articles of organization of the master LLC provide, “Each series shall be treated as a separate entity to the maximum extent permitted by Ind. Code § 23‑18.1‑4‑4 and other applicable law,” and particularly if the articles specifically authorize the master LLC to hold title to interest associated with a series, to be admitted as member to a series, to receive distributions from the series, and, if the series is taxed as a pass-through entity (more about that in the next post), to be allocated a share of the series’ profits and losses.

Under this structure, then the master LLC will issue to itself Class A, Class B, and Class C units, with each of the series then being very similar to a single-member LLC, and issue additional interest in the master LLC to the investors in the two apartment buildings. Of course, under this structure, all of the economic benefits derived from the series will ultimately flow to the members of the master LLC, but with careful drafting of the master LLC operating agreement, distributions and allocations of profits and losses from the series could be directed to the members holding Class M interest to achieve the same economic and tax results that would be produced by the first or second alternatives, again assuming that the master LLC is taxed as a partnership and the series are taxed as disregarded entities.

Structure #4

The fourth structure is a hybrid of the first and third. Under the first structure, the persons to whom Class A, Class B, and Class C units are issued will make capital contributions to the series in exchange for those units. But what if the master LLC provides part of the capital to start a new series?  One answer is that the master LLC could distribute cash to the Class M members, and those members could make capital contributions to the series in exchange for units of interest in the series issued to them in their own names. Alternatively, if it is indeed permissible for a master LLC to hold interest in and to be admitted as a member of a series organized under its own operating agreement, the master LLC could make the contribution directly in exchange for Class A, Class B, or Class C interest. The Class M members would receive the economic benefits and tax consequences of the series’ businesses through their ownership of the master LLC, as opposed to ownership of interest in the series directly. The developer can raise additional capital by issuing units of Class A, Class B, or Class C interest to other investors.

I again caution that I am unaware of any case law in any jurisdiction acknowledging that the third or fourth alternatives are permissible, but given the language of the Indiana statute, it seems likely that Indiana courts would approve such a structure. (In addition, one of my colleagues who is familiar with the use of series LLCs is confident that Structures #3 and #4 are permissible even under some state statutes that do not expressly provide that a series is a separate entity.)  Whether the master LLC’s ownership of interest in a series affects other matters – particularly the enforceability of internal limited liability – is a different question that will be discussed (but unfortunately not definitively answered) later.

Note:  I thank the following lawyers for their time and willingness to discuss these issues with me and for their contributions to my thinking. Any mistakes, errors, or flawed opinions are entirely mine, not theirs.

John M. Cunningham, Attorney at Law; Concord, New Hampshire
Peter G. Lawrence; Perkins Coie LLP; Chicago, Illinois
Peter Parenti; Ramirez & Parenti, PLLC; San Antonio, Texas
Ted Waggoner; Peterson Waggoner & Perkins, LLP; Rochester, Indiana

The next post discusses the federal income taxation of series LLCs.