Delaware statutory trusts and limited liability companies compared: key factors to consider when choosing between them.
As Delaware has become the preferred jurisdiction for statutory trusts and LLCs, it’s important to consider some of the key similarities and differences when choosing between the two types of entities. Delaware statutory trusts (DSTs) and Delaware limited liability companies (LLCs) can both offer tax advantages when properly structured and both are separate legal entities with perpetual existence. This means that parties can agree to structure their businesses however they wish.
DSTs are more commonly used for holding investment assets, such as real estate or aircraft, and are widely viewed as a preferred vehicle for certain structured finance transactions, such as asset securitizations or 1031 exchanges.
LLCs, on the other hand, are more commonly used for manufacturing, services, holding, developing, and operating real estate, and managing intangible property, such as securities and other investments. However, either type of entity can be used to hold any asset class and the choice will depend on relative risks and benefits as advised by Delaware counsel.
When choosing between DSTs and LLCs, there are several factors beyond purpose to take into consideration.
Ease of formation
DSTs are simply formed, through the filing of a certificate of trust with the Delaware Secretary of State and the execution of a governing instrument. The certificate of trust must contain the information required by the Statutory Trust Act including, if the trust is not a registered investment company, the name, address, and signature of a resident Delaware trustee. It is generally advised that the trustee and other relevant parties enter into a declaration of trust or trust agreement to govern the trust.
The formation of LLCs is also relatively straightforward. A certificate of formation, signed by an authorized person setting forth the name of the LLC and the name and address of the LLC’s registered agent in Delaware, is filed with the Delaware Secretary of State and a limited liability company agreement is entered into.
Ownership flexibility and limited liability
A second consideration is ownership flexibility and limited liability. For DSTs, either physical or book-entry certificates can evidence the beneficial interests in the trust. Unless provided otherwise in the trust agreement, those beneficial owners will have the same limited liability protections as a stockholder of a Delaware corporation.
LLCs are also very flexible in terms of ownership structure. Owners of a limited liability company interest are referred to as members, and these members are permitted but not required to manage the business of the LLC and also have limited liability protections.
Management flexibility
DSTs are very flexible and can be managed in any manner prescribed by the trust agreement. As with other types of trusts, DSTs may be managed by their trustees; however, it is not uncommon for a DST to be managed by the beneficial owners or by an administrator as agreed by the parties. It is important to note that unless agreed otherwise, a trustee will not be personally liable for the obligations of the DST and may be able to waive all of its fiduciary duties except for the implied contractual covenant of good faith and fair dealing by providing for this in the trust agreement.
LLCs also offer plenty of management flexibility. Members are permitted but not required to manage the business of the LLC. LLCs may also be structured as manager-managed and appoint managers with full responsibility to manage the company.
Business flexibility
DSTs can merge, consolidate, convert and be structured in classes or series. There is no Delaware statutory requirement that they conduct business or maintain an office in Delaware, other than for at least one trustee of the DST to be physically present in Delaware.
Like DSTs, an LLC may merge or consolidate, and can also reorganize by way of asset sales, conversions, transfers, divisions, and domestications. There is also no Delaware statutory requirement that an LLC carry on business activities or establish or maintain any place of business in Delaware, other than a registered office and registered agent in Delaware.
Use of series structures
Both the Delaware LLC Act and the DST Act contemplate two distinct types of series, an unprotected series, which is equivalent to a class in the corporate context and is a segregation of ownership interests, management, or assets by contract. The second type of series, a protected series, is a statutorily permitted segregation of ownership interests, management, or assets that permits the establishment of an internal liability shield, and requires public notice filing and specialized language in the LLC agreement or trust agreement.
There are advantages and disadvantages associated with protected series structures, whether you use an LLC or a DST. The most notable advantage is the internal liability shield, which insulates assets owned by one series of the LLC or DST from liability associated with a different series of the same LLC or DST.
There is also a significant advantage in terms of flexibility. The protected series structure allows a single LLC or DST to establish series that have different rights and obligations in terms of business objectives, ownership and management for example, without utilizing multiple different entities.
One key disadvantage to consider is that protected series require extremely careful record keeping and accounting. Failure to maintain separateness between protected series can lead to a failure of the liability shields between the series, which defeats the purpose of utilizing a series entity.
These administrative requirements can also lead to increased costs. There is also a bankruptcy element to consider before utilizing a series structure, because it is unclear whether a bankruptcy court would uphold series separateness. It is important to discuss the relative risks and benefits of any Delaware entity structure with Delaware counsel before proceeding. CSC can assist with the formation and administration of both DSTs and LLCs including resident Delaware trustee services, company formation, registered agent, nominee/independent managers, accounting and place of business.
Careful consideration required
In conclusion, choosing between DSTs and LLCs requires careful consideration of your specific business needs and goals. A CSC recent webinar on the topic, “Unlocking Investment Potential – DSTs vs. LLCs, Strategic Considerations Across Industries“, features an in-depth look at some of the considerations discussed above, as well as a deeper dive into how regulatory developments are affecting DSTs and LLCs.
This document is provided by CSC for information purposes only and does not constitute an offer, invitation or inducement to contract. The information herein does not constitute legal, tax, regulatory, accounting or other professional advice and therefore one should seek appropriate professional advice before considering a transaction as described in this document. No liability is accepted whatsoever for any direct or consequential loss arising from the use of this document.
