Unlocking Investment Potential: DSTs vs. LLCs—Strategic Considerations Across Industries

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Christy: Hello, everyone. Welcome to today's webinar, "Unlocking Investment Potential – DSTs vs. LLCs, Strategic Considerations Across Industries." My name is Christy DeMaio Ziegler, and I will be your host today from the CSC webinar team.

We're very fortunate today to have some amazing speakers who will be sharing their insight and expertise with us: Shannon S. Frazier, partner at Morris James LLP, Greg Daniels, Director of Corporate Trust and Agency Services at CSC, together with our moderator, Dave Straub, Director of Business Development at CSC.

So without further ado, I'd like to pass it on to our speakers and let them introduce themselves. Shannon?

Shannon: Hi, everyone. My name is Shannon Frazier, and I'm a partner in the Business Transactions Group at Morris James LLP, which is a Delaware law firm. I have practiced with Morris James for more than 20 years, and while one portion of my practice is dedicated to trustee representation and structured finance transactions, I also spend a considerable amount of time working with LLCs, both in the structured finance context and generally. The Delaware statutory trusts and Delaware limited liability companies are what I'll be talking with you about today. Greg?

Greg: Thanks, Shannon. My name is Greg Daniels. I am a director at CSC and also Delaware Trust Company, primarily specializing in corporate trust and agency services, and where my specialization is, is Delaware statutory trusts. Dave?

Dave: Thanks, Greg. My name is Dave Straub. I'm a Director of Business Development at CSC, and my role is to work with our teams to make sure that our clients are getting the solution that they're looking for.

Today we're going to be covering a number of important things for those that are looking to determine which structure is best to get to their final objective, and specifically we're going to be looking at the distinction between DSTs and LLCs, new regulatory changes, and also what service provider is best for you to help you get to your final objective.

I tell all of my clients getting the structure right up front is critical, and working with experts like you, Shannon, is one way to make sure that you get to the right place. So I thought we should start with what makes Delaware the preferred jurisdiction for statutory trusts and LLCs.

Shannon: Thanks, Dave. This is actually one of the most common questions I receive. What is it about Delaware that makes it so popular as a choice for businesses? And the answer to that is pretty simple. Delaware, according to the Delaware Division of Corporations website, is home to nearly two million business entities, including nearly two-thirds of the Fortune 500 companies and more than half of the publicly traded companies in the U.S. So there's this rich tradition of businesses choosing Delaware as their jurisdiction of formation. And the biggest reasons behind this choice are, first, that Delaware is very business friendly, and we work really hard to keep our entity laws forward-looking. We regularly update our entity law statutes, and Delaware lawyers play a very active role in this process. It makes a huge difference when the people who actually apply the language of the statutes to the practical needs of business are involved in the drafting, and it really allows Delaware to evolve in tandem with the business world.

Second, Delaware has a remarkably well-developed body of business-related case law, and our Court of Chancery is dedicated to the equitable resolution of business matters. Our chancellors are incredibly experienced with complex business transactions and structures. And accordingly, dispute resolution in Delaware tends to be remarkably consistent.

And third, the Delaware Secretary of State is extremely responsive and service-oriented. Formations, dissolutions, good standing certificates, UCC filings, our Secretary of State works very hard to make things like that quickly accessible, which is critical given how fast business sometimes needs to move.

So I think that answers the initial question. Delaware is the jurisdiction of choice because its bench, its bar, and its government all work hand in hand to make it so.

Dave: Thanks, Shannon. In your opinion, what are the key advantages and considerations when choosing between DSTs and LLCs?

Shannon: So this I think is where we really get into sort of the meat and the substance of today's presentation. DSTs and LLCs have really come to the forefront as vehicles of choice for a variety of types of transactions, and they have a number of very similar attributes to consider.

First, they both have certain tax advantages in that neither are subject to Delaware state income tax simply by virtue of being formed here. Delaware tax treatment will parallel federal tax treatment, and pass-through tax treatment is achievable. Now, of course, every structure presents its own unique set of circumstances when it comes to taxes. But as a general matter, DSTs and LLCs can both offer tax advantages when properly structured.

The second similarity is that both LLCs and DSTs are separate legal entities with perpetual existence. And third, the DST and LLC statutes both give maximum effect to freedom of contract. So within the general framework of the law, the parties are free to agree to structure their business however they see fit.

Now building on this idea of freedom of contract. both DSTs and LLCs may be formed for any lawful business purpose. In the case of LLCs, I most commonly see them used for things like manufacturing, services, holding and developing real estate, and holding and managing intangible property, such as securities and other investments. DSTs, on the other hand, are most commonly used for preserving property, like real estate or aircraft, and are widely viewed as a preferred vehicle for certain structured finance transactions, such as asset securitizations or 1031 exchanges.

But when trying to choose between the two types of entities, it's important to look not only at the purpose of the entity, but also to take into account some other considerations. One of these considerations is ease of formation.

DSTs are formed very simply by the filing of a certificate of trust with the Delaware Secretary of State and the execution of a governing instrument, commonly referred to as a trust agreement or a declaration of trust. The certificate of trust must contain the information required by the Statutory Trust Act and may contain other information that the transaction parties deem important or convenient. The trust agreement, while having very few mandatory provisions, will generally appoint the trustee and describe the management and ownership structure of the DST.

A second consideration is ownership flexibility and limited liability. With a DST, you may either have physical or book-entry certificates to evidence the beneficial interests in the trust. And unless you provided otherwise in the trust agreement, those beneficial owners will have the same limited liability as a stockholder of a Delaware corporation. A beneficial interest in a DST is considered personal property. And the parties are free to agree between themselves how to share in profits and losses, whether there are different classes of beneficial interests or beneficial owners, and how those different classes are managed, all as they choose to describe in the trust agreement.

Management flexibility is another consideration. DSTs may be managed by their trustees, but it's also common for a DST to be managed by the beneficial owners or by an administrator all of the parties agree in the trust agreement. It's important to note though that, unless otherwise agreed, a trustee will not be personally liable for the obligations of the DST.

DSTs also have significant business flexibility. They can merge, consolidate, convert, be structured in classes or series, and other than a requirement that at least one trustee of the DST be physically present in Delaware, there is no requirement that they conduct business or maintain an office in the state.

The same considerations have to be examined with respect to LLCs, which are subject to the statutory framework of the Delaware Limited Liability Company Act. As with DSTs, formation of an LLC is straightforward. A certificate of formation, signed by an authorized person and 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. This LLC agreement may be oral or written and will describe the management and ownership structure of the LLC. As with the certificate of trust for a DST, an LLC certificate of formation must contain the information I just mentioned, but may also contain any other information that the parties deem appropriate.

And speaking of ownership structure, LLCs are also very flexible in this regard. 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. In the alternative, the members may choose to appoint a manager or board of managers to oversee the day-to-day operations of the LLC. The LLC Act expressly provides that no member or manager is liable personally for any debt, obligation, or liability of the LLC solely by virtue of such party's status as a member or manager, and expressly empowers an LLC to indemnify and hold harmless its members or managers or any other person from and against any and all claims or demands whatsoever. Also similar to a DST, the LLC agreement can provide for different classes of members or limited liability company interests, each with their own relative rights, powers, and duties.

Management of an LLC is very flexible in that the parties can select the management arrangement that works best for them. Members of an LLC can participate in the management without jeopardizing their limited liability. Or the members may elect to have the LLC managed by someone else, including by a third-party service provider. Or they can fashion a blend of these two approaches as the LLC Act permits the existence of different classes of managers.

Management of an LLC is also very flexible in that the parties can select the management arrangement that works best for them. Members of an LLC can participate in the management without jeopardizing their limited liability. Or the members may elect to have the LLC managed by someone else, including by a third-party service provider. Or they can fashion a blend of these two approaches as the LLC Act permits the existence of different classes of managers.'

Like DSTs, an LLC may merge or consolidate, and it can also reorganize by way of asset sales, conversions, transfers, divisions, and domestications. And there is no requirement that an LLC carry on business activities or establish or maintain any place of business, other than a registered office and registered agent in Delaware. And, of course, an LLC can be structured in series.

Now this is the second time today that I've mentioned series, and I want to take a couple of minutes to go over what that means exactly. From an eagle's eye perspective, a series is a statutorily authorized structure to segregate, rights, powers, obligations, and assets within an LLC or a DST.

Generally, 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 basically a segregation of ownership interests, management, or assets by contract. There's no statutorily granted liability shield. And an unprotected series has none of the rights or powers of a protected series. That's the second type of series, a protected series, which 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.

Now the Delaware LLC Act in 2018 introduced a third type of series, the registered series, and this is an important distinction between LLCs and DSTs because the concept of a registered series is inapplicable to DSTs. A registered series of an LLC is essentially a protected series of an LLC, which is registered by a filing with the Delaware Secretary of State. This registration allows the protected series of the LLC to receive good standing certificates in the name of the protected series itself.

So if an unprotected series is the equivalent of a class, how does a protected series work? In short, a properly established protected series of either an LLC or a DST allows multiple separate cells or series to exist within the larger framework of the LLC or DST. In other words, it's one single LLC or DST subdivided internally in such a way that each subdivision functions as though it's an individual LLC or DST. Each protected series may have its own assets, liabilities, ownership, management structure, name, books, records, and accounts. And each protected series operates like a distinct separate entity despite not having independent legal status.

A protected series has the power and capacity in its own name to enter into contracts, own assets, including real, personal, and intangible property, grant liens and security interests in its property, and sue and be sued. But the key is that the assets and liabilities associated with a particular series of the LLC or DST are compartmentalized, and unless you specifically provide otherwise in the LLC agreement or trust agreement, there's no intermingling of assets or liabilities within a protected series LLC or DST.

Now there are advantages and disadvantages associated with protected series structures whether you use an LLC or a DST. The most valuable advantage is the internal liability shield, which provides that assets owned by one series of the LLC or DST are insulated from liability associated with a different series of the same LLC or DST. There's also a tremendous advantage in terms of flexibility because 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, management, investments, profit sharing, and so forth without you utilizing multiple different entities.

Using a single entity this way can really streamline some costs and administrative burden and in some cases can minimize due diligence because when you're doing your diligence on the entity, you're only having to diligence out a single entity instead of having to look individually at multiple different entities and figure out their formation and authorization structure.

But there are disadvantages too. Protected series require very careful record keeping and accounting, and failure to maintain separateness between protected series can lead to a failure of the liability shields between the series, which of course defeats the whole purpose of utilizing a series entity in the first place. This kind of record keeping and accounting requirement can lead to increased management and administrative costs.

There's also a bankruptcy component to consider before utilizing a series structure because it's unclear whether a bankruptcy court would uphold series separateness. No one has tried taking a series entity or even a single series through bankruptcy yet. So while it's the case that the liability shields of a properly established and maintained protected series entity should be effective to protect the separate series as a matter of internal governance, state law, and contract law, the protected series structure itself has not been tested in the bankruptcy setting. Likewise, not all jurisdictions recognize protected series. So it's unclear if series separateness would be recognized in a jurisdiction that doesn't have a series statute.

So with all of that said, I think those are the biggest considerations when trying to distinguish between a DST and an LLC. Flexibility of ownership, management, and business, ease of formation, and use of series structures are all pivotal in making the determination. Further, and just as importantly, you have to give consideration to your business partners when using these structures. Your choice of registered agent, third-party management, and trustee can really have an impact on your successful use of the entity.

Dave: Thanks, Shannon. Are there any new regulatory changes that could potentially impact the use of DSTs or LLCs in your industry?

Shannon: Actually, yes. So there's a piece of legislation that has just gone into effect, called the Corporate Transparency Act, and I've heard it described as the most significant piece of entity legislation since the enactment of the LLC statutes back in the '90s. What it does, the Corporate Transparency Act mandates the creation of a national database by FinCEN, that's the Financial Crimes Enforcement Network, for the beneficial ownership information of many businesses. And it's the culmination of a 15-year long process to address money laundering.

Unfortunately, the CTA has a multitude of definitional and practical issues. But what it ultimately does is require, subject to criminal penalties for non-compliance, that every individual who directly or indirectly either exercises substantial control over a reporting company or owns or controls at least 25% of the ownership interests of a reporting company register with a federal database.

So the first question to address here is what's a reporting company. A reporting company, as defined in the CTA, includes corporations, LLCs, any other entity created by a filing under the law of a state or Indian tribe, and any other foreign entity registered to do business in a state or Indian tribe. This definition includes DSTs as those are created, as we discussed, by a filing with the Delaware Secretary of State. It does not matter how long ago the entity was formed, and arguably this definition encompasses every single business formed in the United States.

But there are exceptions. Certain types of businesses are exempt from the CTA reporting requirements. In fact, there are some 23 categories of businesses that do not have to report under the CTA. These categories include public companies, financial institutions, registered money transmitting businesses, 1934 Act broker-dealers, registered investment advisors and investment companies, insurance companies, PCAOB accounting firms, public utilities, 501(c)s, and certain political organizations, as well as what are categorized as large companies. This is defined in the CTA as companies that employ more than 20 full-time employees in the U.S., and the company's previous year's federal tax return demonstrates more than $5 million of gross receipts or sales in the aggregate, and that has an operating presence at a physical office in the U.S. So you can see the CTA will most significantly impact smaller businesses and startups, especially because even if a new company has a ton of employees and a physical office, it will still fail the large company test for lack of a prior year tax return, and this means they will qualify as a reporting company.

So once the determination has been made that your entity does qualify as a reporting company under the CTA, the inquiry turns to who has to report what. There are two categories of individuals who have to submit information under the CTA — beneficial owners and applicants.

Beneficial owners encompasses not only those individuals holding equity interest in a reporting company, but also senior officers, anyone with authority over the appointment or removal of any senior officer or a majority of the board of directors or similar body, anyone who directs, determines, or has substantial influence over important matters made by the reporting company, such as corporate directors or LLC managers, anyone with any form of substantial control over the reporting company, and anyone with rights associated with any financing arrangement or interest in a company through contract, arrangement, understanding, or relationship. So this is a really wide-reaching definition and is truly intended to capture anyone who has the power to exert control over the entity.

The applicant category is narrower, and this applies to entities formed in 2024 and later only. Applicant is up to two individuals involved in the formation of the entity, including any individual who directs or controls that filing by another person. Who constitutes an applicant will vary from formation to formation. It's definitely the person who actually submits the certificate creating the entity to the filing authority. But in some circumstances it will also include paralegals, lawyers, trustees, authorized persons, or anyone else involved in the entity formation.

Regardless of whether an individual finds themselves in the position of beneficial owner or applicant, the CTA requires that they submit their name, address, current passport or driver's license number, and an image of that driver's license or current passport. Beneficial owners have to update their information with FinCEN within 30 calendar days after any change, and this obligation to update does not end or expire until the entity is dissolved and terminated. It's also important to note that the reporting company is required to have an EIN by the time of filing with FinCEN, and that the company must report all of its trade or DBA names.

Now the CTA took effect on January 1st of this year, which means that new entities formed on or after January 1, 2024 and before January 1, 2025 must file with FinCEN within 90 days of formation. Entities formed on or after January 1, 2025 must file with FinCEN within 30 days of formation. All other existing businesses, other than inactive and exempt companies, must file by January 1, 2025.

And there are pretty significant consequences for failing to make these filings and failing to keep your information updated. This failure can lead to civil fines of up to $10,000 and up to 2 years in prison.

And all of this is just a really high-level overview of the CTA. There are a number of other nuances and factors that have to be considered. So it's really important that business owners partner with a compliance team to make sure they get this right. As with the choice of trustee in the DST context, the selection of your service team here is going to make all the difference in the world.

Dave: Thanks, Shannon. That was certainly an attention grabber of that last slide, prison time. It's just as important to have a great service provider standing behind you in formations of your LLCs or your statutory trusts. And now we're going to learn a little bit more about Delaware Trust, what makes Delaware Trust different, and who Delaware Trust supports.

Greg: Thanks, Dave. To give you a little bit of background about Corporation Service Company and Delaware Trust, Corporation Service Company is a leading provider of trust services through Delaware Trust Company, our wholly owned subsidiary and a fully regulated financial institution. Founded in 1899, Corporation Service Company has been delivering world-class service for over 120 years, including decades of Delaware statutory trust experience. We are an independent and privately held company headquartered in Delaware, a state widely recognized for its well-thought-out laws pertaining to corporations and trusts. The state of Delaware has a long-standing tradition of creating and maintaining sophisticated, cutting-edge laws that govern trusts, which makes Delaware a great place for trust formations.

Delaware Trust is a fully regulated, Delaware State-chartered, non-depository trust company. We deliver bespoke trust and agency services to clients around the globe in a variety of transaction types. All over the world, in every industry, clients trust CSC to fulfill key trust and agency roles because we are ideally resourced and structured. Clients do not have to be incorporated in Delaware to establish a Delaware statutory trust in order to take advantage of the state's favorable trust statutes and the Delaware's court system.

To protect assets and structure capital market transactions, Delaware statutory trusts are often the special purpose entity of choice, affording contractual flexibility, bankruptcy remoteness, and tax treatment options. A Delaware statutory trust can be used for a variety of transactions, including structuring real estate, securitization transactions, investment funds, cryptocurrency exchange-traded funds, liquidations, equipment finance, and aircraft owner trust just to name a few.

What makes Delaware Trust unique is we are truly an independent partner. Delaware Trust is an independent trust company, not affiliated with any lending institution or investment advisory firm, minimizing the likelihood of conflict of interest. We pride ourselves on being very nimble and can help have a trust established quickly without the endless red tape associated with larger institutions. We are able to work with clients who have a tight time constraint and help make their transaction successful. We are also a one-stop shop, ability to serve as trustee in addition to a number of trust and agency roles to help streamline the number of service providers on your transaction. We are also able to handle filings and qualifications for your trust through our parent company to simplify your administration process with various state departments.

We are a boutique provider that supports corporations, institutional borrowers and debt issuers, restructuring professionals, as well as lenders and bond holders. We also deal with alternative investments and private equity, private debt, real estate, infrastructure, and venture capital. And we also work with the global capital markets participants, including but not limited to issuers, sponsors, investors, originators, advisors, and fund managers.

So why choose Corporation Service Company and Delaware Trust? First, we are very client centric. We're willing to listen to all transaction types and help our clients work through the various issues to make their transaction successful. Our dedicated team understands the nuances of each transaction and allows our clients to focus on the overall success of their project. We are also independent and stable. Our seasoned team of professionals delivers conflict-free services to capital markets participants, alternative investment managers, and advisors as well as corporations and institutions. We pride ourselves on being a client-focused service provider delivering exceptional service for over a century.

We also have innovative technology, and we continuously update our technology and reporting tools that allow our clients to easily monitor the details of their transaction. We understand the need to be flexible and tailor a solution to fit the precise terms of our client's unique transaction.

Our expert team comprises lawyers, corporate trust administrators, and financial professionals, who not only understand Delaware's business-friendly court system, but also operate on a global scale, capable of transacting wherever our clients are. Our team has decades of experience with a full range of trust and agency services. We have worked with clients on numerous transaction types, establishing several hundred Delaware statutory trust offerings.

CSC is also a global company, and we are able to provide solutions in financial markets around the world. Our professionals in the United States, Europe, and Asia-Pacific work as one to deliver fully complementary and multi-jurisdictional solutions. Our global capabilities and team-based approach enable us to work in partnership with our clients regardless of market, service, or asset type. And we also have a passion for the complex.

Delaware Trust has an appetite for handling the most complex deal structures that many institutions shy away from. We have earned the trust of our clients with extensive experience in complex structures. We are local trust and agency specialists with a global reach, and we strive to deliver end-to-end services for our clients. Our ability to engage in complex and cross-border transactions is what truly sets us apart. Drawing on our experience across diverse deal structures, we excel at understanding our client goals, analyzing transaction details, and quickly adapting our services to meet a client's unique business requirements.

Dave: Shannon and Greg, thank you so much for your insights that you shared today. Looking at the information, it feels like this is just the tip of the iceberg that business owners need to consider in choosing the right structure for their objectives and also the consideration of significant regulatory changes that will impact most business owners. Shannon, any final comments?

Shannon: Oh, you're most welcome, Dave. I appreciate the opportunity to talk to everyone today. And you're right, this is definitely just sort of the tip of the iceberg in terms of the factors to be considered when selecting an entity and learning about compliance with the new Corporate Transparency Act. I appreciate the opportunity to have been here today, and it's always such a pleasure to work with the CSC and Delaware Trust team. Thank you.

Dave: Yeah. Thanks, Shannon. Greg, any final comments?

Greg: Yeah, it is always a pleasure to work with Shannon and the Morris James team. We'd like to thank everyone for joining us today. We hope the information was helpful, and we hope it helps with your next transaction.

Dave: Thanks, Greg.