Newly Passed Delaware LLC and LP Law Amendments Require Attention to Various Contractual Arrangements
By: Lori Smith
Effective August 1, 2018, Delaware amended the Delaware Revised Uniform Limited Partnership Act (LP Act) and the Delaware Limited Liability Company Act (LLC Act) to, among other things: (i) add a provision permitting the division of limited liability companies into two or more limited liability companies, (ii) permit the use of blockchain technology and distributed ledgers for certain activities, and (iii) create a new type of Delaware LLC series known as a “registered series.”
Perhaps the most important and novel of these amendments is the addition of the concept of a divisive or divisional merger. Under new Section 18-217 of the LLC Act, a Delaware LLC will be permitted to divide itself into two or more domestic Delaware LLCs. As part of such division, the original Delaware LLC can either continue its existence or terminate as part of the division. Following the division, the surviving or continuing LLCs will each be liable for the debts, liabilities and duties of the original dividing LLC to the extent allocated to each entity pursuant to the plan of division, and no other division LLC will retain or obtain liability for any such pre-existing obligations unless the plan of division constitutes a fraudulent conveyance under applicable law. If a plan of division fails to specify the allocation of any debts and liabilities of the original LLC, then those debts and liabilities become joint and several liabilities of all LLCs resulting from the divisive merger.
Delaware did recognize that this novel type of arrangement (which is contemplated in at least one other state –Texas) would require adjustments to many contractual arrangements, as it would not have been contemplated in existing agreements. Therefore, the amendments provide that any terms of a written contract, indenture or other agreement that restrict, condition or prohibit a Delaware LLC from consummating a merger or consolidation or transferring assets will apply with equal force to a division if: (i) the Delaware LLC was formed prior to August 1, 2018 and (ii) the Delaware LLC entered into such written contract indenture or other agreement prior to August 1, 2018. While it is not yet clear how Delaware courts may interpret or enforce this provision, since the statute does not deal with LLCs formed after August 1, 2018 (or contracts entered into after such date), the implication is that this safe harbor will not apply.
What does this mean for the drafting of various contractual arrangements with LLCs going forward? First, the additional flexibility added by the opportunity to use a divisive merger to manage and dispose of assets may impact provisions in agreements that restrict assignment or transfer of assets. After a divisive merger is effective, the rights, privileges, powers and interests in property of the dividing LLC that have been allocated to a division LLC shall remain vested in each division LLC and shall not be deemed, as a result of such division, to have been assigned or transferred to such division LLC. For LLCs formed after August 1, 2018 and/or which enter into contracts after August 1, 2018, a divisive merger may not be covered by the typical prohibition on assignment, or even a provision that defines assignment to include any transfer resulting from a change of control. Contract drafters should review agreements to ensure that going forward such provisions also include a provision that is broad enough to cover all transfers by operation of law, including conversions, mergers and divisive mergers.
Further, parties to contracts with LLCs, such as lenders or equity investors, who want to prohibit divisions in a similar fashion to restrictions on mergers and other fundamental transactions, should specifically provide for such a restriction in their loan and investment documents. This would be equally true for any covenants between signing and closing in merger and acquisition agreements or member and board/manager veto (voting control) rights in investor rights and equity holder agreements (including any operating agreements for newly formed LLCs).
The amendments do provide a protection for creditors in that a natural person must be designated as the division contact and named in the certificate of division. The division contact must maintain the plan of division and provide creditors of the dividing company, without cost and upon written request, with information regarding the name and address of which division company was allocated the creditor’s claim for six years following the division.
One item to point out in regards to the amendments adding the concept of a registered series is that under the amendments, a registered series is deemed an association for purposes of the Uniform Commercial Code. This is important because of continuing uncertainty in the lending community regarding the proper way to perfect a security interest when dealing with a series LLC. Section 18-215 of the LLC Act currently permits an LLC to establish one or more series of members, managers, limited liability company interests or assets. A series LLC allows for a single entity to maintain separate series as to which: (i) the debts, liabilities, obligations and expenses incurred, contracted for or otherwise existing with respect to a particular series would be enforceable solely against the assets of such series and not against the assets of another series, and (ii) none of the debts, liabilities, obligations or expenses existing with respect to the LLC generally or any other series would be enforceable against the assets of this series. This made it difficult for lenders to determine how to perfect and enforce their rights with respect to series LLCs, as an individual series was not a separately recognized entity as to which a security interest could be recorded. These amendments may facilitate the use of series LLCs in secured financing transactions as the registered series will be a registered organization for purposes of the Delaware Uniform Commercial Code. A registered series will be required to file a separate certificate of registered series with the Delaware Secretary of State and will pay a separate annual franchise fee. There are also amendments to the Delaware UCC which will simplify the process for filing a UCC financing statement against a registered series. Registered series will also be able to obtain good standing certificates and a certificate of existence from the Delaware Secretary of State.
Several sections of the LLC Act and the LP Act were amended to provide express statutory authority for Delaware entities formed pursuant to such Acts to use networks of electronic databases for the creation and maintenance of records and for certain electronic transmissions. This will allow for the use of blockchain and distributed ledgers for matters such as voting by members. These amendments are consistent with last year’s amendments to the Delaware General Corporation Law.
Attorneys and their clients forming or transacting business with Delaware LLCs need to take a careful look at both existing contracts and any newly drafted agreements or templates and precedent forms that are being used to prepare agreements for clients to make sure that they contemplate and address the newly enacted amendments.
If you have questions or would like additional information, please contact Lori Smith (firstname.lastname@example.org; 212.714.3075) or another member of the Corporate and Securities Group.