04.16.2019 | Articles

Lenders Beware! New Delaware Law Requires Document Update

By Brent W. Barringer

As most lending institutions frequently extend credit to limited liability companies formed under the laws of the state of Delaware (“Delaware LLCs”), such lenders must be cognizant of a recent amendment to the Delaware Limited Liability Company Act (the “Act”) which will necessitate updating standard-form loan agreements and/or other loan documents.

Effective August 1, 2018, the Act was amended to enact Section 18-217, which provides that a Delaware LLC (the “Dividing LLC”) may adopt a plan of division to divide such Dividing LLC into two or more new Delaware LLCs (the “Division Companies”). The Dividing LLC’s plan of division is implemented by the filing of a Certificate of Division with the Delaware Secretary of State, together with a Certificate of Formation for each new Division Company.  

In accordance with the plan of division, the assets, debts, liabilities and obligations of the Dividing LLC are allocated among the Division Companies. (The Dividing Company is not required to dissolve and may continue its existence as a surviving entity/Division Company.) As a result of this division, the assets, debts, liabilities and obligations of each Division Company are separate and distinct from the assets, debts, liabilities and obligations of the other Division Companies. But if such division is determined by a court of competent jurisdiction to constitute a fraudulent conveyance, then each Division Company would be jointly and severally liable for all debts and liabilities allocated in the plan of division.

Importantly for lenders, pursuant to Section 18-217(o) (“Section o”) of the Act, if a Dividing LLC was formed prior to August 1, 2018, and is bound by any written contract, indenture or other agreement entered into prior to August 1, 2018 which prohibits (i) the Dividing LLC from consummating any merger or consolidation with or into another party, or (ii) the transfer of assets by the Dividing LLC to another party, then such prohibition shall be deemed to apply to the plan of division. As such, a division by the Dividing LLC into Division Companies would be a default under such agreement.

However, the protections afforded by Section o will not apply to Dividing LLCs that are formed on or after August 1, 2018, or to contracts or agreements entered into by a Dividing LLC on or after such date. Accordingly, borrowers could circumvent standard prohibitions on mergers, consolidations and transfer of assets contained in loan documents merely by authorizing a plan of division, and transferring assets from the borrower to Division Companies.

All loan documents entered into on or after August 1, 2018 should include provisions that explicitly prohibit the division of limited liability companies into two or more separate limited liability companies.  Further, the post-closing loan audits typically conducted by lenders should now include investigating whether such a division has occurred under Delaware law, and taking all necessary steps to protect the lender’s collateral (e.g., filing additional financing statements). Fortunately, under the new law, the Dividing LLC is required to specify a “division contact” in the Certificate of Divisions who, upon the written request of any creditor within six (6) years of the division, shall provide such creditor with the name and address of the Division Company to whom such creditor’s claim was allocated pursuant to the plan of division.

Brent Barringer

© Hackett Feinberg P.C.  Attorney advertising. This article has been prepared for informational purposes only and is not legal advice. This information is not intended to create an attorney-client or similar relationship.

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