The state of Delaware recently enacted an amendment to the Delaware Limited Liability Company Act (the “Act”), effective August 1, 2018, which allows a limited liability company to divide into two or more limited liability companies, with the assets, liabilities and duties allocated among those companies in a plan of division. In order to divide a limited liability company, new Section 18-217 of the Act provides that the original limited liability company must adopt a plan of division and file a Certificate of Division with the Delaware Secretary of State. However, the plan of division itself is an internal document that is not available to the public, and no notice is required to be given to creditors, before or after the division.
Under the plan of division, the debts and liabilities of the dividing company are allocated among the surviving and resulting companies (referred to as the “division companies”), and absent a fraudulent conveyance, the division companies are responsible only for those debts and liabilities allocated to each under the plan of division. If, however, the division constitutes a fraudulent transfer (as determined by a court of competent jurisdiction), then each division company is jointly and severally liable for all of the liabilities, notwithstanding the allocation made in the plan of division. The Certificate of Division filed with the Delaware Secretary of State must specify the name and address of a “division contact” who is required, upon the request of any creditor and for six years after the division, to provide such creditor with the name and business address of the company to which the claim of such creditor was apportioned under the plan of division.
If a dividing company was formed prior to August 1, 2018, and is a party to any written contract, indenture or agreement entered into prior to August 1, 2018, that by its terms restricts, conditions or prohibits mergers and consolidations or the transfer of assets, then such restriction, condition or prohibition shall be deemed to apply to a division as if it were a merger, consolidation or transfer of assets. After that, however, all contracts, indentures and agreements must specify the restrictions, conditions and prohibitions on the division of a limited liability company.
The impact of this Amendment on secured creditors is unknown, and the interpretation of this new law is evolving. However, there are immediate actions that a secured creditor can take to protect its interests when dealing with the Delaware limited liability company. First, all agreements, including loan documents entered into after August 1, 2018, with a Delaware limited liability company should contain express restrictions, conditions and prohibitions on the division of a limited liability company. Second, when reviewing operating agreements for Delaware limited liability companies, the secured creditor should determine if there are any prohibitions on the company entering into a plan of division, and if necessary, require that the agreement be amended to prohibit a plan of division. Third, the secured creditor must be diligent in policing its obligors and its collateral, to determine if a division of the limited liability company has occurred under Delaware law, and take actions to protect its interests accordingly, such as timely filing a new financing statement for any name changes.
While the new division process protects creditors from fraudulent conveyances, this is the only protection afforded to creditors, and it is unclear how much protection is really being provided, since it is difficult and expensive for a creditor to prove that a fraudulent transfer has occurred. Additionally, the creditor may not even be aware of the division (and a resulting fraudulent conveyance) until long after the division occurs [1]. For secured lenders, the amendment to the Act also creates many other concerns, such as (i) the extent of its security interest in after-acquired property of the surviving company, and (ii) maintaining perfection and attachment of its security interest.
[1] Generally, the statute of limitations in Delaware for a fraudulent transfer is four years.
Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.
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