Locke Lord QuickStudy: A Divisive Issue for Borrowers and Lenders: Delaware’s New LLC Division Statute

Delaware has adopted amendments to its Limited Liability Company Act that permit so-called “divisions” to be effected by a Delaware limited liability company (“LLC”). These amendments, which became effective on August 1, 2018, can have a significant effect on loan agreements entered into on or after that date, regardless of whether the borrower is now a Delaware LLC.

A division permits a Delaware LLC to divide into two or more Delaware LLCs, which may or may not include the dividing LLC, and to allocate its assets and liabilities among those LLCs, with the only limitation, if not restricted by contract, being that there not be a fraudulent transfer. Thus, a Delaware LLC borrower or guarantor is able on its own to divide and allocate obligations, along with specified assets, to the new LLC. Transferred assets will remain subject to any existing liens but the underlying obligation will become a non-recourse obligation of the transferee LLC unless it is allocated to it.

As noted above, the loan agreement can restrict the LLC’s ability to undertake a division. Accordingly, we recommend that lenders consider revising their loan agreement forms to add divisions to the actions that are prohibited unless consented to by the lender. Existing “baskets” and exceptions to restrictions contained in covenants intended to govern mergers, asset sales and dividends might not be appropriate for divisions, which potentially can create credit issues that are different from those created by other transactions.

We also recommend that divisions be prohibited in loan agreements unless consented to by the lender even if the borrower or guarantor is not then a Delaware LLC because restructurings and reorganizations can occur that result in the borrower or guarantor becoming a Delaware LLC. In addition, three other states (Arizona, Pennsylvania and Texas) now permit divisions by various entities and other states may consider similar legislation and Delaware may consider extending its division provisions to other entities.

Loan agreements entered into before August 1, 2018 do not present the same problem described in this alert because the Delaware legislation provides that divisions are to be treated as mergers or transfers of assets under any restrictions in those agreements, so that if mergers or transfers of assets are restricted, divisions will be also. Covenants in pre-August 1, 2018 loan agreements should be reviewed, however, to evaluate whether divisions might be permitted under existing baskets but with unanticipated and undesirable results. For all post-August 1, 2018 loan agreements, as recommended above, lenders should consider expressly prohibiting divisions unless they consent.