Effective August 1, 2018, the Delaware Limited Liability Company Act (DLLCA) was amended to include a new divisive merger statute. Unlike a traditional merger, whereby two or more entities merge to become one entity, a divisive merger involves one entity dividing into multiple entities. Further, the dividing entity is not required to terminate in connection with the division and may continue as a surviving entity. The assets, liabilities and obligations of the dividing entity are allocated among the new entities formed pursuant to the merger and the surviving entity, if applicable. A divisive merger is not deemed to be an assignment or transfer of the dividing entity’s assets or liabilities under Texas or Delaware state law. Therefore, a divisive merger may be used to avoid certain transfer restrictions in contracts. The Texas Business Organizations Code (TBOC) includes divisive merger provisions similar to Delaware’s new divisive merger statute. This article explores certain differences between a divisive merger under Texas law and Delaware law.
Availability of Divisive Merger
The most notable difference between the Texas and Delaware divisive merger statutes is the limited application of the Delaware statute to only a Delaware limited liability company (LLC). DLLCA § 18-217 allows a domestic Delaware limited liability company to divide itself into two or more domestic LLCs and to allocate the assets and liabilities of the dividing LLC among itself (if the dividing LLC survives the division) and the newly formed LLCs. In contrast, the TBOC allows any domestic Texas entity, including a corporation, partnership, LLC or limited partnership, to enter into a divisive merger. Further, a Texas entity may divide itself into various forms of entities, including both domestic and foreign corporations, partnerships and LLCs. However, other forms of Delaware entities could take advantage of Delaware’s divisive merger statute by converting into a Delaware LLC prior to the division.
To effect a divisive merger under Texas law, the dividing entity must adopt a plan of merger. Similarly, to effect a divisive merger under Delaware law, the dividing entity must adopt a plan of division. Such plan must set forth certain statutorily-required items, including the allocation of the dividing entity’s assets and liabilities among the surviving entity (if applicable) and the entities formed pursuant to the division. Pursuant to DLLCA § 18-217(g)(3), a plan of division must also set forth the name and business address of a “division contact.” For a period of six years after the effective date of the division, the division contact must provide to any creditor of the dividing LLC, at the request of such creditor, the name and address of the company to which such creditor’s claim was allocated pursuant to the division. The division contact can be a natural person who is a Delaware resident, the surviving LLC (if applicable), one of the LLCs formed in connection with the division or any other Delaware business entity. It is unclear from the statute whether a successor division contact must be appointed if the division contact converts into a non-Delaware entity. In contrast, the TBOC does not require a plan of merger to designate a specific contact for creditors. Instead, the surviving entity (if applicable) and each entity formed pursuant to the merger are required to furnish a copy of the plan of merger to any creditor of the dividing company, upon request of such creditor. The requirement in Delaware to appoint a division contact to serve for a period of six years could require dividing companies to employ a corporate service provider to serve as the division contact, should the dividing company and all of the companies formed pursuant to the division desire to terminate their existence before the six-year period expires.
Allocation of Assets and Liabilities
Under Texas law, the dividing entity must file a certificate of merger with the Texas Secretary of State. Similarly, under Delaware law, the dividing company must file a certificate of division with the Delaware Secretary of State. From and after the time that such certificate becomes effective, the assets, debts, liabilities and obligations of the dividing entity will vest in the entities to which they are allocated under the plan of merger or division, and no other entity will be liable for such debts, liabilities or obligations, subject to a finding that such allocation constitutes a fraudulent transfer. Further, any debts or liabilities of the dividing entity that are not allocated under the plan merger or division shall be the joint and several obligations of the surviving entity (if applicable) and each of the entities formed pursuant to the division.
Pursuant to TBOC § 10.008(b), if a plan of merger does not provide for the allocation of a particular asset of the dividing entity, the unallocated asset will be deemed to be owned in undivided interest by the surviving entity (if applicable) and each entity formed pursuant to the merger, pro rata to the total number of surviving and newly-formed entities. Conversely, the DLLCA does not include an expressed mechanism for apportioning unallocated assets. Therefore, in Delaware, litigation may be required to apportion any assets that were unallocated under the plan of division.
Application to Transfer Restrictions
A divisive merger may be used to avoid certain transfer restrictions in contracts. Notably, the Delaware statute provides that if an LLC formed prior to August 1, 2018 is a party to an agreement entered into prior to August 1, 2018 and such agreement restricts the consummation of a merger or consolidation by the LLC or the transfer or assignment of the LLC’s assets, then such restrictions shall be deemed to apply to a division of such LLC as if the division was a merger, consolidation or transfer of assets. Therefore, a Delaware divisive merger cannot be used to avoid assignment and transfer restrictions in agreements entered into prior to August 1, 2018. The Texas statute does not contain a similar provision.
Without careful drafting of transfer restrictions in agreements, a divisive merger may be used to avoid such restrictions. The new Delaware divisive merger statute increases the availability of divisive mergers; however, parties considering a divisive merger should be aware of the differences between a divisive merger under Texas law and Delaware law, including the limited application of the Delaware statute to only Delaware LLCs and the limited ability to use the Delaware statute to avoid assignment and transfer restrictions in agreements entered into prior to August 1, 2018.