Effective August 1, 2018, the Delaware Limited Liability Company Act (the Delaware LLC Act) allows a Delaware limited liability company (an LLC) to divide into two or more LLCs and allocate the assets, liabilities, rights and duties of the dividing LLC among itself and/or newly created LLCs (a Divisive Merger). The Divisive Merger provision is set forth in the new Section 18-217 of the Delaware LLC Act (the Divisive Merger Amendment). The complete language of the Divisive Merger Amendment can be found here.

Mechanics of a Divisive Merger

Under the Divisive Merger Amendment, an LLC must create a plan of division (a Plan), which does not need to be filed publicly. The Plan must state:

  1. the terms and conditions of the division, including (x) any conversion or exchange of the LLC interests of the dividing LLC into or for LLC interests or other securities of the division LLCs and (y) the identification and allocation of assets, properties, rights, series, debts, liabilities, and duties of the dividing LLC among the division LLCs;
  2. the name of each resulting LLC, including the surviving LLC if there is one;
  3. the name and business address of a division contact that will have custody of a copy of the Plan; and
  4. any other matters that the dividing LLC determines it should include.

If the four prongs above are met, a resulting LLC is only liable for the debts, liabilities and duties allocated to it in the Plan. The Plan must be adopted in the same manner as a plan of merger. This adoption can be done as specified in the LLC agreement, or if unspecified, the Plan must be adopted by 50 percent or more of the members of the dividing LLC.

Once the Plan is adopted, a certificate of division in compliance with the Divisive Merger Amendment must be filed simultaneously with certificates of formation for the new LLCs in the office of the Delaware Secretary of State. The certificates of division must all have the same effective date or time, including a future effective date.

After the Divisive Merger is effective, all liens on property of the dividing company remain preserved and unimpaired on such property after it is allocated to the division LLC. Each division LLC is jointly and severally liable for any liabilities (i) not allocated in the Plan or (ii) if the division would constitute a fraudulent transfer under applicable law. The Divisive Merger Amendment provides that if a dividing LLC is a party to a contract, indenture, or other agreement with a third party that was entered into prior to August 1, 2018, and such contract has restrictions on mergers, consolidations or transfer of assets, those restriction will apply to a division as if it were a merger, consolidation, or transfer of assets, as applicable. However, for agreements entered into on or after August 1, 2018, no such legal treatment is afforded under Delaware law.

Treatment of Divisive Mergers Under Credit Agreement and Indenture Covenants

Henceforth, it is critical in drafting covenants in credit agreements and indentures that Divisive Mergers involving borrowers, guarantors or restricted subsidiaries either be prohibited or treated as asset sales, restricted payments and/or investments, as appropriate. (For example, if a borrower was to effect a Divisive Merger, it may have the effect of a spin-off dividend, but not be treated as a dividend under the customary covenant language.) As credit agreements and indentures typically do not prohibit the formation of new guarantors or restricted subsidiaries as LLCs, and often do not prohibit mergers by borrowers/issuers with and into LLCs, credit agreement, commitment letter and indenture forms and precedents will need to be revised and likely modified to address the Divisive Merger loophole. While Delaware is the most common jurisdiction of formation for business entities, market participants should also be aware that Texas permits divisive mergers for business entities