LLC conversions and mergers can raise questions about an LLC’s existing contracts. Consider: two individuals guaranty an LLC’s debts to a limited partnership. Some time later, in unrelated transactions, (1) the limited partnership (the creditor) merges into an LLC, and (2) the debtor, an LLC, converts to a limited partnership. Later the debtor defaults and the creditor sues the guarantors to collect. The guarantors claim they are excused because the creditor they promised to pay is not the entity suing them on their guaranty, and the company whose debts the creditor is trying to collect is a different entity than the company whose debts they guaranteed. The guaranty contract is silent on conversions and mergers and does not state that the contract covers the parties’ “successors and assigns,” as many contracts do.
This unwieldy scenario was presented to the Texas Court of Appeals in Wasserberg v. Flooring Services of Texas, LLC, No 14-11-00736, 2012 WL 3016861 (Tex. Ct. App. July 24, 2012). After thoroughly reviewing the arguments, the court found that the conversion and the merger did not excuse the guarantors from their guaranty contract.
Background. Flooring Services of Texas, LP (Flooring LP), a limited partnership, was a provider of flooring products and services for homes built by Waterhill Company, LLC (Waterhill LLC). In 2002 Jonathan Wasserberg and Jason Felt personally guaranteed payment of Waterhill LLC’s debts to Flooring LP, and thereafter Flooring LP continued to provide flooring to Waterhill LLC.
In 2003 Waterhill LLC converted to Waterhill Companies Limited (Waterhill LP), a limited partnership. In 2007 Flooring LP merged into Flooring Services of Texas, LLC (Flooring LLC). Thus the LLC converted to a new limited partnership, and the old limited partnership merged into a new LLC.
Later, Flooring LLC sued Waterhill LP for payment for flooring it had provided, and sued Wasserberg and Felt on their guaranties. The trial court ruled in favor of Flooring LLC on its claim against Waterhill LP, and ruled against Wasserberg and Felt on their guaranties. Wasserberg and Felt appealed.
The gist of Wasserberg and Felt’s argument was that they were not liable on their guaranties for debts owing by Waterhill LP to Flooring LLC because “neither the party seeking to enforce the guarant[ies] nor the party whose performance was guaranteed is named by the existing document.” Wasserberg, 2012 WL 3016861, at *2.
Debtor’s Conversion from an LLC to a Limited Partnership. The Court of Appeals first reviewed the rule of strictissimi juris, which mandates that “a guarantor may require that the terms of his guaranty be strictly followed, and that the agreement not be extended beyond its precise terms by construction or implication.” Id. The court then examined the applicability of Wasserberg’s and Felt’s guaranties to debts incurred by Waterhill LP. Wasserberg and Felt contended that their guaranties only covered debts incurred by Waterhill LLC, and that after Waterhill LLC converted to Waterhill LP, Waterhill LLC no longer existed. Id. at *3.
The court disagreed, however, with the proposition that the LLC no longer existed after it converted to a limited partnership. According to its Articles of Conversion, Waterhill LLC had converted to Waterhill LP under the authority of the Texas Revised Limited Partnership Act and the Texas Business Corporation Act. The Revised Limited Partnership Act at that time provided that “[w]hen a conversion of a converting entity takes effect … the converting entity shall continue to exist, without interruption, but in the organizational form of the converted entity rather than in its prior organization form.” Id. (for the equivalent current version see Tex. Bus. Orgs. Code § 10.106(1)).
According to the court, “the Articles of Conversion and Texas law constitute proof that Waterhill Company, LLC continued to exist in the organizational form of [Waterhill LP] when the goods and services at issue were provided.” Id. The guaranties were therefore applicable to debts incurred by Waterhill LP after the conversion.
Creditor’s Merger of Limited Partnership Into an LLC. Wasserberg and Felt also argued that Flooring LLC could not enforce the guaranties because the guaranty contracts did not name Flooring LLC, and because the guaranty contracts did not have language applying the contracts to Flooring LP’s “successors or assigns.” Id. at *4.
Wasserberg and Felt’s argument relied on Marshall v. Ford Motor Co., 878 S.W.2d 629 (Tex. Ct. App. 1994). The court in Marshall refused to enforce a guaranty of all payment obligations of Jomar Parts Warehouse to Ford Marketing Corporation, “for sales made by Ford Marketing Corporation to Jomar,” after Ford Marketing Corporation merged with Ford Motor Company. Marshall, 878 S.W.2d at 631-32. In Marshall, as in Wasserberg, the guaranty contract did not state that it would continue for the benefit of the successors or assigns of the named creditor. The Marshall court refused to enforce the guaranty beyond its precise terms, which explicitly covered only debts arising from sales made by Jomar to Ford Marketing Corporation.
The Wasserberg court distinguished Marshall, interpreting the language in Wasserberg’s and Felt’s guaranties to cover all credit extended to Waterhill LLC. Unlike the Marshall guaranty, the Wasserberg guaranties were not limited to debts arising from goods and services provided by Flooring LP. The court also rejected Wasserberg and Felt’s contention that when an entity seeks to extend a guaranty to actions by a successor entity, the guaranty must include language so stating. Wasserberg, 2012 WL 3016861, at *4.
Wasserberg and Felt also contended that Flooring LLC presented no evidence that it was the owner of the guaranty contracts. The court pointed out, though, that evidence of the merger of Flooring LP into Flooring LLC had been introduced, and that the applicable merger statutes state that all rights of the parties to a merger are vested in the survivor without the need for any formal transfer or assignment. Id. at n.5.
The Court of Appeals accordingly affirmed the trial court’s ruling, enforcing Wasserberg’s and Felt’s guaranties.
Comment. Wasserberg illustrates the difference between a merger and a conversion. The court easily dispatched the argument that when Waterhill LLC converted to Waterhill LP it became a different entity, by pointing out that the statute says that the converted entity continues to exist, without interruption, in its new organizational form. In other words, it’s a one-party transaction that is treated almost as inconsequentially as a name change (at least as far as third parties are concerned). The converting entity’s business, assets, rights, and liabilities are unchanged.
Mergers are different. They involve at least two entities, and the aggregate business, assets, rights, and liabilities of the resulting, merged company may be much different from those of either of the parties to the merger. The fact that the business of the merged company may be different from that of either party to the merger underpins the result in Marshall. The scope of a guarantor’s liability from guaranteeing the debts of a parts seller to a manufacturer could expand greatly if the manufacturer merged with a much larger company, resulting in greater purchases and greater guaranteed debt. There would be no comparable change flowing from the conversion of an LLC to a limited partnership, or vice versa.
Wasserberg also shows the importance of precise drafting in financial instruments. The guaranty in Wasserberg had stated that it covered all debts of Waterhill LLC to Flooring LP. If its language had instead covered only those debts of Waterhill LLC resulting from product sales by Flooring LP to Waterhill LLC, Marshall would have applied and the case probably would have come out differently.