Delaware limited liability companies (LLCs) may now divide their assets, rights and obligations among two or more newly created LLCs, in what is known as a “divisive merger.” This significant change to Delaware corporate law was introduced by amendments to the Delaware Limited Liability Company Act, which took effect in August. Although similar provisions were already enacted in Texas, their adoption in Delaware law may have a bigger impact on the markets because Delaware is the most common jurisdiction to create business entities.

We have taken a closer look at the structure of divisive mergers, and what they could mean for current and future contracts. The new provisions could create new risks for creditors, because a divisive merger may reduce the pool of assets available for repayment. Because of this, it is important to negotiate contracts which clearly address this issue, to avoid any unintended consequences.

The anatomy of a divisive merger

Before proceeding with a divisive merger, an LLC must create a plan of division, which it is not required to file publicly. The plan must include the following four items:

  • The terms and conditions of the division, including a description of:
    1. Changes to the dividing LLC’s assets and liabilities
    2. Allocation of the dividing LLC’s assets and liabilities among the new companies
  • The name of each resulting LLC, including the surviving one as applicable.
  • The name and address of a contact who has custody of the division plan.
  • Any other matters the dividing LLC wishes to include in the plan.

Under the third requirement, any creditor can present a request to the division plan’s custodian, to obtain the name and business address of the company to which their claim was assigned. The creditors must be provided this information free of charge, but this provision is limited to six years following the effective date of the division.

If all four conditions are met, the resulting LLC is usually liable only for the obligations assigned to it in the plan. The plan is adopted in the same way as a plan of merger – that is, as specified in the LLC agreement or with the approval of at least half of the members of the dividing LLC.

Application of division plan is limited by contracts, legislation

How final is the division? It depends on the nature of the liability and on the completeness of the division plan.

  • Some interests must be preserved: After the divisive merger takes place, all liens on property of the dividing company are unimpaired after they are allocated to a new LLC.
  • Other interests are shared: All division LLCs are jointly and severally liable for any liabilities not allocated in the plan.
  • There is an exception for fraud: If the division would constitute a fraudulent transfer under the applicable law, all division LLCs are jointly and severally responsible for those liabilities as well.

Another important factor is whether the dividing company entered into contractual obligations before the division. If these obligations were created before the amendments took effect on Aug. 1, and if these contracts had restrictions on mergers, consolidations or transfer of assets, those will also apply to a division. If the contracts are entered into after Aug. 1, these protections are not available.

The bigger picture: new contracts should take divisive mergers into account

If a contract created under this new framework involves borrowers, guarantors or restricted subsidiaries, it is important to consider provisions that either prohibit divisive mergers or treat them as asset sales, restricted payments or investments, as appropriate. Conversely, divisive mergers provide additional flexibility for creditors, by creating a new way of managing and disposing of assets.

For both parties, it is important to add clarity to their contractual relationship because it is unclear at this stage how the Delaware courts will interpret contractual provisions under the new legislation. For example, a divisive merger may not be covered by the typical provisions on assignments. Accordingly, both parties should consider concluding agreements that cover all forms of transfers, including divisive mergers, to ensure the agreement provides long-term stability in their business relationship.