The 2018 annual revisions to the Delaware Limited Liability Company Act, Del. Code Ann. Tit. 6, § 18-101 et seq. (the “Act”), bring two key changes. As Delaware LLCs are a favored legal entity to develop and hold real estate, lenders to these entities should pay particular attention and supplement their loan documentation accordingly.
- Effective August 1, 2018, the Act now allows an existing LLC to divide and allocate assets, which may result in a potential loss of loan collateral.
- Effective August 1, 2019, the Act will allow LLCs to formally register series with the Delaware Secretary of State, allowing lenders to track a series’ assets and liabilities.
While the ability to register series solves confusion concerning the filing of UCC-1 financing statements, the idea of a borrowing LLC dividing into multiple LLCs can leave lenders scrambling to keep track of their loan collateral.
1) Dividing LLCs; effective August 1, 2018
Delaware is now following in the footsteps of Texas and Arizona, giving LLCs the ability to divide into two or more distinct entities, not necessarily resembling the original entity. If the LLC’s currently in force operating agreement, before August 1, 2018, prohibited or conditioned a merger, this provision will remain in force and the division will be treated as if it were a merger. Barring any such restrictions, a vote of a majority of the voting interests of the LLC allows the LLC to adopt a plan of division under § 18-217(g) of the Act, whereby the resulting companies are listed, the division of membership interests are detailed, and an allocation of the assets and liabilities of the newly formed companies is described. To effectuate the division under § 18-217(h) of the Act, a certificate of division is filed with the Delaware Secretary of State listing the name of the original LLC, whether the original LLC will continue in existence, the name of each new LLC, and the name and address of each division contact for each new LLC. It is important to point out that the allocation of assets during this process is not considered a transfer or distribution under Delaware law, and the division of the original LLC is not considered a dissolution, even if the original LLC does not survive.
The new changes provide comfort for lenders in two ways. First, the Act provides that the obligations of the original LLC, although allocated pursuant to the plan of division, are not invalidated in any way as a result of the division. Second, under § 18-217(l)(6) of the Act, the “debts and liabilities of the [original LLC] that are not allocated by the plan of division shall be the joint and several debts and liabilities of all the [resulting LLCs].” Although these two protections now appear in the Act, a review of lender’s loan documents is necessary and changes such as restricting the division of a borrowing LLC should certainly be considered.
2) Registered series; effective August 1, 2019
Before the 2018 revisions, LLC series created pursuant to an operating agreement did not have to be filed with, and were therefore not tracked by, the Delaware Secretary of State. Instead, the certificate of formation only needed to contain a general notice of the limitation of liabilities concerning the individually created series. Now, pursuant to § 18-218(a) of the Act, a series may be established as a registered organization by filing a certificate of registered series with the Delaware Secretary of State.
Before lending to a series, a lender should require that the series become registered. By formally documenting the series’ information- the LLC it is tied to and a list of the specific assets associated with such series- several concerns are put to rest. First, Lenders often have trouble, or are at least uneasy, about lending to a series due to the worry of properly perfecting a security interest. Because a series is not a registered organization, UCC Article 9 treats a series as an individual or a non-registered organization. However, the definition of individual is not defined in the UCC and a non-registered organization is defined as “any other legal or commercial entity,” which causes confusion as a “series” is not defined as an entity under the Act. Until now, and until a series is registered with the Delaware Secretary of State, it is not only difficult to determine the location of a series, but questions arise as to whether a series even falls under the scope of UCC Article 9. By adding a requirement to register a series before a loan closes, both of these concerns are addressed. An Article 9 UCC filing on a particular series LLC will be a properly filed UCC statement.
If you would like to learn more, or as a lender would like proposed language to add to your standard documents, please contact Ted Harrington at [email protected] or any of our commercial lending attorneys at Boodell & Domanskis, LLC for assistance.