September 6, 2018 - On Wednesday, the LSTA hosted a webinar on “Credit Agreements, Divisions of LLCs and the New Delaware Law” presented by Emin Guseynov of Orrick, Herrington & Sutcliffe LLP and Sabrina Rusnak-Carlson of THL Credit. On August 1, 2018, an amendment to the Delaware Limited Liability Company Act took effect which enables a limited liability company (LLC) to divide into two or more newly formed LLCs with the dividing company continuing its existence or terminating its existence from and after the effectiveness of the certificate of division. The amendment is designed to facilitate spinoffs and provide LLCs with flexibility in managing and possibly disposing of assets and liabilities; however, because credit agreements generally do not have restrictions on a borrower or its subsidiaries dividing into multiple LLCs and allocating assets and debts to the resultant LLCs, customary protections for lenders under existing and new credit agreements may no longer be helpful.
Importantly, two regulatory protections are provided for in the statute. First, the new section is subject to the statutory fraudulent transfer restriction which is indeed good news for lenders; however, that can be difficult to prove, and there is no clear standard as to what is explicitly permitted or prohibited, and LLCs may be able to transfer certain important assets without violating the fraudulent transfer standard. Second, there is also a regulatory preservation of unimpaired liens; however, the statutory language is not entirely clear, and parties should check their credit agreements and forms to see if they provide for the automatic release of liens in certain circumstances.
All entities formed on or after August 1, 2018, are governed by the new section, and although those formed before that date are also so governed, regulatory safe harbor language provides that if the dividing company is a party to an agreement before that date that restricts the consummation of a merger or the transfer of assets by the dividing company to another party, then such restriction shall be deemed to apply to a division as if it were a merger. Although helpful, it seems that the safe harbor language would not apply to a new LLC formed today. It seems that perhaps the fact that Delaware saw fit to legislate a safe-harbor stating that divisions of pre-August LLCs would constitute transfers for pre-August agreements, suggests that the Delaware legislature thinks that without that safe-harbor, they would not. Lenders should be aware that a Delaware LLC borrower could divide itself into different LLCs, and as part of that, those LLCs could allocate assets to newly formed LLCs (that are not borrowers or loan parties) without violating covenants or triggering any mandatory prepayments under the credit agreement. Loan market participants should carefully review their forms and credit agreements and consider expanding (i) the definition of “asset sale” and “restricted payments” to incorporate the effective transfer or distribution of assets via divisions, (ii) the further assurances covenant to require any LLCs formed under any division to guarantee obligations and pledge assets and equity to the same extent as the original LLC, (iii) the negative covenants related to mergers and other fundamental changes to prevent divisions unless those LLCs become guarantors/grantors under the credit documents, and (iv) to the extent applicable, the restriction on investments in, and dispositions to, immaterial subsidiaries and unrestricted subsidiaries to include the transfer of assets via division. Finally, there is one additional available option which is to include a full restriction on divisions in the applicable Limited Liability Company Agreement. Although this may be the clearest solution, its implementation poses practical challenges, and borrowers may object to this type of blanket restriction. Click here for the presentation and replay; and here for the Orrick Client Alert.