United States: Divisive Mergers And Impact On Fund Financings

Last Updated: April 5 2019
Article by Ann Richardson Knox and Christopher A. Davis


Private equity and other types of investment funds ("Funds") often utilize financing to more quickly access funds for investments, working capital and other purposes. Such financing products include both facilities secured by a Fund's investment assets or the net asset value of the equity in such assets ("NAV Facilities") and subscription-backed credit facilities. Subscription-backed credit facilities, sometimes referred to as "capital call" or "capital commitment" facilities (each a "Subscription Facility" and together with NAV Facilities, "Facilities"), are secured by pledges of the contractual rights of the Fund to require its investors to pay in capital to the Fund from time to time, which rights arise from the Fund's organizational documents. The ability of a Fund to utilize such Facilities and the extent to which the contemplated security for a particular Facility is feasible requires careful review and consideration of the Fund's governing agreement, usually a limited partnership ("LP") or limited liability company ("LLC") agreement.

While prior issues of the Market Review discussed updates in technology relating to Series LPs and LLCs and their impact on Facilities, this article focuses on recent changes in the laws relating to business entities that permit such entities to consummate transactions informally known as divisive mergers (each, a "Divisive Merger"). Such Divisive Merger statutes permit business entities to divide into multiple entities and to allocate liabilities and assets of the dividing entity amongst surviving entities. While other states were first in passing Divisive Merger statutes, this article focuses mainly on the recent changes in Delaware law, as most Funds organized in the United States are formed in Delaware.

Because Divisive Mergers permit business entities to restructure their assets and liabilities more easily, they can create problems for lenders ("Lenders") in Facilities if the effect of Divisive Mergers is not properly considered and accounted for in Facility documentation. In particular, Divisive Mergers may impact Lenders in existing Facilities, as obligors thereunder could potentially allocate liabilities relating to a Facility to other successor entities. Additionally, this could affect the status of capital commitments or asset security for Facilities should such assets be re-allocated to entities that are not obligors. Accordingly, it is important for Lenders and Funds to understand this new technology in order to assess the impact on existing Facilities and to properly conduct due diligence and document new Facilities. This article includes a summary of the changes in law surrounding Divisive Mergers, a discussion of the impact of this new technology on existing credit agreements and a review of considerations for improved diligence and loan documentation moving forward.

Background of Divisive Mergers

The first Divisive Merger statute was passed in Texas in 2006 and related to limited liability companies, limited partnerships, corporations and any other business entity organized in Texas.1 Divisive Mergers, initially unique to Texas but which were also implemented by Arizona and Pennsylvania in 2016,2 permitted such entities additional, flexible restructuring options. For example, such statutes permit business entities to reorganize their assets and liabilities for a number of purposes. Such purposes may include efficient division of entities to end a partnership where equity holders are unable to effectively work together, to spin off certain assets or liabilities so as to restructure an entity's balance sheet or to assign contracts that may otherwise be unassignable. Where used to facilitate asset transfers, such statutes permit LLCs to achieve such objectives without having to execute numerous transfer agreements and potentially without violating transfer restrictions included in the contracts that the dividing LLC may wish to reallocate.3 Not to be outdone, in August 2018, Delaware followed suit by enacting changes to the Delaware Limited Liability Company Act (the "LLC Act"), which permit limited liability companies organized in Delaware (a "Delaware LLC") to divide and allocate assets and liabilities to one or more newly formed Delaware LLCs (such amendments, the "Amendments").4

Plan of Division

Pursuant to the Amendments, an existing Delaware LLC (the "Dividing Company") may divide its "assets, property, rights, series, debts, liabilities and duties" among itself (if the Dividing Company is intended to survive the Divisive Merger) and any new Delaware LLCs that are created in connection with such Divisive Merger ("Resulting Companies," and together with any Dividing Company that survives, the "Division Companies").5

The Amendments provide that a Dividing Company may only affect a division through a plan of division (a "Plan").6 A Plan is required to set forth the terms and conditions of the Divisive Merger, including information as to how the limited liability company interests of the Dividing Company will be treated in connection with the Divisive Merger (e.g., conversion, exchange or cancellation of such interests) and the allocation of "assets, property, rights, series, debts, liabilities and duties" of the Dividing Company among the Division Companies.7 The Plan is also required to include the names of each entity that survives the Divisive Merger, the name and business address of a division contact who maintains a copy of the Plan (a "Division Contact") and other matters which the Dividing Company chooses to include.8 A Plan is not required to list each individual asset and liability of the Dividing Company that is to be allocated, so long as such assets and liabilities are "reasonably identified" by any method where the identity of such assets and liabilities is "objectively determinable."9 While the Plan is not filed with the State of Delaware and, therefore, would not be obtained through a search of the company records, a certificate of division ("Certificate") is required to be filed by "the surviving company" if there is one, or any other Division Company.10

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1 See Texas Business Organizations Code §1.002(55)(A).

2 See 29 Ariz. Rev. Stat. §2601 et seq. and 15 Pa. Cons. Stat. Subchapter F.

3 See Delaware LLC Act §18–217(l)(8) and §18–217(o) (providing that an allocation of assets as part of a Divisive Merger will not be deemed a "transfer" and that a contract that a Delaware LLC is party to that restricts transfers of assets will only be deemed to apply to a Divisive Merger as if it was a transfer of assets if such contract was entered into prior to August 1, 2018).

4 See Delaware LLC Act §18–217.

5 Delaware LLC Act §18–217(g)(1)(b).

6 Delaware LLC Act §18–217(g).

7 Id.

8 Id.

9 Delaware LLC Act §18–217(l)(7).

10 Delaware LLC Act §18–217(h).

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