CRITICAL DISTINCTIONS BETWEEN TEXAS AND DELAWARE LLC LAW
Texas is becoming an increasingly popular destination for businesses choosing to form an LLC. In this continuing legal education (CLE*) credit-eligible program, we’ll highlight some meaningful differences between Texas and Delaware business entity law and demonstrate how practitioners must be wary of these key differences through a study of relevant statutes and cases.LEARN MORE
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Join Byron F. Egan and Daniel Lewis of Jackson Walker LLP in Dallas as we discuss some of the distinctive aspects of LLC laws, including certain fundamental provisions of Texas Business Organizations Code (BOC) and the Delaware Limited Liability Company Act. We’ll also cover relevant Texas and Delaware cases and applicable federal, Texas, and Delaware tax considerations.
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Annie: Hello, everyone, and welcome to today's webinar, "Critical Distinctions Between Texas and Delaware LLC Law." My name is Annie Triboletti, and I will be your moderator.
Joining us today are guest speakers Byron Egan and Daniel Lewis from Jackson Walker. And with that, let's welcome Byron and Daniel.
Byron: Well, thank you and welcome to everyone. We're talking from Dallas, Texas, where it's a warm 85 degrees, headed up to well over 100 today.
So we have five business entity forms in both Texas and Delaware to choose from. We have the traditional corporation. We have the general partnership. We have the limited partnership. We have the limited liability partnership and limited liability companies. But we're going to be focusing today on LLCs in Texas and in Delaware. We will discuss other entities for comparison and because courts in LLC cases may refer to precedent in those other areas for precedent regarding LLCs.
In the slides that you're going to be seeing there will be references to "Egan On Entities" and various sections and pages. Those are references to "Egan On Entities," my book, "Corporations, Partnerships and Limited Liability Companies in Texas" (Fourth Edition, 2023), which is available from CSC and LexisNexis with the link below.
I said we're going to be focusing on LLCs, and the reason is that we're forming them in Texas at a 15.2 to 1 ratio. Repeat, we're forming over 15 LLCs for every corporation that we're forming in Texas, and the other entities are way down the list. So the result of that is although we've had a corporation for almost two centuries, we now have about five times as many LLCs as we do corporations in Texas.
In Delaware, the ratio is a little bit different. It's about 3.9% LLCs formations in 2022 over corporations, and they now have substantially more, about 3.8% more LLCs in Delaware, even though they've had them for two centuries.
So the focus today is going to be on LLCs. But in Texas, we have a new development that affects LLCs and other entities in Texas. Currently, disputes regarding LLCs and other entities are tried in Texas District Courts, generally jurisdiction courts with elected judges, for which trial by jury is generally and typically available. Appeals go to an intermediate Court of Appeals and ultimately to the Texas Supreme Court. But that is changing.
After 10 years of efforts, in 2023, the Legislature passed a bill to create specialized business courts in Texas. These are analogous to the Delaware Court of Chancery, but a bit different. This is House Bill 19 that we'll be referring to. This bill will take effect on September 1 of '23, but we're not going to have trials for another year, and even then only in the five major metropolitan areas, Austin, Dallas, Fort Worth, Houston, and San Antonio, and surrounding counties. But it takes a year basically after you go effective to begin to get judges appointed, to have rules adopted by the Supreme Court, and so on. Appeals from the Business Courts are going to be heard by a newly-created Court of Appeals and ultimately to the Supreme Court.
With a new court system with appointed judges, we're going to have likely challenges to the constitutionality of the legislation, and the legislation provides that there's a direct appeal to the Texas Supreme Court. It has original jurisdiction over any constitutional challenge. So if there is one, that's how it's going to play out.
The hot button issue has been are the judges going be elected as they are currently, or are they going to be appointed judges? And what the Legislature decided is we're going to have Business Court judges appointed by the governor, with the advice and consent of the Texas Senate, and they're going to be appointed to two-year terms and may be reappointed at the end of that term. That's basically a constitutional requirement.
The judges, they're seeking to have experience in business disputes and transactions to be the judges. So they'll have to be licensed attorneys. They will have to have at least 10 years of experience in complex commercial disputes and transactions and must have been a resident of the county within the division of the court to which the judge is appointed for at least five years. So the idea is to give you both experience and local judges.
The Bill contemplates that the Supreme Court will be adopting procedural rules and that the courts will be providing written opinions that will have precedential value and serve to enhance the commercial certainty. Currently, District Courts typically do not write opinions that are published with respect to their decisions. So there is somewhat of an uncertainty as to what Texas law is until you get appeals. The Courts of Appeals, both the civil appeals and the Supreme Court will currently be having written opinions, and now the Business Courts will also.
The Business Court cases may be tried to a jury when required by the Constitution. The contemplation is that most cases will not have jury trials. But it's a constitutional right, and we'll see how it plays out.
Jurisdiction has been a difficulty in the Legislature. What kind of cases of cases are going to go to the Business Courts? And what the Legislature ultimately decided is that first you want significant disputes. So the courts will have jurisdiction over cases where the amount in controversy exceeds $5 million, and those will be derivative proceedings, breach of fiduciary duty claims, matters of corporate governance, piercing the corporate veil claims, securities claims, and the like.
Then there's another level where the amount in controversy needs to exceed $10 million, and that's very complicated. The Bill goes for a couple of pages in detailing the jurisdiction. But the essence of it is that there will be financial loan agreement transactions, except in the case of banks or savings and loans or the like, and then there will be another class for purchase and sale agreements if the parties have agreed initially or subsequently to Business Court jurisdiction. So that's going to be an issue for us sit-down lawyers. Are you going to provide in your agreements for a choice of venue, and if so, are you going to provide for Texas law to govern and for the cases to go to the Business Court, assuming they meet the other jurisdictional requirements?
There's an exception that if it's a publicly traded company or the case involves injunctive or declaratory relief, then there's no amount of controversy required.
Delaware is similar, but they're quite a bit different. Disputes in Delaware regarding LLCs are typically tried in the Delaware Court of Chancery, which is an equity court of limited jurisdiction with appointed judges, and they do not have any jury trials. Appeals from the Chancery Court go directly to the Supreme Court.
So this is a change in Texas law that you'll be seeing unfold. The first cases will be a year out, but there will be a lot of planning in between.
Texas originally had its entities in separate statutes, like Delaware does today, with one for corporations, one for partnerships, and one for LLCs. But in 2003, the Texas Legislature decided that all business entities, including nonprofit corporations, ought to be in one code, one business organizations code, one statute book. And so any new entities formed after January 1, 2006 would be under the new code, and after 2010, all Texas entities are going to be governed by the Code.
The TBOC codified source law, and it's been amended in every legislative session, since and including the one ended May 29, and that's in response to cases and other states' statutory changes. We have a Bar committee that develops laws and watches what's going on elsewhere and in our courts and recommends changes. And we have a Texas Business Law Foundation which hires a lobbyist to get the stuff filed and passed.
The organization of the Code is it has a hub and spoke approach. And the hub is basically in Chapters 1 and 2 in Title 1, and that will deal with definitions. It will deal with the formation of entities. It will deal with mergers of entities. It will deal with indemnification and other things that are common to all forms of entities. There will be, of course, differences between the forms, but the idea is to have a hub with the common provisions and then the spoke in separate provisions. So we'll have a chapter for corporations, one for LLCs, one for partnerships, etc.
The Delaware statutes are like Texas used to be, a separate statute for each kind of entity. And the Delaware LLC laws are in the Delaware Limited Liability Company Act.
So Daniel, these entities are taxed, and that's going to be important in your choice of entity. Do you want to tell us a little bit about it?
Daniel: Indeed. Absolutely. Thanks, Byron, and thank you, everyone, for attending. So we're going to pick up now with an aspect of entity choice that is always at the top of people's minds, which is tax. And obviously, people tend to want to minimize their taxes when they can. So this is something that you definitely ask your client about and you think through as you make those decisions.
So jumping right in, we've got a few stats here on corporate taxes. And I think the key difference to remember between corporations and LLCs, both in Delaware and Texas, is the pass-through treatment versus being taxed at the entity level. Corporations are going to go ahead and pay taxes at the entity level, whereas an LLC will pass through to its members. And I guess I just kind of jumped the gun and got ahead of myself a little bit. So I won't belabor the point here.
In Texas, you also need to be cognizant of your margin taxes. Those are going to be due in May every year. And as a general rule, this is going to apply to all business entities, with a couple exceptions we've listed for you all here. This is basically your gross receipts after some deductions for some of these items below listed here, your W-2, cost of goods sold, 30% of gross receipts, or just $1 million. And although you might think that looks, sounds, and acts a lot like an income tax, the Supreme Court of Texas would disagree with you based on a 2012 case, the Allcat Claims Service, L.P. case.
And so I won't get into all the nitty-gritty since you can read it for yourself here as well as in "Egan On Entities." But ultimately, you're going to be looking at paying a portion that has to do with your Texas gross receipts versus U.S. gross receipts.
So we've discussed some of the aspects of Texas entity taxation. Now let's take a look at Delaware here. The corporate tax rate is a little bit higher than a lot of states. And we know that Texas actually does not have a corporate income tax, although, as we just discussed, there is that margin tax. But the Delaware General Corporation Law is going to have some generous exemptions here. And so it very well may be that you don't end up paying a great deal in the way of Delaware corporate income tax if you maintain your statutory corporate office or if your activities are considered confinement and maintenance or management of your intangible investments, which captures quite a few Delaware entities. So that's something to consider.
But now let's turn to the entities we're more focused on today, LLCs. Delaware's state income tax does not apply at the entity level to an LLC unless you want to, for various reasons, opt in. I'm not a tax expert, so I won't presume to know what those reasons might be, but suffice it to say it's always good to consult with a tax expert.
It is good to bear in mind that LLC members might be taxed differently based on whether they are a resident or a non-resident and based on where the income is sourced or attributable to.
So let's take a moment here and shift gears just a little bit and discuss some of the basic vocabulary that comes into play when you're dealing with LLCs in Texas. So whereas in a corporation you've got shareholders or stockholders, in a limited liability company you've got members, who are the owners. They're analogous to shareholders. You could have a member-managed LLC. We do see that a fair amount. Or you might have a manager-managed LLC. Managers are essentially the same thing as the directors on a corporation's board. Again, those managers might be the members, they might not be the members. It's up to you to decide, and so that's something to discuss and spell out in your governing documents.
Now let's take a quick look at a little bit of LLC vocabulary that's pertinent to Delaware. If you're an LLC in Delaware, the Delaware Limited Liability Company Act will govern you. Just as in Texas, the LLC's owners are members and are again analogous to the stockholders or shareholders of the corporation.
So the first governing and kind of formative document that you would need to get your LLC up and off the ground is your certificate of formation. In Texas, you are going to file that with the Texas Secretary of State, and it's also going to come with a little filing fee. Just a quick Google search will do the trick, you can find a template certificate of formation, and the Texas Secretary of State even provides this nice PDF where you can just fill in and sign.
But however you go about it, you want to make sure your certificate of formation contains these items that we've listed out in the second bullet point here. So what is the entity's name? You've got to state that it's an LLC and so on and so forth. I won't hash out all of these. Again, feel free to access the slide deck afterwards or check this out more closely in "Egan On Entities." But the gist of it is you just want the Secretary of State to have some basic info about you and how they can contact you and just kind of be aware of what companies are out there and existing in the state.
One final point to flag here, if you change managers, that doesn't necessarily require you to amend your certificate of formation. You may want to anyway, and it can just kind of help keep everything clean. But that's just something worth noting.
The certificate of formation, like we said, is going to get filed with the Secretary of State. Generally, it's going to be effective when it's filed. But you could also in your certificate say that you want to delay the effectiveness for whatever reason.
You might also form your LLC under a plan of merger or conversion, in which case you'll need a separate certificate of formation that's filed with the certificate of conversion or merger.
And generally, a Texas LLC can conduct any lawful business. It's got kind of broad powers and capabilities. But you could also choose to restrict what your company is going to do by stating otherwise.
I think the key thing to bear in mind when you are going to name your LLC is you need to have something like LLC or limited liability company in the name. It's obviously a little confusing to everyone if you go around naming things ABC, Inc., but it's not a corporation. It's actually an LLC. And so that's what drives that rule.
Let's see. Now I'll leave it to folks to guide them to a couple of these other finer points in the book if they so choose.
Now let's turn to where most of the meat and potatoes are going to be in a Texas LLC's governance. It's going to be in its company agreement or a limited liability company agreement, as you might otherwise hear these things called. In Texas, we tend to call them company agreements. This is going to really spell out how things work for this entity, who is going to manage it, how are we going to govern its securities, its membership interests.
There's a little bit of maybe some interesting things that come up when you don't actually write out your company agreement. As a little bit of an aside, I did some research into this a little bit last fall, where we had some doctors and medical investors who had an LLC, but they never actually wrote out a company agreement. And things went south, and it suddenly became rather difficult to discern: Well, what were we going to do? How was this going to be governed? How was it going to be managed? We don't know any of these things because no one wrote it out. That doesn't necessarily mean that it can't be oral or implied, but it does get messy and it's probably going to help guide everyone if you just write it out. And for what it's worth, if you just hopped onto Westlaw, you can find a nice little practical law form for Texas that gives you a really good starting point.
Other things you might see in a company agreement, besides management or officers and whatnot, you'll probably also want to discuss capital accounts and how gains and losses are going to be allocated, how distributions will work. People are usually going to be very interested in the distribution of gains. That's typically how you're going to get paid in all of this.
And a few other things to point out, you can, in fact, have a single-member LLC that you might think, "Well, why would you really need a company agreement if there's just one person involved?" There could be a number of reasons. Maybe this is going to be a wholly-owned subsidiary, but it might get moved around in your corporate structure. It might get sold to someone else, in which case they're kind of stepping into these shoes here. So just because there's only one member also doesn't necessarily mean that you want to bypass this step. It's still probably going to be a good idea to have that company agreement there just to again spell out how everything is going to work.
Now let's turn to Delaware a little bit. Just as in Texas, you're going to form your limited liability company with a certificate of formation. It's going to have that same general list of basic information, which again is really just aimed at helping the Secretary of State know what entities exist in the state, how to get in touch with them, and just kind of that basic information.
In Delaware, we also see limited liability company agreements. They don't tend to get called company agreements the way they do here in Texas. It will usually just be called the limited liability company agreement and often will get abbreviated as LLCA. Again, you're going to see pretty similar things to Texas. You're going to want to spell out management here. Is it member-managed? Is it manager-managed? How many managers are there? Are there officers? Things like that. This is also going to discuss distributions, allocations, capital accounts, and how money is going to move and flow through this entity.
So looking a little bit more closely at management here and flipping back to Texas, if your LLC is manager-managed, again that just means managers are going to oversee it. They might be members as well as managers, but they might not be. This is basically just going to go ahead and make them separate and distinct, which can be helpful if you want to swap out managers, if members might buy or sell their membership interests, and things of that nature. Your managers don't have to be natural persons. They could be other entities. We see that all the time. Again, it's kind of up to you. Limited liability companies are sort of a business sandbox. You can do most anything you want with them, which is part of their beauty is their flexibility.
You probably also want to take some time in your company agreement to state who can bind this LLC in contracts and otherwise. You don't want some member going rogue and starting to sign contracts and get you locked into leases and other things without the other members being on board with that. So that's something you would do well to spell out here.
Again, you should probably also take a little bit of time and just think about what's the process for choosing your managers. How long are managers going to be managers? If we don't like what they're doing, can we remove them? One of the first things I did with Byron, when I came to our firm, was we had a client who used to be a manager at a company and was getting a little dissatisfied and frustrated by the current management, and he was trying to figure out how to remove them. And we ultimately had to think of some creative ways because the company agreement itself did not actually say how long the managers were going to be managers or how you can remove them, things like that. So it's also worth just thinking through that process and making sure everyone knows how that's going to work if things maybe get a little bit south down the road.
An LLC can have certain agents, and this is again something you can look into in a little bit more depth in "Egan On Entities." But I think just to keep things moving along, that can conclude our management portion. Byron, I'll turn it back over to you for fiduciary duties.
Byron: Well, fiduciary duties are certainly a hot button issue. And of course, the question is what is a fiduciary duty and who owes it? In a corporation, a director owes the duty to be careful in what is being done, to be informed when the director makes a decision. And one of the challenges in the courthouse is were the directors adequately informed. Another question is, is the director acting in the best interest of the corporation, or is the director acting in the director's personal interest? That's the duty of loyalty. And then we have the duty of obedience, which is basically to follow the law and the governing documents. That's a corporation.
The TBOC, by the way that is the Texas Business Organizations Code, it does not specifically address whether managers or members have fiduciary or other duties. It doesn't even attempt to define them. But it implies that they may exist under various statutory provisions that permit a company agreement to expand or restrict them, and may even limit or eliminate the duties or the liabilities for breaching them. So that's a critical point of what you're going to put into your company agreement. And if you're silent, then there are going to be the traditional corporate fiduciary duties.
In a manager-managed, so we talked about management, and in an LLC you can have managers who are the equivalent of directors who manage the business and affairs of the company and elect officers or select officers because this is very much a matter of contract. But it could be managed by the members. You can do essentially the same thing in a corporation. But the managers, be it the elected managers or be it the members that are managing the business are going to be generally assumed to have fiduciary duties managed and measured by reference to the corporate duties. That's if the company agreement doesn't say otherwise.
But that gets to our duties as to drafting as lawyers. So by analogy to corporate directors, managers can have the duties of obedience, care, and loyalty and would have the business judgment rule benefit. So the business judgment rule, in the corporate context, is that the courts will defer to the business judgment of directors when they make decisions.
It's not the business of the court to second-guess the business judgment of a director. But then, of course, courts can't resist doing it. So particularly in Delaware, they're going to grade whether the directors or the managers got enough information to make an informed decision. Texas tends not to second-guess managers or directors. The courts sort of say the manager is making the decisions for the business, and that includes how much information that manager should have. So that's the difference in Texas and Delaware law, that fiduciary duties are generally owed to all of the members of the LLC, just like the corporate fiduciary duty is owed to all of the corporation's shareholders.
Now you can write in your LLC documents to whom the duties are owed. But that presupposes that there are going to be duties. So as we said, the presumption is that there are fiduciary duties, like corporate fiduciary duties, but the TBOC in these three sections allows a company agreement to expand, restrict, or waive duties, any duties, including fiduciary duties, and associated liabilities of members, managers, officers, and other persons to the LLC or to its members or managers. So that's a contractarian approach to it. Delaware essentially follows the same approach. To the extent that any or all fiduciary duties are waived, there will be no fiduciary duty to breach, and thus there would be no liability for breach of fiduciary duty.
TBOC §7.001 allows for the limitation or elimination of liability, so the focus is on liability, to the LLC or corporation or other entity for breach of fiduciary or other duties and, in the case of a member-managed LLC, of those members with management responsibilities, with a big exception for a breach of the duty of loyalty, or acts of bad faith, or where the person is receiving an improper personal benefit, or where there's a statutory liability, like for breach of securities laws. So that §7.001 applies to corporations and partnerships, etc., whereas 101.052, etc. apply only to LLCs. So that's a big difference.
A company agreement provision restricting or eliminating fiduciary duties and limiting or eliminating liability as permitted could read as follows. I'm not going to read the whole thing to you, but you get the idea. The agreement is not intended to and doesn't create or impose any fiduciary or other duty on any member or manager. Furthermore, the members and managers, to the fullest extent permitted by applicable law, which is defined to be the TBOC, allow the elimination of duties or restrictions, then we agree that the obligations are contractual in nature and are only as expressly set forth. So we're basically waiving all other duties.
And then we say that to the extent there is a duty, it's not fiduciary. A breach of the fiduciary duty is a tort, for which there are remedies and that includes punitive damages. But a breach of contract is a breach of a contract, and that's usually limited to actual damages. There are obviously exceptions to all of these things.
So then you get into, well, wait a minute, if you have eliminated all of the duties, except as set forth in this agreement, then what are the duties? And that gets to be dicey. You want to limit things. So what about competition with the entity? You certainly don't want to authorize somebody to steal money from the entity. You want people to be using the assets of the company for the benefit of the company and so on. So those are things that you need to spell out in your company agreement if you're eliminating fiduciary duties.
And then what about other business relationships? Business opportunities, are they going to be waived? If you've got a private equity investor that's making lots of investments in lots of portfolio companies, it may want to restrict what the managers of this particular company can do, but have absolute leeway to do whatever it wants to do with its other companies.
So these are highly negotiated provisions, and sometimes your investors may not agree to the limitations. And by the way, as lawyers, we've got to think very carefully, is elimination or waiver of fiduciary duties right in this situation? That's a question, and we're going to have to answer it for our clients. And if they don't ask us, we ought to be discussing it with them.
Now, in Delaware, there is a common-law duty of good faith and fair dealing. And I've had dialogues with the Supreme Court justices in Delaware. I say that you've eliminated fiduciary duties, but in your opinions basically using good faith and fair dealing is a way to morph into fiduciary duties which you've otherwise eliminated, and they, of course, disagree with me. But in Texas, it does not exist in all relationships. Where there is a "special relationship" between the parties, as in an LLC, then there may be an implied duty of good faith and fair dealing. So that's the case law thing that you just need to think about.
There are no reported decisions about good faith and fair dealing in the LLC context. But it's likely that, just like fiduciary duties, in the right case a court is going to find them.
TBOC 101.601 provides for the principle of freedom of contract to be applicable to LLCs, which allows the elimination of fiduciary duties as we talked about.
101.255 is based on the corporate statute, which allows a corporation for transactions between the managers and members of an LLC and other entities that have a financial interest in the transactions, and it will not be void. But for it to be enforceable, material facts have to be disclosed to the people that are approving it or known and so on and so forth.
In a joint venture, the duty of a manager to all members could be an issue since the joint venture very often has the management determined by a particular party, who they expect to be operating in their benefit. So it's again one of the things you need to deal with.
In Delaware, they went through a long period of time where it was uncertain about fiduciary duties, whether they can be eliminated. The Limited Liability Company Act does not codify them, but provides that they may be eliminated. And another statute says that unless modified, common-law fiduciary duties apply to LLCs in Delaware. Again, Delaware is a contractarian state, and it will allow waivers of fiduciary duties.
We've got a sample provision eliminating fiduciary duties that basically says that we're waiving and eliminating all fiduciary duties, but we're not eliminating the contractual covenant of good faith and fair dealing, which is non-waivable under Delaware law. Obviously, as in Texas, there can be serious negotiations as to how that is going to work.
In Delaware, if you're going to limit fiduciary duties, you've got to be very careful that you're very expressed as to what you're doing. In at least one situation, the chancellor said that an agreement's coyness can make it unenforceable. So if you're not precise in what you're doing, you may by limiting the liability create a concept that, except as you expressly set forth, all of the fiduciary duties are in there. So you've got to be very, very careful.
Caremark is a concept in Delaware that's pretty serious because what that takes is what looks like a duty of care obligation violation and makes it a duty of loyalty violation. So in Delaware, this is the Caremark doctrine. They can be found to have violated the fiduciary duty of loyalty when they fail to act in the face of a known duty to act.
And for Texas folks, they'll remember Blue Bell Creameries. That's a Delaware Supreme Court opinion in Marchand v. Barnhill, where Blue Bell was a Subchapter S Delaware corporation, headquartered in Brenham, Texas, and it made ice cream that was tainted with listeria in one instance and eight people were sickened and three died. So that produced a recall of the ice cream, a suspension of operations, a laying off of a third of the workforce, and to survive they had to enter into a highly dilutive transaction with a private equity investor. Needless to say, there's a lawsuit that gets filed and the derivative action alleging the directors breached their fiduciary duties.
The Delaware Supreme Court held that, while Blue Bell had food safety programs in place and nominally complied with FDA regulations, and the Vice Chancellor had found that the board got information, that they knew that management had these programs in effect, but the directors were not hands-on involved. So the Court writes the complaint alleges that Blue Bell's board had no committee overseeing food safety, no full board-level process to address food safety issues, and the board had no process for safety reports and developments to be reported to it.
So the bottom line is the directors had a duty of loyalty to make a good faith effort to have a system for monitoring the compliance risks and that the failure to do that was a failure to satisfy mission-critical compliance obligations. And the directors were liable. So that suggests that boards of directors of corporations should have special committees tasked with monitoring corporate risks and so on and so forth. After Marchand, there have been a number of Caremark kind of cases in Delaware, and it's going to surface more and more in Delaware disputes.
Caremark has not been adopted by the Texas courts. What is a Caremark duty of loyalty claim, they would treat as a duty of care claim. And under Gearhart and Sneed v. Webre, there would be strong Texas deference to the business judgment of the directors. So the idea is courts are not willing to second-guess the business judgment of directors.
Joint ventures, Daniel, do you want to talk about those?
Daniel: Absolutely. Okay. So a joint venture, or you might hear it sometimes just referred to as a JV in corporate slang, is where two, and it can be more than two, but generally two entities are going to team up and come together to do something. It could be in a real estate context. Maybe it's to buy an airplane. It could be all sorts of things. And generally, an LLC is going to be the best way to formally, I guess, implement this decision to team up.
And so if you want some more details on how things might go a little bit wrong if you just start throwing around the term "joint venture" and you don't really mean it, you can read up on this Dernick Resources Inc. case in "Egan on Entities." Given our time, I'm going to go ahead and move on though.
Here's one case that's worth flagging while we're discussing JVs though. This is Energy Transfer Partners. It's a decently famous case here in Texas now. So what we had was ETP or Energy Transfer Partners and Enterprise, they have similar names, sorry for the confusion there, entered into these agreements. And they said, look, we're not going to be obligated to do anything until we've executed a definitive joint venture agreement or sometimes you'll hear it called the JVA. That's really just in Texas your company agreement or in Delaware your LLCA. And we need the JVA to be approved by our boards of directors.
So they never actually did sign their definitive JVA. But they went ahead and they were spending time and money on the projects. Things seemed like they were doing well. They were kind of holding themselves out to the public as being a joint venture. They'd market this pipeline to potential customers still kind of holding themselves out as a joint venture. But their marketing efforts did not get them where they wanted to be.
And so as is always the case when we're looking at a court case, things went south. And so Enterprise said, all right, look, we're terminating, and we're not going to participate anymore. And we're going to go and make an agreement with another large pipeline company. Well, ETP did not like that. They sued Enterprise. They said, look, we had this agreement. You breached it, and what's more you had fiduciary duties.
So all they really had though were these preliminary agreements. No one actually signed it and was bound to it you might think. And so the jury found that, hey, even though you didn't sign this, your ensuing conduct did make this a Texas general partnership. And so, yeah, you did breach your fiduciary duty of loyalty. And so a big, ole basically a half billion dollar judgment was entered in favor of the ETP.
The Supreme Court of Texas held that actually no, no partnership was created. We had an NDA and we had a letter of intent, and those things spelled out that no party was bound to proceed with the transaction unless and until a definitive JVA was executed. They never did actually execute a JVA, and so no, there's no actual duties the Supreme Court of Texas said.
I'd say the punch line here is this is a good cautionary tale about, number one, if you been negotiating definitive deal documents, make sure those get signed before you actually go out there and start running the joint venture that you're going to run. Otherwise, if things go badly, your counterpart might decide they want to drag you into court and sue you for a lot of money. And it also illustrates that actually in Texas we're not necessarily going to find that your course of dealings implied that there was a partnership here. But I want to also put that little caveat here that their NDA and their letter of intent that they did sign had expressly talked about, look, if we don't actually sign definitive deal documents, then we're not bound.
So what would happen if you didn't have the signed NDA and LOI that said that? That's a question for another day. Suffice it to say I would not risk it. I would make sure you sign everything.
Okay, so having gone through that, let's look a little bit at business combinations. So LLCs can merge with one or more other LLCs or other entities, like corporations, partnerships, and whatnot. This is mostly just going to depend on what your constituent documents, your company agreement, your certificate of formation, and whatnot allow.
Also a Texas LLC can merge with or it can turn into a Delaware LLC. I did that for number of entities earlier this year, as well as the other direction of going Delaware to Texas. Not an especially complicated process. And the Texas Secretary of State and the Delaware Secretary of State very helpfully have a lot of fill and sign PDF forms that will help guide you through that. But it is a bit of an endeavor. You're going to want to update your governing documents. You don't want to have a Texas LLC's company agreement talk about how it's a Texas entity and it's going to be governed by Texas law and whatnot, turn it into a Delaware company and then not update that. That can create some hiccups that you would probably prefer to avoid.
Given where we are on time, I think suffice it to say your merger is going to be governed by a written plan of merger. It's going to need to be filed with the Secretary of State. And you can look at "Egan On Entities" to get some more details on that.
You're going to want to make sure that you have complied with your governing documents as you go about a merger. Generally, the default is that a majority of the LLC's members by membership interest need to approve these sorts of things. Although you've got to check your governing documents. Maybe you have a company agreement that requires a super majority for something like this, which is not uncommon. The point being you need to make sure everyone is on board. Otherwise, you might try to go through with the merger and you could find yourself getting dragged into court by disgruntled members who you just kind of railroaded into doing this.
Let's see. Then another thing to apply here is your company agreement is typically going to have some restrictions on just assigning of membership interests. You don't want to just start handing out your membership interests willy-nilly. That could get you in trouble with the SEC or the IRS or cause Texas franchise tax problems and all sorts of things. So again, look to your company agreement. Make sure you read it carefully and know what it says and comply with those restrictions on assignment.
Byron, I'll defer to you here, but I know we're pretty short on time at this point.
Byron: Daniel, you were just talking about business combinations. And Texas, since 1989, has had the concept of a divisive merger. We thought, well, you could put entities together. So why not be able to divide them by a merger? So we define merger to include the division of an entity into two or more new domestic entities or organizations. You have to have a plan of merger that provides how that's going to happen and how you're going to divide and allocate the property and the assets among the entities. But if you have it expressly done, then you're basically . . .
Okay, a divisive merger is done pursuant to a plan of merger that specifies how the assets are allocated and how the liabilities are allocated. And under our statutes, if you are expressed as to what you're doing, then the court will respect that allocation. So you can put assets in good company and bad company and liabilities the same way and minimize some of your liabilities. But there are a couple of exceptions, and the big one is you can't impair the rights of existing creditors. So if somebody has got a security interest, you can't violate that security interest. If you've got a transfer, it may be a fraudulent transfer if you don't have adequate assets being left in both entities to satisfy creditors.
So that's a short summary of what you can do for a divisive merger. That's a very complicated situation. Delaware has a similar concept. They call it a division. But we allowed it for corporations, partnerships, and limited liability companies. So any kind of entity can do it, the divisive merger. In fact, we can even do divisive mergers with other states' entities. We've said that a Texas entity can effect a divisive merger with another state if the laws of that state permit it. We can merge with a billy goat if the laws governing the billy goat so permitted it.