First State Update:
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From a global perspective, the Delaware LLC continues to be one of the most flexible business entities. Join us as we take a detailed look at the 2018 amendments to the Delaware Limited Liability Company Act in this free CSC webinar. Inform and advise your clients looking to make the most of Delaware’s limited liability company statute with the most up-to-date information in your repertoire.
Join Matthew J. O’Toole, Christopher N. Kelly, and Michael P. Maxwell of Potter Anderson & Corroon LLP as they share their insights, outline associated case law, and discuss amendments to the act. O’Toole is also senior legal advisor to CSC and LexisNexis for their joint publications, as well as a co-author of the detailed guide on the subject, Symonds & O'Toole on Delaware Limited Liability Companies. Messrs. Symonds and O'Toole serve as legal advisors on CSCPublishing's Delaware Laws Governing Business Entities Annotated.
Anu: Hello, everyone and welcome to today's webinar, "First State Update: 2018 Case Law Development and Updates to Delaware's LLC Act." My name is Anu Shah and I will be your moderator. Joining us today are guest speakers Matthew O'Toole, Christopher Kelly and Michael Maxwell of Potter, Anderson and Corroon LLP. And with that, let's welcome Matt, Chris and Mike. Matt, would you like to kick things off?
Matthew: Thank you, Anu. Good morning, everyone. We're glad you could join us this morning. As Anu said, my name is Matt O'Toole. I'm a partner with Potter, Anderson in Wilmington, Delaware. My partner, Chris Kelly is a litigator who frequently appears in Delaware Chancery Court cases involving Delaware business entities including LLCs. He's also a frequent writer on Delaware law topics including LLC matters. Chris will start today's program by surveying just a few of the cases involving Delaware LLCs that were decided by the Delaware Chancery Court this year and the first of those cases is the Miller case. Chris, we'll turn it over to you.
Christopher: Thanks, Matt. So our first two cases today deal primarily with the implied covenant of good faith and fair dealing. So to set the stage, let's go over a few of the key principles guiding an implied covenant analysis. The implied covenant in here is ever contract governed by Delaware law including LLC agreements. It's mandatory and non-waivable. LLC agreements may not eliminate the implied covenant that's statutorily required. LLC agreements may not limit or eliminate liability for a bad faith violation of the implied covenant.
The implied covenant embodies the law's expectation that each party to a contract will act with good faith toward the other with respect to the subject matter of the contract. However, it's a free floating requirement that a party act in some morally commendable sense. It won't override the express terms of the contract. However, because gaps always exist in contracts the implied covenant may be used to imply terms to fill those gaps.
The implied covenant is applied cautiously by courts. It's a narrow gap filler. As a result, it's rarely invoked successfully. Further, when fiduciary duties are disclaimed, a court will be all the more hesitant to resort to the implied covenant.
The typical case for application of the implied covenant is where a party acts unreasonably or arbitrarily in an unanticipated way frustrating the fruits of the bargain that was struck between the parties. Essentially one party violated the spirit of the contract, if not, it's explicit terms.
However, the implied covenant cannot be used to save a party from a bad deal and it cannot replicate fiduciary duty review. With those principles in mind, let's turn to the first case, Miller versus HCP & Company. As alleged in the complaint, Christopher Miller cofounded Trumpet Search LLC in 2008 and was a member and manager. HCP was a private equity firm that first invested in Trumpet in 2014. At the time, it acquired a majority of Trumpet's class D units and became the largest member of the LLC. Then in 2016 HCP purchased almost all of Trumpet's newly created class E units and in connection with that investment the parties amended Trumpet's operating agreement.
Under the amended agreement, HCP was entitled to a first priority return of 200% of its class E capital contribution. The distribution waterfall in the amended agreement effectively would give HCP which also held 90% of the next in line class B units. The first 30 million in any sale of the LLC, before any proceeds would go to the other members. The operating agreement waived all fiduciary duties of Trumpet's members and managers and provided HCP the right to appoint a majority of Trumpet's seven person board.
The agreement also gave the HCP controlled board the right to approve a sale of Trumpet to an independent third party and provided that the board could determine in its sole discretion the manner in which a third-party sale would occur whether as a sale of assets, a merger, a transfer of membership interests or otherwise. If the board approved the sale, the operating agreement obligated every member to consent to it.
A few months later HCP allegedly pushed for a sale of Trumpet to MTS Health Partners, a third party that was unaffiliated with any of the Trumpet members and managers. MTS initially offered 31 million to buy Trumpet. In response the non-HCP managers objected to the lack of an open market sale process and what they perceived to be a low price.
To address those concerns, the HCP managers permitted Trumpet to conduct an abbreviated sale process and allowed them to contact two potential buyers who had previously expressed interest. This outreach led to competing indications of interest including one valuing Trumpet between 50 and 60 million but no other firm bids. HCP continued to pursue a sale to MTS. For its part, MTS allegedly threatened to revoke its offer or to file suit for breach of a purported exclusivity agreement as a result of Trumpet's outreach to the other perspective buyers. The competitive bidding pressure nonetheless did move MTS to increase its bid from 31 million up to 41 million and then again to 43 million.
According to the complaint the HCP managers exploited the lack of other firm offers on the table at the time. Not to mention MTS's threat of litigation to persuade two of the three non-HCP managers into accepting MTS's offer under which non-HCP holders received little or no consideration for their interest in the LLC.
Plaintiff filed suit against HCP and its board appointees for breach of the implied covenant in good faith and fair dealing and alleged that when Trumpet's operating agreement was amended you reasonably expected that any sale would be by auction in order to maximize the sale price. Plaintiff also alleged that after HCP gained control of Trumpet, it set out to force a sale that would give it a quick exit that ignored the interests of other members further down in the distribution waterfall. Defendants moved to dismiss.
The Court of Chancery granted that motion. The court determined that Trumpet's operating agreement did not have any gap for the implied covenant to fill and rejected plaintiff's assertion that the agreement was silent as to how Trumpet could be marketed and sold and thus an auction sale requirement should be implied. The court found that the LLC agreement did not require the Trumpet board to conduct an auction. On the contrary, the court concluded that the agreement explicitly vested the board with full discretion as to the manner in which a sale is conducted subject to the limitation that the company is ultimately sold to an unaffiliated third-party buyer.
The court viewed the LLC agreement as providing the Trumpet board unfettered discretion to determine both how the company will be marketed and how the sale will be structured so long as the transaction did not involve insiders.
The court also found in principle that when a contract confers discretion on one party, the implied covenant requires that that discretion be exercised reasonably and in good faith and be inapplicable. The court explained that the LLC agreement explicitly defines the scope of the board's discretion in that it required any sale to be to a third party. Therefore no gap existed in the contract and there was no reason for the court to turn to the implied covenant to address how the discretion should be exercised.
In the court's view, the Trumpet operating agreement demonstrated that the parties considered the implications of giving discretion to a conflicted board and they expressly addressed that scenario by including the third-party sale requirement. Consequently the contracting parties left no room for the implied convent to operate.
The court further held that even if the Trumpet LLC agreement had a gap as to how Trumpet could be sold the plaintiff's implied covenant claim failed because there was nothing to suggest his reasonable expectations have been frustrated. Quite to the contrary, the explicit terms of Trumpet's LLC agreement showed that the parties in fact contemplated that Trumpet might be sold through private negotiation rather than open market process.
And although the plaintiff alleged a process that was tilted in favor of defendant's interest, the court concluded that the defendant's alleged conduct was not arbitrary, unreasonable or unanticipated. The court observed that the parties could've anticipated the quick sale scenario because the defendant's interest in a quick exit regardless of who it would impact other members was clear on the face of the agreement's distribution waterfall.
Further, the court noted that HCP did not consummate MTS's initial 31 million offer but rather permitted some sale process to take place over several months and negotiated for a significant increase in MTS's initial bid.
The court further noted that if plaintiff wanted to prevent this conduct he should've negotiated for expressed contractual protections such as for example a minimum sale price, a majority of the minority condition or a period in which a sale was prohibited. The court explained that the plaintiff negotiated for none of those terms and it was unwilling to give plaintiff what he failed to get at the bargaining table. Accordingly the Court of Chancery dismissed the plaintiff's complaint.
On appeal the Delaware Supreme Court affirmed but on different grounds. The Supreme Court disagreed with the Trial Court that the operating agreement provisioned governing the manner of sale addressed how the company was to be sold. In the Supreme Court's view, the manner of sale provision only gave the board sole discretion as to the structure of the transaction after it had agreed to sell the company. Therefore according to the Supreme Court that provision did not address how the company was to be sold.
The Court further stated that even if the provision applied to the way in which the company was sold as the Court of Chancery had interpreted it, the mere vesting sole discretion in the board did not relieve it of its obligation to use that discretion in accordance with the implied covenant of good faith and fair dealing.
The Court also noted that the fact that the LLC agreement had more specific provisions addressed the conflict of interest transactions, had relevance to the implied covenant analysis, but did not limit or preclude its application. Nonetheless, the Supreme Court agreed with the Court of Chancery's underlying determination that the implied covenant could not be used to imply Revlon-like sale requirements into the Trumpet operating agreement.
The Supreme Court explained that the operating agreement's clear elimination of fiduciary duties precluded plaintiff's argument that the implied covenant imposed the affirmative duties of corporate boards of directors in a change of control context under Revlon. The Supreme Court did note however that the record below arguably could've supported a more targeted claim of contractual impropriety but that the plaintiff did not attempt to advance any such targeted claim or argument. The Supreme Court did not elaborate on this hint about a more targeted claim potentially being colorful. Accordingly the Supreme Court affirmed the dismissal of the complaint.
Turning to our next case, In re Oxbow Carbon, I just want to note that lawyers at our firm are involved in the case but not any of us. Our statements today are solely based on the review of the court's opinions and they're our views alone and not the views of our firm, any other firm lawyers or any firm client.
Michael: And that goes for everything that we're saying today.
Matthew: Very true. The case involved a dispute between minority members of an LLC and its majority member concerning the requirements for the minority members to force an exit sale of the company pursuant to its operating agreement. The litigation primarily focused on whether the LLC agreement permitted the minority members to satisfy certain exit sale requirements by making a top-off payment to small unit holders affiliated with the majority member who otherwise would not receive sufficient consideration in an exit sale in order to satisfy the LLC's requirements.
Following trial the Court of Chancery applied the implied covenant of good faith and fair dealing to infer that a top-off payment was permissible under the circumstances. The dispute centered on Oxbow Carbon LLC and the desire of certain of its minority members who together owned approximately one third of the company to cash out their stake in the company. The minority members right to force an exit sale of the company was trigged pursuant to the terms of the LLC agreement following the minority members' exercise that were put right under the LLC agreement and the company's rejection of that put.
The LLC agreement contain a number of requirements for an exit sale in order for it to occur including that an exit sale, one, must exceed the fair market value of the company. Two, may not require any other member to engage in exit sale unless the resulting proceeds to such member when combined with the prior distributions it received equal at least 1.5 times such members' aggregate capital contributions. And three, an exit sale must apply the same terms and conditions to all of Oxbow's members.
So I'll refer to the last two requirements as the 1.5 clause or the 1.5 requirement and the equal treatment provision for. . .must apply the same terms and conditions in an exit sale. After commencing the sale process the company received a letter of intent from a third party that valued the company at $177 per unit, an amount that exceeded the company's fair market value as that term was defined in the LLC agreement. The parties disagreed however whether the terms of the third party's offer satisfied the exit sale requirements under the LLC agreement leading to litigation.
In the litigation the parties started a number of claims and counterclaims but the central focus ultimately was on the parties' competing interpretations of the requirements for an exit sale. In particular the parties disputed whether an exit sale could proceed notwithstanding the fact that the third party's bid did not satisfy the 1.5 times requirement as to the two small investors affiliated with the majority member who invested in the company four years after the LLC was organized at a price of $300 per unit. The small holders held 1.4% of the company's equity. The majority member and his affiliates claimed that an exit sale could not proceed unless all members participated, the consideration paid exceeded fair market value, each member received at least 1.5 times its capital contributions, and all members were offered the same terms and conditions.
That meant that the majority member was essentially arguing that these requirements could only be satisfied if all members were offered the consideration required to satisfy the 1.5 times requirement as the small holders which amounted to $414 per unit.
Given the then current market conditions such an offer was virtually impossible. The minority members in contrast argued that the third-party bid satisfied the exit sale requirements because the small holders could be left behind in an exit sale or alternatively even if the small holders could not be left behind, the LLC agreement permitted a top-off payment to be paid to them on top of the exit sale consideration such that the small holders received 1.5 times their capital contribution.
The Court of Chancery ultimately rejected the leave behind theory finding that the plain language of the LLC agreement foreclose that interpretation and required all members to participate in the sale. Instead the court focused its analysis on the highest amount interpretation i.e. that everyone had to receive at least $414 in order for the small holders to satisfy the 1.5 times requirement or the top-off option argued by the minority members.
The court first addressed the minority members' argument that the small holders were never formally admitted as members of Oxbow and therefore could not block an exit sale because Oxbow's board of directors did not follow organizational formalities required under the LLC agreement to admit the small holders as members. The court held that the minority members' argument was barred by latches because all of Oxbow's members had treated the small holders as members of Oxbow since they were first issued units in the company years earlier.
The court then analyzed the implied covenant claim. The court first addressed the plain meaning of the exit sale requirements stating that when read together with the equal treatment requirement the 1.5 times clause calls for reading the LLC agreement to require the highest amount interpretation. That is the $414 that would satisfy the 1.5 clause for the small holders. And therefore the highest amount interpretation is the only rating that gives effect that LLC agreement as a whole.
Despite that finding, the court found that it produced an extreme and unforeseen result because of the failure to address the small holders' rights when the company admitted them. According to the court, issues of compelling fairness called for deploying the implied covenant to fill the gap created when the company admitted the small holders because without it the fortuitous admission of the small holders gutted the exit sale right.
In applying the implied covenant the court determined that the parties intentionally left the gap in the provision of the LLC agreement governing admission of new members which left it to the board to determine the terms and conditions for admission of the new members. The court explained that the majority member created gap regarding the terms on which the small holders became members because the board never established the terms for their admission in 2011.
Further the court found that the time of contracting relevant to the implied covenant analysis was not 2007 when the parties originally executed the LLC agreement but rather 2011 when the issue of admitting new members arose. Having determined that a gap existed, the court held that the top-off option should be implied to fill that gap. The court reasoned that if the parties had addressed the issue when the small holders were issued units in the company the minority members never would've consented to admitting the small holders if they had understood that the admission would reset the 1.5 clause and that the majority member would not have insisted on the highest amount interpretation.
Rather the court found that the most likely outcome was that the parties would've agreed to a seller top off whereby the minority members could complete an exit sale if they came with sufficient additional funds to satisfy the 1.5 clause for the small holders. Because the court found that the top-off option was viable under the LLC agreement and because a third party bid otherwise satisfied the requirements for an exit sale, the court ultimately ruled that the transaction that the minority members had secured met the requirements for an exit sale.
The court requested supplemental briefing on the appropriate remedy and following that briefing and hearing, the court awarded a multi-part remedy. First the court decreed specific performance ordering that the parties complete the exit sale process. The court appointed a monitor to oversee the parties' compliance with the exit sale right.
The second component was a potential award of compensatory damages to the extent that the transaction achieved the value less than the third-party offer adjusted to account for the lost time value.
The third component was an award of damages equal to the minority members' pro rata share of the expenses the company incurred for the litigation and any duplicative amounts the company will have to spend on financial and legal advisors for the sales process.
So turning to our final case, MHS Capital versus Goggin. Plaintiff MHS owned 23% of East Coast Miner LLC, a Delaware Limited Liability Company formed by investors in U.S. Coal, a coal mining company, in order buy a senior debt note from U.S. Coal for 21 million. The defendants included Keith Goggin, the sole manager of the ECM and who held a 12% stake in the company. Goggin's two friends also were defendants, Goodwin and Collins who. . .and each held 11% and 7% stakes in ECM.
When ECM purchased the senior debt note from U.S. Coal, it attained a security interest in assets owned by the Licking River Division of U.S. Coal. That security interest gave ECM the right to credit bid for the LR assets in the event U.S. Coal ever filed for bankruptcy which it did in May 2014. According to the complaint Goggin repeatedly told MHS that ECM would receive a majority stake in the reorganized LR division of U.S. Coal following the bankruptcy and that this stake would allow ECM to receive the full value of its secured interest in the LR assets.
But Goggin allegedly had other plans. As alleged in the complaint, Goggin set up a separate entity named East Coast Miner II, ECM II and then with his friend Goodwin's assistance he created another entity which was made up of ECM, ECM II, Goggin and Goodwin to take advantage of ECM's credit bid rights essentially forcing ECM to share the proceeds of those assets with ECM II, Goggin and his friend Goodwin thereby diluting the interest in the LR assets ECM had expected to receive.
The bankruptcy court entered a sale order authorizing the sale of certain LR assets to ECM and/or ECM II as credit bid purchasers. In a separate set of transactions Goggin allegedly misappropriated ECM's proprietary and confidential information in order to affect the assignment of ECM's interest in the reorganized LR division to another new entity Goggin formed with Collins, Ember Energy. The second bankruptcy court authorized the sale of certain LR assets to Ember.
ECM's operating agreement contained two provisions of relevance in MHS's suit against Goggin, Goodwin and Collins. First, the agreement stated that the manager shall discharge his duties in good faith with the care an ordinarily prudent person in a light position would exercise under similar circumstances and in a manner he reasonably believes to be in the best interest of the company.
Second, the operating agreement provided that the manager shall not be liable to the company or any member for monetary damages for breach of such person's duty as the manager except as otherwise required under the Delaware LLC Act.
MHS brought 12 claims against the defendants including for breach of fiduciary duty, fraud, breach of the operating agreement, breach of implied covenant, aiding and abetting and other claims. On defense motions to dismiss, the defendants argued that the LLC agreement precluded an award of monetary damages and that any award of equitable relief was precluded by the bankruptcy court sale orders.
The Court of Chancery dismissed some but not all of the claims on that notion. Of pertinence is the court's analysis of the breach of contract and breach of fiduciary duty claims. The court found that MHS's allegation stated a claim against Goggin for breach of the operating agreements contractual standard of conduct. The court then found the defendant's arguments as the availability or unavailability of certain forms of equitable relief to be premature finding that as a court of equity, it had broad discretionary power to fashion appropriate equitable relief and it could depart from strict application of the ordinary forms of relief where circumstances require. The court therefore found it could potentially be able to craft an equitable remedy and that it may be possible that any such equitable relief would not derogate the bankruptcy sale orders.
The court dismissed the fiduciary duty claims finding them duplicative of the breach of contract claim. The court explained that Delaware law is clear that fiduciary duty claims may not proceed in tandem with breach of contract claims absent an independent basis for the fiduciary duty claims apart from the contractual claims. And the court found no such independent basis alleged in the complaint.
The court also dismissed the implied covenant claim finding that rested entirely on conduct explicitly addressed by the LLC agreement. Therefore there was no need to read into the contract implicit promises on Goggin's part because provisions of the agreement already addressed those issues. In short, there was no gap for the implied covenant to fill.
Michael: Great. Thanks, Matt. Good morning, everyone. As Matt mentioned, we're now going to discuss some of the recent amendments to the Delaware Limited Liability Company Act. This year there were a number of amendments enacted and we're going to discuss some of these. . .the more significant ones including the use of networks and electronic databases such as blockchain providing for a new form of reorganization known as division, providing for formation of public benefit LLCs and revisions to the series and statutes to provide for a new type of series, a registered series.
Now most of these amendments became effective on August 1st of this year but I'll note that the amendments relating to the series LLCs will not become effective until August 1st, 2019. With that, we'll jump to our. . .the first amendment which is the electronic networks and databases. So several sections of the LLC Act have been amended to provide expressed authority for Delaware LLCs to use electronic networks or databases for the creation and maintenance of LLC records and for certain electronic transmissions. These updates reflect changes similar to those previously made to the general corporation law of the state of Delaware.
To understand these changes I thought it would be first helpful to understand a little bit about what we mean when we talk about the electronic networks of databases. Often this terminology refers to blockchain technology which you may or may not have seen in ads and commercials. It's a buzzword that's been thrown around in the legal community and the technology community for the last several years. But I guess the first question is what is blockchain. Well, blockchain in its simplest form is a distributive ledger that stores records of transactions.
And a distributive ledger is a ledger that is replicated repeatedly through a public network so that it is available to everyone simultaneously. Therefore each time a transaction occurs, the ledger's updated in each replicated ledger so that everyone with access to the ledger has a record of the transaction at the same time without the need for an intermediary. The potential applications include ledgers for maintaining shares of capital stock or membership interest of an LLC, financial instruments such as UCC filings, real estate transactions, vital records, etc.
The idea is that this blockchain technology could make corporate record keeping and commercial transactions more efficient, accurate, secure and transparent.
Now one additional point with that background set is that, you know, the changes made to the LLC Act this year provide expressed statutory authority for the use of electronic networks or databases. So I'll note that given the flexibility of the LLC Act previously there's nothing that would've prevented these types of networks and electronic databases from being used under the act prior to the amendments. But what the legislature and the Delaware state legislature has done with these changes is provided expressed statutory authority just to provide additional comfort that you can use this type of technology and it is a growing technology.
Matthew: Yeah, Mike. I'll just interject that as Mike's slides mentioned, these amendments to the LLC Act correspond to 2017 amendments to the general corporation law. They are replicated as well in other Delaware alternative entity statutes and all of these changes emanate from the Delaware blockchain initiative which was kicked off in 2016 and really is in keeping with Delaware's receptivity to technological developments and having enabling statutes that allow Delaware business entities to take advantage of these advances in technology.
The Delaware blockchain initiative is continuing, it's evolving beyond the initial enactment of these enabling statutes and, you know, the future consequences of the blockchain initiative remain unclear at this point but there is activity particularly in relation to the Delaware secretary of state's office and they're updating their approaches and the forms of their records potentially to allow for the use of blockchain technology, distributive ledger technology, smart contracts. So stay tuned. We may have more information in that regard in 2019.
Michael: Thanks, Matt. Great. So moving onto the next amendment we're going to discuss today. It's the new section 18-217 was enacted to permit a Delaware LLC to divide into two or more separate and distinct LLCs. So this enables LLCs with various assets to separate the assets. . .and I mentioned even liabilities. To separate the assets and liabilities apart almost akin to a reverse merger.
There are handful of other states that I believe have enacted a statute similar to this but not a lot. And so Delaware again is, you know, on the cutting edge I think of trying to add flexibility to the statutes to enable companies to reorganize and take actions that help give them flexibility in the way they structure their transactions.
So unlike a classic asset transfer to another entity a division under 18-217 allows an LLC to be split apart into smaller free standing LLCs according to a plan of division adopted by the original LLC or the dividing LLC. The law does not require identical ownership or management. So by design, pools of assets can be reduced into smaller pools without needing to transfer the assets out of the LLC.
Now you could see that this structure might be useful in the context of a business, divorce or separation. For example, if two members of an LLC can't agree on how they would proceed, they could agree to proceed separately following an LLC division.
Additionally it might be useful in selling a particular portion of a business or a division of a business without selling the entire LLC. So allow you to. . .similar to what you do maybe in a spin off. But there's some practical applications that may be forthcoming as a result of this new statute.
The division is effected pursuant to the adoption of a plan of division and the filing with the Secretary of State of a certificate of division and a separate certificate formation for each new LLC that's formed pursuant to the division.
Now whether or not an LLC can be divided is subject to its LLC agreement. If the LLC agreement of the dividing company specifies the manner of adoption a plan of division, well, then the plan of division will be adopted as specified in the LLC agreement. If the LLC agreement of the dividing company does not specify however the manner of adopting a plan of division and does not prohibit a division, the plan of division shall be adopted in the same manner as it's specified in the LLC agreement for authorizing a merger or consolidation that involves the LLC as a constituent party to the merger or consolidation.
Now if the LLC agreement of a dividing company does not specify the manner of adopting a plan of division or authorizing a merger or consolidation involving the LLC and does not prohibit a division of the LLC or a merger, the adoption of the plan of division shall be authorized for the approval by members who own more than 50% of the then current percentage or other interest in the profits of the dividing company owned by all the members.
Now when an LLC decides to divide, the resulting LLCs and the surviving LLC is applicable, then file a certificate of division and a certificate of formation with the secretary of state. And as I mentioned each new LLC must file a certificate of formation along with the certificate of division.
The original LLC has the option to either continue its existence or terminate as a result of the division. So the contents of the certificate of division require that there be the name of the LLC and whether the dividing LLC is a surviving LLC or whether it will cease its existence. The date, it must include the date of the filling of the original certificate of formation, it must include the name of each division company that is each surviving LLC and each resulting LLC and it must contain the name and business address of each division contact.
Now division contact means in connection with any division, a natural person who's a Delaware resident or any division company involved in the division or any other LLC or other business entity organized under the laws of the state of Delaware. And the division contact’s job is to maintain a copy of the plan of division for a period of six years from the effective date of the division and shall provide without cost to any creditor of the dividing company within 30 days following the division contact’s receipt of a written request from such creditor, a name and business address of the division company through which the claim is such creditor was allocated pursuant to the plan of division.
Matthew: And I'll just interject there, Mike. That's one of several creditor friendly provisions that were included in this new statute.
Michael: Right. Yeah, as we go along you'll notice there are a few different provisions that are helpful to creditors taking into account their interest as this is a new and novel concept.
Moving on with the contents of the certificate of division. To the extent that the division certificate will not be effective upon the filing of the certificate of division feature effective date or time should be included. Also should be included that the division. . .a statement that the division has been approved in accordance with the LLC Act, Section 217 and that the plan of division is on file at a place of business of such division company as specified therein and the address of that company should be stated therein as well.
Finally, a copy of the. . .a statement that the copy of the plan of division will be furnished by such division company on request and without cost to any member of a dividing company. And this is similar to what you would find I think in a certificate of merger in other similar types of transaction.
So then that takes us to the next step in the division that we're. . .we'll talk about the key document in a division which is the plan of division. Now I'll note here initially that a plan of division may affect any amendment to an LLC agreement or the adoption of a new LLC agreement of the dividing LLC if it's. . .will be surviving LLC in the division. A new LLC must be adopted for each resulting LLC.
So the contents of a plan of division include an allocation of assets, property, rights, series, debts, liabilities and duties of a dividing LLC and the resulting LLCs. And this plan is the key document as I mentioned that provides for the asset ownership and the ownership of liabilities and how existing creditors are to be paid.
The plan of division must also state how interest in the dividing LLC will be exchanged for or converted to interest in the new LLCs or their property. And the plan of division must list the name of each resulting LLC and the name of the surviving LLC if it will survive the division.
The plan of division is also required to list the name and business address of a division contact which we just discussed.
That brings us now to what happens when you have a division, what are the effects of a division. Now as I mentioned, the plan of division gives you a great amount of latitude to structure the division as the parties see fit and gives them some flexibility in that regard. The effects of the division are as follows. The dividing LLC will be subdivided into the states and independent resulting LLC named in the plan of division and if the dividing LLC is not the surviving LLC as we mentioned, the existence of dividing LLC or the original LLC shall cease.
All the rights, privileges, powers and property, real personal mix of the dividing LLC and all the debts due on whatever account to it as well as other things and other causes of action shall without further action be allocated to invest it in applicable division company in a manner and basis with such effect as specified in the plan of division. Again the plan of division gives you control over how you make those allocations.
Each division company from and after the effectiveness of the filing of the certificate of division or the effectiveness of the certificate of division can be liable as a separate and distinct LLC for such debts and liabilities as are allocated to such division company pursuant to the plan of division in the manner and on the basis provided in that plan of division.
Additionally each of the debts, liabilities and duties of the dividing company shall without further action be allocated to be the debts, liabilities and duties as specified in the plan of division for such division company.
Now that's so long as the plan of division does not constitute a fraudulent transfer under applicable law. And again another predator protection, predator friendly protection that's been provided in the statute.
All liens upon any property of the dividing company shall be preserved unimpaired and all debts, liabilities and duties of a dividing company shall remain attached to the division company to which such debt, liabilities and duties have been allocated in the plan of division and may be enforced against such division company to the same extent as if those debts and liabilities were originally incurred or contracted by. . .in its capacity as an LLC.
Now in the event that the allocation of assets, debts, liabilities and duties to division companies in accordance with the plan of division are determined by court of competent jurisdiction that constituted fraudulent transfer. Then each division company. . .so the surviving LLCs and any new LLCs will be jointly and separately viable on account of such fraudulent transfer notwithstanding the allocations made in the plan of division. Note however that that doesn’t affect the validity and the effectiveness of the division itself. It just means that companies post division will be jointly and separately viable for those debts and liabilities.
An additional protection for creditors as well is that the debts and liabilities of a dividing company that are not allocated by the plan of division specifically shall be joined in several debts and liabilities of all the division companies.
Now similar to other statutory provisions namely I think series it's not necessary that you list each individual asset property, right, series, debt, liability or duty in the dividing company to be allocated but it must be reasonably identified by any method whether identity of such assets, reliabilities are objectively determinable.
Finally I. . .the results of. . .the rights, privileges and powers and interest in the property and the liabilities remain best in each division company and are not to be deemed as a result of division to have been fined or transferred to such division company for any purposes of the laws of the state of Delaware. So a division or an allocation of assets or liabilities pursuant to a division is intended to not be a transfer under Delaware law.
Matthew: Which is similar to what our laws provide with respect for example to a conversion.
Michael: Exactly. So it's essentially another fundamental transaction added to the statute that permits you . . . similar mergers, conversions to, you know, just added flexibility in how you structure your constructions. As we mentioned at the beginning there's a couple maybe practical applications to this and it remains to be seen how widely used it. But there are handful of states that have used this.
Christopher: And Mike, just to be clear, those amendments became effective already? Correct?
Michael: That's correct. And in fact all LLCs formed prior to August 1st, 2018. . .and this is another creditor protection are government by the section provided that if they. . .a dividing company is a party to any written contract, indenture or other agreement has been entered into on or prior to August 1st, 2018 which is the effectiveness. . .effective date of these amendments that by its terms restricts or conditions or prohibits the consummation of a merger or consolidation by a dividing company with or into another party or the transfer of assets by the dividing company to another party. And that restriction or prohibition shall be deemed to apply to a division as if it weren’t a merger, consolidation or transfer of assets. Again so contracts that are in force are already in place have that protection against a division so you can't use a division as an end run around restrictions on transfer of assets or merger of consolidation.
Matthew: If time permits at the end, maybe we'll come back to that and explore some related issues.
Michael: Right. So next we're now going to explore amendments to the series statutes in the Delaware LLC Act and I'll note that the changes that we're talking about now, while enacted this year will not become effective until August 1st, 2019. And the. . .as a reminder, series. . .the concept of a series was added to the LLC Act in 1996 providing that a LLC can provide for one or more series of members, managers, LLC interest or assets.
And historically under 18-215B of the LLC Act an LLC may provide for the creation of a series by providing a notice in a certificate of formation that its series are subject to limited liability or siloes I guess. We call it re-fencing of the assets. And by providing that notice it allowed a series or an LLC to create separate series almost as if they were part of a, you know, a separately legal entity but not quite but under an umbrella of an LLC and. . .but the series were treated in many important respects as if they were a separate LLC.
And if properly structured and implemented these series, the members or LLC interests or assets could possess further attributes pertaining uniquely to series that would offer business planners benefits that were unique. And one of the key components of section 18-215 was that the records maintained for series established pursuant to that provision 18-215b would be maintained separate and accounted for so that the assets and liabilities would be with respect to such particular series and not the LLC generally or, you know, if the plan. . .the drafters of the LLC agreement desired they could also provide that the assets and liabilities would be for the LLC generally or for a number of different series. There's contractual flexibility. But the idea was that if desired an LLC series could have assets and liabilities and a separate business purpose and objective singular to that series itself and not to the LLC as a general matter or to the other series of such LLC.
Matthew: Now I think the key concept in relation to the series, this statutory means of accomplishing in effect the creation of limited recourse obligations and liabilities. That is not changed at all by these amendments, correct?
Michael: That's exactly right, Matt. So what's been added to the LLC Act this year is a definite. . .or to be effective again August 1st, 2019 is a new definition of series that divides a series or refers to series as a designated series that members, managers, LLC interests or assets which may or may not be a protected series or a registered series. So now that brings us to the concept of what is a protected series and what is a registered series.
And a protected series is similar to what we were just describing as the historical aspect of a series under 18-215b of the LLC Act which is a designated series of members or managers or assets established in accordance with 18-215b. The nomenclature has changed so that we. . .now when we refer to those types of series we distinguish them and call them a protective series. Additionally a new concept of registered series has been added to the LLC Act.
Going back quickly to the protected series concept essentially like Matt said it's the same thing as what we've historically had except there's a few additional changes here. First, section 18-215b has been updated to expressly provide that a member or a manager of a protected series shall not have personal liability for debt, obligations or liabilities of such protected series solely by reason of being a member or manager thereof or acting as a manager.
Additionally 18-215b12 has been amended to provide that irrespective of the number of members or managers of a protected series a protected series is an association for all purposes of Delaware law and this includes the Delaware UCC which has some similar amendments being. . .becoming effective in August 1st, 2019. And so it. . .and that's association where I guess the protected series would then be classified as an association which is a person under the ECC.
Now in newer section 18-218 has been added to the LLC Act establishing a concept of a registered series. So this has similar rights, powers and interest series limitations on liabilities protected series established under 18-215b. It's also likewise in association under Delaware law. The registered series is distinct in a few other ways including its formation however. So a registered series is formed by the filing of a certificate of registered series with the secretary of state and accordingly a registered series therefore qualifies as a registered organizations for persons of Delaware law and in particular the Delaware UCC.
Now there's no requirement in the notice in the certificate of formation that any specific registered series be referenced in a notice or that notice used. . .such notice used the term registered when referencing a series or include a reference to section 18-218 or in fact the certificate of formation be amended if it includes a reference to 18-215. Any reference to 18-215 and the certificate of formation has one or more registered series shall be deemed referenced to 218 with respect to such registered series.
And the fact that a certificate of formation contains a foregoing notice of limitation on liabilities of a series on file with the secretary of state shall constitute notice of the limitation of liabilities of a registered series.
So as I mentioned, in order to form a registered series of an LLC certificate of registered series must be filed with the secretary of state. It has to set forth the name of the LLC, the name of the registered series. It may include any other matter that the members of a registered series determine to include.
Additionally there's been a couple of other conforming changes made to other provisions of the LLC Act to incorporate this series concept and make room and accommodate the concept of a registered series. For converting a protected series to a registered series of a same LLC. And I think it's very similar to what you would do for the provisions of merger or consolidation or other types of fundamental transactions in that they have to improve, you know, and if the LLC agreement does not provide specifically for how those. . .how this transaction will be approved then it would be approved by the authorized numbers of such protected series who own more than 50% of the concurrent percentage or other interests in the profits of those protected series.
Series shall be deemed to be the same series as the converting protected series and shall constitute a continuation of the existing protected series in the form of a registered series similar to a conversion of an LLC to another form of entity conversion to registered series has to be filed as well as a certificate of registered series. 18-220 addresses conversion of a registered series to a protected series again of the same LLC and it's similar to provisions for 18. . .as for 18-219. And finally 18-221 addresses the merger or consolidation of one or more registered series with or into one or more registered series again of the same LLC. And similar to provisions of. . .on merger of an LLC. They're similar formalities that need to be followed to enact that as are set forth in 18-221.
So that takes us through the series. You know, this new concept of a protected series and registered series. And as I said, you know, the registered series. . .or all of the series amendments although inactive this year will become effective August 1st, 2019.
Now we'll touch quickly on public benefit LLCs. This is a new provision that was added to the statute this year. It allows an LLC to elect to become a statutory public benefit LLC and what that means is statutory public benefit LLC is a for profit LLC formed under and subject to the requirements of the LLC Act but it's intended to produce a public benefit or public benefits and to operate in a responsible and sustainable manner. And a public benefit means a positive effect or reduction of negative effects on one or more categories or persons, entities, communities or interests including but not limited to artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific or technological nature. And a public benefit provisions means a provision of the LLC agreement contemplated by this new section.
So to that end a statutory public benefit LLC is to be managed in a manner that balances the members' pecuniary interests. The best interests of those materially affected by the LLC's conduct and public benefit or benefits set forth in the certificate of formation.
And so in order to form a public benefit LLC, a certificate of formation shall state in the heading that it is a statutory public benefit LLC and shall set forth one or more specific public benefits promoted by the LLC and its certificate of formation. Now note that the LLC agreement or the statutory public benefit LLC may not contain a provision inconsistent with the provisions of this new subchapter of the LLC Act.
Matthew: Michael, just to interject but public benefit limited liability companies in many respects parallel public benefit corporations that have been permitted in Delaware for several years now and the enabling of public benefit, statutory public benefit LLCs is a piece with the some of the other amendments that were enacted this year in terms of facilitating transactional flexibility for Delaware companies. There's. . .it is the case today. It was the case before these recent amendments came in that you could have a non-statutory public benefit Delaware limited liability company. This is just another addition of statutory public benefit LLC provisions to the LLC Act is just another available tool in the kit for practitioners, business people, Delaware LLCs and again it's consistent with the notion as you see with the addition of the division statute with the more comprehensive treatment of series and the very treatment of different types of series Delaware is interested in enabling companies that maximum flexibility in terms of the transactions in which they can engage.
Michael: Thanks. And that brings up a good point. In fact the new subchapter 12 dealing with public benefit LLCs actually addresses that it's not intended to limit the accomplishment of a public benefit LLC through means outside of the statute. Again, alluding to the, you know, extreme flexibility that we have under the LLC Act under. . .in Delaware to provide contractually for essentially whatever you want to do as long as it's not violating the act.
Matthew: And I just. . .let me clarify one thing I just said in terms of the state allowing maximum flexibility in terms of transactions. That's not entirely the case. There are for example those creditor protections that are baked into the division statute. There re creditor protections that apply in the context of our series laws and so it's not an anything goes type of regime here. It's simply one that fosters responsible flexibility. And along those lines in terms of responsibility and not anything goes, Mike, the amendments regarding judicial cancellation of the certificate of formation.
Michael: Thanks. That's exactly right. So our next amendment effective August 1st, 2018 has a new section 18-112 that's been added to the act that essentially allows upon motion by the attorney general for the Court of Chancery to cancel the certificate of formation of a Delaware LLC if it can be shown that there was abuse or misuse of its LLC powers, privileges or existence.
And so this new section empowers the Court of Chancery to point trustees and receivers and otherwise to administer and wind up the affairs of an LLC whose certificate of formation has been so canceled including power to determine the rights of its members and creditors. Now again this is. . .you know, there's been the case in a few limited instances where an LLC has been used for purposes that. . .possibly illegal and this just gives power to the attorney general to make a motion with due process to have, you know, such LLCs canceled.
Matthew: And I think this is consistent with our general assembly's efforts over a period of years to regulate LLCs in a responsible way to facilitate law enforcement efforts to understand who's behind some of these companies, take effective action in regard to LLCs that are engaged in wrongdoing. Some of those other provisions include for example the prohibition against bearer shares that was enacted several years ago. There's been a requirement in place again for a number of years that each LLC have a "communications contact" identified who can be tapped in effect by law enforcement in appropriate circumstances to identify, to provide a path to the record of the owners of the LLC. This year there were amendments enacted that allow for rule making by the secretary of state's office in regard to, you know, matters pertaining to registered agents and entity formation. So this new section, 18-112 is really consistent with that general approach that Delaware has taken over a period of years to again facilitate law enforcement efforts when LLCs like other business entities, not just in Delaware around the country and around the world, go beyond what they are legally permitted to do and engage in illegal conduct.