Corporate Close-Up: Delaware Legislation Authorizes LLC Divisions

Recent legislation in Delaware (2018 S.B. 183) amended the state’s Limited Liability Company Act to enable a limited liability company (LLC) to divide into two or more newly formed LLCs, with the dividing company either continuing or terminating its existence. Delaware joins only a few other states, including Arizona, Pennsylvania, and Texas, that permit LLC divisions. 

Under the new law, any Delaware LLC formed on or after Aug. 1, 2018, may adopt a plan of division and divide into two or more Delaware LLCs. The plan of division must provide detailed information about how a dividing LLC’s assets and liabilities will be allocated among the resulting companies. A feature of the new division statute is that ownership of the dividing LLC’s assets and liability for its debts vest by operation of law in the resulting LLCs to which they are allocated. Vesting of assets by operation of law provides a potential benefit of avoiding transfer restrictions that might be triggered in a different type of transaction, as well as avoiding cumbersome documentation requirements associated with transferring title to assets.

The new statutory provisions also provide protection for creditors of the dividing LLC. If the plan of division does not allocate any liability or obligation to a surviving or resulting entity, all LLCs remaining after the division are jointly and severally liable for the obligation. Joint and several liability also arises if a court determines that the allocation of assets or liabilities constitutes a fraudulent transfer.

Texas, since 2006, and Arizona, since 2015, have allowed any type of domestic entity, not just LLCs, to enter into a division transaction (or divisive merger, as the transaction is referred to in Texas) in which two or more new entities (or one or more new entities with survival of the dividing entity) are created. The requirements to adopt a plan of division and allocate assets and liabilities of the dividing entity are similar to those adopted by Delaware, and both Texas and Arizona statutes provide that ownership of assets vests by operation of law in the new or surviving entities. There is a substantial body of case law in Texas interpreting the applicable merger statute and finding that asset assignments generally do not violate various transfer restrictions.

On the other hand, procedures for allocating liabilities appear somewhat more burdensome in Arizona. When a division becomes effective in Arizona, each resulting entity is jointly and severally liable for the obligations of the dividing entity, unless the creditors of the dividing entity consent in writing to the allocation of liabilities adopted in the plan of division.

Pennsylvania legislation authorizing the division of any domestic entity became effective July 1, 2015. Property of the dividing entity generally remains with the dividing entity or vests by operation of law in newly formed organizations, as provided in the plan of division. Pennsylvania, however, does impose additional documentation requirements in connection with changes in ownership of certain real estate, motor vehicles, and secured collateral.

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Is Delaware likely to permit divisions by other unincorporated business entities in the near future?

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