Trends in Delaware corporate law tend to be indicators of change across the corporate sector. 2018 saw a few significant developments in Delaware corporate law. It is important that individuals, particularly business owners and officers/executives, are aware of such changes.

Material Adverse Effect

In October 2018 a Delaware court issued a finding of a Material Adverse Effect (“MAE”) in the case of Akorn Inc. v. Fresenius KABI AG. Until the court’s decision in Akorn, no Delaware court had made such a finding.  Although the outcome in the case is significant, it will likely continue to be difficult to establish the occurrence of a Material Adverse Effect because it will be rare to have a case with as blatant malfeasance as there was in Akorn. Nonetheless, it is significant that such a finding was made and opens the door to the possibility of it occurring again in the future. Akorn also underscores the importance of the buyer complying with its contractual obligations in order to assert a claim based on the occurrence of an MAE because the buyer’s ability to exercise a termination right is withdrawn if it is in material breach of any of its contractual obligations.

Delaware Corporate Law Amendments    

  1. Divisional Mergers: New Form of Delaware LLC Reorganization

Effective August 1, 2018, Section 18-217 of the Delaware LLC Act (“DLLCA”) permits an LLC to divide into two or more newly formed LLCs with the pre-merger LLC either surviving or terminating. A division may be used to accomplish a spin-off, the sale of lines of business, or the sale of assets, rights and properties, as well as liabilities. The latter would eliminate the need to transfer assets and liabilities to newly formed LLCs by specifying, in the plan of division, where the assets and liabilities of the dividing company should go. Divisional mergers will also make it easier to sell several lines of business to separate buyers at the same time. It is important to note that while it is required that a certificate of division be filed with the Delaware Secretary of State, the plan of division need not be publicly available.

The “divisional merger” amendment includes provisions to protect creditors of the pre-merger LLC and allows LLCs to prohibit divisional mergers in their LLC Agreements. A division can be treated as a tax-free transaction in certain cases, including a division used to effectuate a pro rata spin-off to existing members. Since the amendment specifically states that the allocation of assets in a division does not constitute a transfer or assignment, transfer taxes may not be imposed, however, it is wise to review the laws of the applicable jurisdiction to be sure.

  1. Creation of Registered Series

Series LLCs were first introduced in Delaware in 1996. In a Delaware series LLC, each series is treated as a separate entity, and in turn the debts, liabilities, obligations and expenses of one series cannot be enforced against another series of the LLC or against the LLC as a whole. Series LLCs established under the current DLLCA do not meet the Uniform Commercial Code’s (“UCC”) definition of a “registered organization” because the series is not formed or organized by filing a public record. Since series LLCs do not fit within the UCC framework, security interests in a series LLC cannot currently be perfected by filing a UCC-1 financing statement. This characteristic makes series LLCs unpopular for structuring secured transactions.

Amendments to the DCLLCA provide for the creation of a registered series under new section 18-218. A registered series is an association formed by filing a certificate of registered series and is therefore considered a “registered organization” under the Uniform Commercial Code. This classification will allow secured parties to perfect security interests in most assets owned by a registered series by filing a UCC-1 financing statement with the Delaware Secretary of State. The fact that a registered series can be perfected will allow them to be used in secured finance transactions. The current series LLCs established under Section 18-215(b), which cannot be perfected, will be re-named a “protected series” under the DCLLCA amendments. These amendments will become effective August 1, 2019 to give the Delaware Secretary of State’s office ample time to prepare new certificates and filings associated with the registered series.

The amendments also allow a protected series to convert to a registered series and a registered series to convert back to a protected series. The conversion requires the consent of members holding 50% of the profits of the series. Also, one or more registered series of an LLC may merge with or into one or more other registered series of the same LLC. This must be approved in accordance with the LLC agreement or by members holding more than 50% of the interest in profits of each merging series if the LLC agreement is silent. The Uniform Protected Series Act has been approved by the Uniform Law Commission, which may result in more states adopting series provisions.

  1. Creation of Statutory Public Benefit LLCs

The DLLCA was amended to add a new chapter which addresses the formation of statutory public benefit LLCs. Like public benefit corporations, statutory public benefit LLCs are intended to produce a public benefit. The amendments are akin to the provisions of the Delaware General Corporate Law (“DGCL”) that relate to public benefit corporations.

  1. Use of Networks of Electronic Databases

The DGCL was amended in 2017 to allow for the use of blockchain and distributed ledger technologies for corporate records. In 2018, amendments were adopted to the LLC and LP Acts to allow for the use of such new technology for the creation and maintenance of records and for certain electronic transmissions as well as in the governance and activities of the LLCs and LPs.

  1. Corporation/LLC Abuse of Powers

Amendments to the DGCL and DLLCA were adopted to grant the Delaware Attorney General the power to file a motion in the Court of Chancery to revoke a corporation’s charter or cancel the certificate of formation of any LLC for abuse of powers. The Court of Chancery also has the power to appoint a trustee to administer and wind up the affairs of a corporation or LLC that has committed such abuse.

  1. Ratification of Defective Corporate Acts

Delaware Corporate Law provides that a “defective corporate act” is a corporate act or transaction that was within the power granted to a corporation by the DGCL but was then determined to be void or voidable due to the company’s failure to obtain the proper authorization to enter into the act. Section 204 of the DGCL was adopted in 2014 as a tool for corporations to approve defective corporate acts. Since its adoption, several amendments have been made. The first amendment reminds us that the Section can be used as a tool to ratify corporate acts where there are no shares of valid stock outstanding. Amendments adopted in 2018 also provide that where a stockholder vote is needed for the approval of a defective corporate act, the notice of the stockholder meeting may be given as of the record date for the defective corporate act if it involved the establishment of a record date. This is helpful because corporations are more likely to have a list of stockholders as of the record date for the defective corporate act. Further, public companies are permitted to give notice of the stockholder meeting via a document publicly filed with the SEC.

Additionally, amendments adopted in 2018 allow for the ratification of a corporate act that was within the corporation’s powers under the DGCL even though it was not authorized in accordance with the DGCL or the corporation’s bylaws. However, the amendments do not permit the validation of an act that was intentionally not authorized.

It is essential that individuals, counsel and other corporate representatives be aware of developments in Delaware corporate law and how they impact operations, governance and the structuring of transactions moving forward. Accordingly, it is recommended that you consult with legal counsel that has an understanding of the current state of corporate law in the State of Delaware prior to undertaking any transaction.

 

 

New Jersey restaurant and club owners who do not possess a coveted New Jersey liquor license can now advertise that they allow customers to bring their own beer or wine or as it is more commonly known, “Bring Your Own Booze” (BYOB).

BYOB is a concept as inherent in New Jersey culture as Bon Jovi.  Tommy’s and Gina’s date night involves a cozy pizzeria where the veal special is outstanding, but the pizzeria does not serve liquor.   Yearning for a little wine with dinner, they swing by the liquor store a few blocks away and pick up a bottle of red wine on the way to their romantic meal.  While this scene is common place in the restaurants of New Jersey, a sign or other advertisement publicizing “BYOB” is not to be found.  New Jersey’s archaic liquor license laws have always banned restaurant owners from publicizing the ability for customers to BYOB, but on November 20, 2018, a New Jersey Federal Judge struck down the prohibition ruling that the ban was unconstitutional because it places a content-based restriction on commercial speech.

In order for a restriction on speech to be viewed as constitutional, it must pass strict scrutiny, the most stringent standard of judicial review used by the Federal Courts. Here, the court found that the content-based restriction on speech failed the strict scrutiny test because it was not supported by a compelling government interest nor was it the least restrictive means of achieving the government’s stated purpose.

Commercial speech such as BYOB advertisement is no exception to the high standard of review and such content based restrictions are presumptively unconstitutional.  The ruling is just in time for the start of 2019.  It doesn’t make a difference if Tommy and Gina make it or not, but they can now be better informed of their BYOB options.

When we last blogged in January about what borrowers can do to prepare for a potential cessation of the London interbank offered rate (“LIBOR”), there was a lot of uncertainty surrounding whether LIBOR would actually be replaced, what that replacement would be, and whether the market would have sufficient time to react.  Due to this uncertainty, we advised taking a “wait-and-see” approach with respect to borrowers reaching out to affirmatively modify their existing loan documents that reference a LIBOR rate to include LIBOR fallback language, except in the cases where borrowers were already in the process of negotiating an amendment for other reasons.  Although there has been some significant movement in both the development of LIBOR fallback language and the determination of the replacement rate since our last blog post, there has not yet been enough movement for us to change our advice at this time.

ARRC FALLBACK LANGUAGE

One major development since our last blog post is the publication by the Alternative Reference Rates Committee (the “ARRC”) of its Consultation Regarding More Robust LIBOR Fallback Contract Language for New Originations of LIBOR Syndicated Business Loans (the “Consultation”) on September 24, 2018.  As noted in our last blog post, the ARRC was established in 2014 by the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York for the purpose of recommending a LIBOR alternative, identifying best practices for contract sturdiness in the interest rate market, and creating a plan to implement the new reference rate.  In the Consultation, the ARRC offered two general proposals for sample LIBOR fallback language and asked market participants for their commentary up until November 8, 2018.  The LIBOR fallback language was developed by a working group of the ARRC co-chaired by the Loan Syndications and Trading Association (“LSTA”), a highly influential trade group in the syndicated loan market, which gives it a lot of credibility in the marketplace.

Although the fallback language is not yet finalized, even in its current unfinished state, it provides some valuable guidance for borrowers who are currently involved in negotiations over either a new credit agreement or an amendment to their existing credit agreement.  At a high level, the Consultation takes two basic approaches to LIBOR fallback language, the amendment approach and the hardwired approach, each of which is discussed below.  Please note that the Consultation also discusses the different consent requirements under the amendment approach and hardwired approach, which are not addressed in this article.

THE AMENDMENT APPROACH

The amendment approach provides a streamlined mechanic for negotiating a replacement to LIBOR and a replacement LIBOR spread upon the occurrence of a “trigger event.”  A trigger event is essentially an action that gives rise to the conversion from LIBOR to a new reference rate.  Under the amendment approach, a trigger event is basically either (i) a public statement that LIBOR will fail to be published, or the actual failure of LIBOR to be published (a “Benchmark Discontinuance Event”), or (ii) a determination by the administrative agent or required lenders that new or amended loans are incorporating a new rate to replace LIBOR.  If either of these trigger events occur, the Borrower and the administrative agent may amend the agreement to replace LIBOR with an alternate benchmark rate (including a replacement benchmark spread), in each case giving due consideration to then-existing market convention and endorsements or recommendations by relevant governmental bodies such as the Federal Reserve Board, the Federal Reserve Bank of New York or a committee convened by either or both of them (each a “Relevant Governmental Body”).

As you can see from the above, the amendment approach is flexible in many respects, which is positive in some ways and negative in others.  On the positive side, it allows for LIBOR language to be amended if other lenders are incorporating a rate other than LIBOR, which could be well before the time, if any, that LIBOR becomes unavailable.  This gives borrowers and lenders the flexibility to get well ahead of the LIBOR issue if they desire.  Additionally, the amendment approach does not automatically replace LIBOR with a fixed replacement rate such as the Secured Overnight Financing Rate (“SOFR”), the alternative replacement rate selected by the ARRC.  Instead, it gives borrowers and lenders the ability to choose both the replacement rate and the applicable spread.  On the negative side, the ARRC pointed out in the Consultation that it may not be practicable to use the amendment approach if thousands of loans must be amended simultaneously due to a potential LIBOR cessation.  Moreover, this added flexibility comes at the price of allowing the lender or borrower to “game” an amendment depending on whether the credit market is then lender-friendly or borrower-friendly.  In a lender-friendly market, the lenders could block a proposed rate and force the borrowers into a higher interest rate (such as the alternate base rate).  In a borrower-friendly market, the borrowers could block any proposed spread to the replacement rate.  Although the hardwired approach addresses these concerns, it has its pros and cons as well, which are discussed below.

THE HARDWIRED APPROACH

As suggested by its name, under the hardwired approach the LIBOR replacement language is hardwired into the agreement, which is obviously much less flexible than the amendment approach.  Similar to the amendment approach, the replacement language also becomes effective upon the occurrence of a trigger event, which is either (i) a Benchmark Discontinuance Event, or (ii) an agreed upon number of outstanding publicly filed syndicated loans being priced over term SOFR plus a replacement benchmark spread.  If either of these trigger events occur, LIBOR is automatically replaced in accordance with a waterfall approach where the first available option is chosen from the following: first (1) Term SOFR, or, if not available for the appropriate tenor, interpolated SOFR, then (2) Compounded SOFR, then (3) Overnight SOFR, then (4) a rate chosen giving due consideration to then-existing market convention and endorsements or recommendations by any Relevant Governmental Body.  In addition, the existing LIBOR spread is automatically replaced by a spread adjustment, or method of calculating a spread adjustment, that has been selected, endorsed or recommended by the Relevant Governmental Body or, if not available, the spread adjustment or method of calculating the spread adjustment is selected by the International Swaps and Derivatives Association, Inc.

Like the amendment approach, the hardwired approach has its pros and cons.  On the pro side, it provides borrowers and lenders with the certainty that if and when LIBOR is discontinued, it is highly likely that some version of SOFR will be inserted as a replacement rate with a market replacement spread.  On the con side, as of now SOFR is only being quoted as an overnight rate, so it is currently unclear what the actual replacement to LIBOR (and the replacement spread) will look like if LIBOR is discontinued.  That being said, the ARRC has said that part of its transition plan for implementing SOFR will include the development of multiple forward rates, so it is likely that the waterfall will be fully populated well before LIBOR’s potential cessation.

In summary, although the ARRC has made great strides in drafting LIBOR fallback language, at the current time we do not think it is far enough along to advise borrowers to proactively request amendments to their existing credit agreements with LIBOR-based loans.  However, if a borrower is currently involved in an amendment or a new credit, we still recommend that they consider including either the amendment approach or the hardwired approach in its current form.  Although neither approach is perfect, both are preferable to the option of automatically defaulting to the alternate base rate.   

On October 2, 2018 the NJ Division of Alcoholic Beverage Control  (“ABC”) decided to suspend enforcement of the September 21, 2018 “ Special Ruling” regarding limited brewery licenses . The suspension of the regulations will provide the ABC with the opportunity to  discuss the impact of the new regulations with craft breweries, restaurants, and other licensees. In addition the ABC will work with lawmakers to determine if new legislation is needed to update the 2012 law which authorized limited brewery licenses that gave rise to the issuance of the  Special Ruling.

Walmart’s U.S. patent application involving blockchain technology is one of many blockchain-based patent applications that have been filed by large companies smitten with blockchain technology.  Published May 17, 2018, but filed November 16, 2017, the application is based on a provisional patent filing in November 2016.  In its application, Walmart seeks to patent a blockchain-based marketplace where buyers and resellers of products can leverage blockchain technology’s immutability and security to record characteristics of retail goods and the transactions involving those goods.  The application has not yet been examined, and must undergo prosecution which is highly likely to change the scope of any patent ultimately granted, if at all. Until allowed, it is difficult to predict the impact any patent granted from this application may have on competitors and industries seeking to similarly leverage blockchain-based marketplaces.

The blockchain technology originally used to code the Bitcoin blockchain is not patentable because it is not actually “new.”  However, customized variations of the original Bitcoin code and other decentralized systems that employ similar technologies may be patentable.  General ledger methods and hardware to record and track characteristics and transactions relating to good and services are ancient.  Even computer-aided ledger methods and hardware (e.g., centralized databases) are decades old.   Blockchains, although more recently developed, have generally been known and practiced since the inception of the Bitcoin blockchain’s open, albeit pseudonymous, ledger in 2009.  Accordingly, the maturity of blockchain technology generally renders the basic Bitcoin blockchain unable to pass the novelty and nonobviousness requirements for patentability.  Nonetheless, blockchain technology is being increasingly customized to specific uses, some of which may qualify for patent protection.

Blockchains are digital databases that use cryptography to secure records, or “blocks,” of information.  Each block is timestamped and includes a record of the blocks that preceded it.  The database is decentralized over a network of computers and the information in each block, including the historical information, may only be tampered with if an actor gains control of 51% of the computers in the network.  This ensures the integrity of information on blockchains by making hacking economically inefficient and extremely difficult.  Blockchains can not only store basic information, such as a record of transactions of digital money like Bitcoin, but can also use the information to function as a computer and perform tasks.  These automated processes are commonly known as “smart contracts.”  Smart contracts and the security and immutability of blockchains facilitate large-scale automation and remove the need for trusted third parties to verify transfers and ownership of goods and information.

Blockchain technology is promising.  Corporations like Walmart are racing to file patents covering specific blockchain structures and applications to secure competitive advantages going forward.  Additionally, corporations may file blockchain patents as marketing ploys to create buzz for their business, especially because blockchain infrastructures are difficult to scale for commercial operability.  Amid the hype and hysteria, it is important to understand what a blockchain patent covers and how to protect your company’s proprietary rights.