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to assert a claim based on the occurrence of an MAE because the buyer’s ability to exercise a termination right is withdrawn if it is in material breach of any of its contractual obligations.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.

 

 

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 June 14, 2018, the SEC’s Division of Corporation Finance Director, William Hinman, gave a speech titled “Digital Asset Transactions: When Howey Met Gary (Plastic).”  This speech provides additional insight into the SEC’s view as to whether cryptocurrencies and initial coin offerings (“ICOs”) are securities.  Here is a summary:

In his speech, Hinman explains that ICOs typically involve passive investors who purchase tokens in hopes that a promoter builds a successful network.  He posits that the networks involved are rarely functional, and that the token purchase “looks a lot more like a bet on the success of the enterprise and not a purchase of something used to exchange for goods or services on the network.”  These circumstances, combined with token marketing efforts that “are rarely narrowly targeted to token users,” are indicators that an ICO is a securities transaction.

ICO issuers have recently tried to avoid their tokens being classified as securities by labeling them “utility tokens” and arguing that the tokens are for consumptive use.  Hinman directly addresses this practice, stating that labeling something a “utility token” does not prevent it from being a security. While he conceded that tokens by themselves and tokens purchased for consumption only are likely not securities, he emphasized that the “economic substance of the transaction” determines whether a token sale is a securities transaction.  Specifically, the speech focused on the “investment strategy” used, and states that “virtually any assets” can be securities “provided the investor is reasonably expecting profits from the promoter’s efforts.”

To support the above concept that securities can be broadly defined to include an “investment strategy,”  Hinman explains that, as outlined in Gary Plastic Packaging Corp. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., the Howey test “is not static and does not strictly inhere to the instrument.”  The non-static interpretation of Howey is critical because it indicates that tokens which start as securities can lose that designation over time as a token’s network becomes “sufficiently decentralized.”  Hinman clarified that a security-token loses its status as a security when it becomes decentralized enough that purchasers “no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts,”  noting that, as a system becomes increasingly decentralized, “material information asymmetries recede” and the “ability to identity an issuer or promoter to make the requisite disclosure [required in securities offerings] becomes difficult, and less meaningful.”  This interpretation rewards systems that prioritize decentralization with a shield from securities laws, but creates ambiguity regarding the requirements for a network to become “sufficiently decentralized.”

In light of the above, Hinman finds that Bitcoin and Ethereum’s native token, Ether, are not securities because they are decentralized enough that the efforts of others are not a “key determining factor” in whether an investment in Bitcoin or Ether is successful.  The speech adds that applying the disclosure regime of the federal securities laws to Bitcoin and Ethereum transactions would “add little value”, and that, “[o]ver time, there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required.”

As the State of New Jersey continues to evaluate the expansion of current legislation related to medicinal use cannabis and the legalization of recreational cannabis, proposed legislation advancing in the New Jersey legislature has set its sights on marijuana’s less psychotropic relative – industrial hemp.

If passed, Assembly Bill No. 1330 (the “Bill”), introduced in February of 2018 and sponsored by Assemblyman Reed Gusciora, would enable licensed businesses to plant, grow, harvest, possess, process, distribute, buy and sell industrial hemp for commercial purposes. The Bill defines industrial hemp as an agricultural product that is part of the plant of any variety of Cannabis sativa L. with a delta-9-tetrahydrocannabinol (“THC”) concentration of 0.3% or less on a dry weight basis. This threshold of THC is intended to ensure that legally harvested industrial hemp maintains no more than a small percentage of THC, the psychoactive, “high-producing” ingredient in marijuana. To ensure compliance, the Bill requires that licensees submit, on an annual basis, documentation confirming that such industrial hemp is of a permissible type and THC concentration.

Pursuant to the Bill, prospective growers and distributors must apply to the Secretary of Agriculture (the “Secretary”) for an industrial hemp license, which must include specific documentation with respect to, and a legal description of, the land to be used for growth and production of the crop. Applicants are also required to submit to fingerprinting and both a nationwide and statewide criminal history and background check by the Department of Law and Public Safety and/or the Federal Bureau of Investigation. All issued licenses will be valid only for the site or sites specified in the license, and for a period of one (1) year from the date of issuance, unless otherwise adjusted by the Department of Agriculture to align with the normal growing season and to facilitate reasonable harvesting, processing and sale or distribution timing.

The Bill also tasks the Secretary, in consultation with the Attorney General, to adopt certain rules and regulations facilitating administration and enforcement. These regulations include (1) the establishment of approved varieties of industrial hemp and methods to distinguish it from other types of marijuana, (2) testing protocol for THC levels, (3) licensing requirements, fees and renewal procedures, and (4) penalties for administration and enforcement. Finally, the Bill requires that licensees notify the Secretary and the Attorney General of all sales or distributions of industrial hemp during the calendar year, and identify by name and address each distributee of industrial hemp for such calendar year.

Beyond the Bill, industrial hemp would be subject to the protections of the Right to Farm Act, and the land used for its cultivation may be eligible for valuation and taxation benefits provided by the New Jersey Farmland Assessment Act of 1964 – an Act permitting land actively devoted to agricultural use to be assessed at its productivity value, which is often less than the property tax assessment value of the property.

The enactment of the Bill is poised to offer a substantial boost to New Jersey’s agricultural industry, introducing what some view as a new “cash crop” to New Jersey’s repertoire and would afford New Jersey farmers the opportunity to diversify their products and compete in a nearly $500 million industry, catalyzing manufacturing and economic opportunity across the State. The Bill now also finds federal legislative support, following introduction of the Hemp Farming Act of 2018 in late April, co-sponsored by Senate Majority Leader Mitch McConnell (R-KY) and Senate Minority Leader Charles E. Schumer (D-NY). The federal bill, among other things, would remove industrial hemp from Schedule I of the Controlled Substances Act, and would empower the states to be the primary regulators of the industry.

After months of uncertainty surrounding the enforceability of state marijuana legislation in light of federal prohibitions, President Trump may have offered the legal cannabis industry some solace.

Late last week, President Trump promised to abandon Justice Department efforts to target recreational marijuana in states that have legalized adult use. The threat of increased federal enforcement came in early January, with Attorney General Jeff Sessions’s rescission of the Obama-era “Cole Memorandum”. The issuance of the Attorney General’s competing memo garnered opposition from Senator Cory Gardner – a top Senate Republican from the State of Colorado, who immediately blocked nearly twenty Justice Department nominees in retaliation. After a months-long stalemate, President Trump assured Senator Gardner that rescission of the Cole Memo would not adversely impact the legal cannabis industry in Colorado, and committed to supporting a “federalism-based legislative solution to this states’ rights issue”.

For many, including Senator Gardner, this proclamation by the President assuages concerns about a cannabis industry stifled by federal regulation and fear of prosecution.  At a minimum, many feel that this demonstrates a shift in the federal narrative toward looser regulation, governed on a state-by-state basis. On the other hand, many remain cautious in light of mixed signals from the administration, fearing that the President’s commitment applied only to Colorado under these narrow circumstances.

With this backdrop, lawmakers continue to pursue a bi-partisan legislative solution, aimed at prohibiting the use of federal funds and resources to target recreational marijuana businesses operating legally under state law. If successful, these measures would provide much needed comfort to the legal cannabis industry, likely fostering rapid growth and increased investment opportunities.