Delaware Corporate Amendments

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to assert a claim based on the occurrence of an MAE because the buyer’s ability to exercise a termination right is withdrawn if it is in material breach of any of its contractual obligations.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