Pub. 4 2016 Issue 2

Issue 2. 2016 7 “limited liability company interest” solely to an assignment of economic rights in a LLC. While economic rights are freely assignable under Delaware law, management rights are a different matter. Absent permis- sive language in the LLC operating agreement or specific action by the members of the LLC authorizing the assignment of management rights, the assignee of a “limited liability company interest” under Delaware law will not have the right to partici- pate in the management of the business and affairs of the LLC. 2 For practical purposes, this means that while a lender will most likely have the right to economic participation upon the assign- ment of “membership interests” in a Delaware LLC, such lender will have no right to control the economic direction of the LLC, to demand financial information or review other records of the LLC, or to compel dissolution of the LLC. At first glance, such an outcome seems irrational. How is it possible that Delaware law permits a secured party to succeed to economic rights, while allowing the borrower to retain all management rights in the LLC? However, it must be remem- bered that this outcome is not mandated by the Delaware LLC Act, but merely follows from the careless use of the phrase “limited liability company interests” as well as the application of Delaware’s default laws when the parties have not brought about their intended outcome by careful review of the LLC’s operating agreement and inclusion of appropriate contractual provisions in the security agreement. Another important issue to acknowledge is that while “lim- ited liability company interests” may generally be pledged as security for a loan in accordance with Delaware’s policy to give “maximum effect to the principle of freedom of contract and to the enforceability” of LLC agreements, 3 Delaware also permits and enforces restrictions on the alienability of these interests. 4 Article 9 of the Uniform Commercial Code would normally operate to override such anti-assignment language. However, the Delaware LLC Act expressly provides that Article 9’s anti-assignment provisions “do not apply to any interest in a limited liability company.” 5 As a result, because Article 9 does not trump Delaware’s LLC interest anti-assignment language and because other state statues may have similar anti-assign- ment language, lenders would be wise to review the borrower’s LLC agreement to determine whether an amendment or waiver is necessary to permit the assignment of economic rights in the LLC. Solution/Conclusion Fortunately for lenders, state laws afford the contractual free- dom necessary to assign both economic and management rights in a LLC. Accordingly, to achieve an effective assignment, lenders and their counsel should conduct a thorough review of (1) the terms used in both the relevant state LLC statute and in the borrower’s LLC operating agreement to describe econom- ic and management rights, and (2) the provisions in both the relevant state LLC statute and in the borrower’s LLC operating agreement governing the assignability of these rights. This review will, at the very least, allow the lender to know whether modification of the operating agreement is necessary to permit assignment of both economic and management rights. Addi- tionally, a detailed review will provide lenders and their counsel with the ammunition needed to clearly articulate in their secu- rity agreements the interests in the LLC borrower they intend to take as collateral. Thus, instead of relying on familiar yet imperfect terms like “membership interests” or “limited liability company interests” to describe their collateral, lenders will use words and phrases with foundation in both the statutory law as well as the applicable LLC operating agreement. Only by so doing can lenders have confidence that their intended security interest in a LLC encompasses both economic and management rights. n 1 Del. Code Ann. tit. 6, § 18-101(8) 2 Id. at § 18-702(a). See also § 18-702(b)(1) (providing further that unless the LLC agreement provides otherwise, “[a]n assignment of a limited liability company interest does not entitle the assignee to become or to exercise any rights or powers of a member[.]” Id. at § 18-702(b)(1). 3 Id. at § 18-1101(b) 4 Id. at § 18-702(a). 5 Id. at § 18-1101(g). Landon A. Hardcastle is an attorney with the law firm of Jones Waldo and concentrates his practice in commercial finance. Landon may be reached at Lhardcastle@joneswaldo.com or 801-534-7288.