Updates on Regulation, Trading, and Market Reforms for the Alternative Investment Community

Delaware Law Updates

On July 23, 2018, Delaware amended the Delaware limited liability company act (the “LLC Act”). The two key amendments were to (a) permit a divisive or divisional merger and (b) create provisions related to a registered series.

Divide Away! (aka Divisive Mergers)

The LLC Act now permits a divisive or divisional merger. Under new Section 18-217 of the LLC Act, a Delaware LLC will be permitted to divide itself into two or more domestic Delaware LLCs. As part of such division, the original Delaware LLC can either continue its existence or terminate as part of the division. Following the division, the surviving or continuing LLCs will each be liable for the debts, liabilities and duties of the original dividing LLC to the extent allocated to each entity pursuant to the plan of division, and no other post-division LLC will retain or obtain liability for any such pre-existing obligations unless the plan of division constitutes a fraudulent conveyance under applicable law. If a plan of division fails to specify the allocation of any debts and liabilities of the original LLC, then those debts and liabilities become joint and several liabilities of all LLCs resulting from the divisive merger.

Due to the fairly novel concept, the amendments also provide that the terms of a written contract, indenture or other agreement that restrict, condition or prohibit a Delaware LLC from consummating a merger or consolidation or transferring assets will apply with equal force to a division if: (i) the Delaware LLC was formed prior to August 1, 2018 and (ii) the Delaware LLC entered into such written contract indenture or other agreement prior to August 1, 2018.

The implication of this safe harbor is that, for contractual arrangements after August 1, 2018, a divisive merger may not be covered by the typical prohibition on assignment contained in many agreements. Contract drafters should review agreements to ensure that going forward such provisions also include a provision that is broad enough to cover all transfers by operation of law, including conversions, mergers and divisive mergers.

Registered Series

Section 18-215 of the LLC Act currently permits an LLC to establish one or more series of members, managers, limited liability company interests or assets (“Series LLCs”). A Series LLC allows for a single entity to maintain separate series as to which: (i) the debts, liabilities, obligations and expenses incurred, contracted for or otherwise existing with respect to a particular series would be enforceable solely against the assets of such series and not against the assets of another series, and (ii) none of the debts, liabilities, obligations or expenses existing with respect to the LLC generally or any other series would be enforceable against the assets of this series.

Under the recently added Section 18-218 a Series LLC may now be registered with the Delaware Secretary of State (a “Registered Series LLC”). Registered Series LLCs were introduced, in part, to provide additional certainty with respect to the perfection of a security interest in the Series LLCs.

Non-registered Series LLCs formed under Section 18-215 are now called a “protected series.” A Registered Series LLC is deemed an association for purposes of the Uniform Commercial Code. These amendments may facilitate the use of Registered Series LLCs in secured financing transactions as the Registered Series LLC will be a registered organization for purposes of the Delaware Uniform Commercial Code. A Registered Series LLC will be required to file a separate Certificate of Registered Series with the Delaware Secretary of State and will pay a separate annual franchise fee. There are also amendments to the Delaware UCC which will simplify the process for filing a UCC financing statement against a Registered Series LLC. Registered Series LLCs will also be able to obtain good standing certificates and certificates of existence from the Delaware Secretary of State.

Delaware Supreme Court Permits Application of “Material Adverse Effect” (“MAE”) Condition in Merger Agreement to Terminate Merger

On December 7, 2018, the Delaware Supreme Court affirmed the Chancery Court’s opinion in Akorn Inc. v. Fresenius Kabi AG, et al., permitting the cancellation of the February 2017 merger agreement between Akorn and Fresenius. The Chancery Court determined that the deterioration in Akorn’s financial performance constituted an MAE. Immediately after signing the merger agreement, Akorn’s financial performance “dropped off a cliff.” Akorn attributed the decline to unexpected market competition and the loss of a key contract. For the full year 2017, Akorn’s revenue, operating income, and earnings per share fell by 25%, 105% and 113%, respectively, and its EBITDA and adjusted EBITDA fell by 86% and 51%, respectively. The decline in financial results continued through the first quarter of 2018. In contrast, Akorn had shown persistent growth over the prior five years. In addition, Akorn’s financial performance in the first quarter of 2017—before the merger agreement was signed—did not exhibit the downturn of the ensuing three quarters of 2017.

The duration of the downturn in Akorn’s finances was significant to the Chancery Court’s analysis. For an acquirer that is purchasing the target as part of a long-term strategy, the Chancery Court noted that an MAE must “substantially threaten the overall earnings potential of the target in a durationally-significant manner,” and that the relevant period is “measured in years rather than months.” In finding that Akorn had suffered an MAE, the Chancery Court observed that Akorn’s dramatic downturn had already continued for a year and showed no signs of abating. Importantly, the Chancery Court noted that “[t]here is every reason to think that the additional competition will persist and no reason to believe that Akorn will recapture its lost contract.”

The Akorn decision is regarded as the first Delaware decision holding that an MAE had occurred. Since the Chancery Court’s 246-page opinion was highly fact-specific, it remains to be seen whether the Delaware courts will follow the Akorn case under different fact scenarios. While the opinion demonstrates the uphill climb a buyer would face in attempting to use an MAE clause to terminate an acquisition, it does provide helpful guidance on the exercise of a right that may have been viewed as purely formalistic by buy- and sell-side parties. Although the Chancery Court reviewed and discussed specific financial metrics in determining that an MAE had occurred, it emphasized that it was not establishing bright-line quantitative tests. Qualitative factors relating to Akorn’s regulatory shortcomings and behavior appeared to be critical to certain aspects of the decision. Going forward, buyers, targets and their counsel will want to carefully consider the ramifications of the Chancery Court’s decision in drafting and analyzing MAE clauses in acquisition agreements.

About the author

Mark Diamond

Mark Diamond has been practicing corporate and securities law for almost 40 years. After 10 years in private practice, where he specialized in corporate finance and merger and acquisition transactions, Mr. Diamond became in-house counsel and compliance officer for major Wall Street firms, including Lehman Brothers, Deutsche Bank, Wasserstein Perella and Robertson Stephens. While at Lehman Brothers and Deutsche Bank, Mr. Diamond spent five years in Hong Kong as legal counsel for Asian matters and helped structure equity derivatives products. After his Wall Street firm positions, Mr. Diamond became general counsel for a hedge fund management company, where he structured and helped launch a number of hedge funds and provided regulatory advice. In 2004, Mr. Diamond returned to private practice, specializing in the representation of investment fund managers and broker-dealers in both regulatory and transactional matters. Read more

Benjamin L. Douglas

Ben Douglas counsels businesses in all areas of asset management, including private investment advisers and wealth managers, hedge, real estate, and venture funds, fintech start-ups, mutual fund managers, and firms with hybrid businesses (such as private fund advisers that also sub-advise mutual funds). He handles matters ranging from fund formation, regulatory compliance and service provider relationships, to complex sales and acquisitions of asset management businesses. Read more

Geoffrey Perusse

Geoffrey Perusse represents sponsors and managers of private funds across asset classes, including real estate, private equity, debt, venture capital and hedge funds, with respect to the structuring, formation and operation of the funds, as well as operational and compliance matters. Read more

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Updates on Regulation, Trading, and Market Reforms for the Alternative Investment Community