"It's like biology," was shouted across the room when the new law allowing Delaware LLCs to divide was explained recently at a Delaware registered agent meeting hosted by the Delaware Secretary of State.
For example, an LLC inherited by two siblings which holds a primary residence and a beach house could be divided so each sibling could get their own house in two separate single-member LLCs. This split would end the partnership and the headaches of dual management. Dividing would also not require the "buyout" by one partner or a sale, but instead is just one LLC splitting into two where each member walks away from the other with their own property, which could have favorable tax consequences.
How to Divide a Delaware LLC
The Delaware LLC Act's recent amendments to permit a Delaware LLC to divide into two or more separate and distinct LLCs enables LLCs with various assets to break the assets apart like a reverse merger to ringfence assets separately. Unlike a classic asset transfer to another entity, it allows an LLC to be chopped apart into smaller free-standing LLCs according to a plan of division adopted by the original LLC. The law does not even require identical ownership or management. By design, pools of assets can be reduced into smaller pools without needing to transfer assets out of the LLC. A division is something to consider in the context of a business divorce. When two members of an LLC cannot agree on how to proceed together, they could agree to proceed separately following an LLC division.
In addition to traditional LLCs being able to divide, the amendments also give a Delaware Series LLC the ability to pull the ripcord to jettison separate protected series. The amendments will be the next step in mapping out how a Series LLC could "spin off" a protected series into its own distinct traditional LLC. The "incubator" strategy of using a Series LLC to fund promising new business ideas in their own protected series and eventually "spinning-off" the most profitable series into separate LLCs would more economically facilitated with the Series LLC over traditional LLCs.
The LLC's Operating Agreement Still Matters
Keep in mind that whether or not an LLC can be divided is subject to its LLC Operating Agreement. If the LLC Operating Agreement does not address divisions, the new law requires a Plan of Division to be approved by LLC members who own more than 50 percent of the pre-division company. When an LLC decides to divide, the resulting LLCs and the surviving LLC if applicable, must file a Certificate of Division and a Certificate of Formation with the Secretary of State. The original LLC has the option to either continue its existence or terminate as a result of the division.
Dividing an LLC Requires a Plan of Division
A Plan of Division, which is its own document distinct from the Operating Agreement, must include the allocation of assets, property, rights, series, debts, liabilities and duties of the dividing LLC among the resulting LLCs. This plan is the key document that provides for asset ownership and how existing creditors are to be paid. The Plan of Division must also say how interests in the dividing LLC will be exchanged for, or converted to, interests in the new LLCs or other property. The Plan of Division must list the name of each resulting LLC and the name of the surviving LLC if it will survive the division.
The Plan of Division is also required to list the name and business address of a "Division Contact" who is required to keep a copy of the Plan of Division for at least six years after the effective date. The Division Contact is responsible for keeping record of and updating important information regarding the new and surviving LLCs. The Division Contact is required to provide, in that six-year period, without fee, the name and business address of the Division LLC to which the claim of that creditor was allocated within 30 days of receipt of a written request.
The Series LLC is even better suited for these types of situations. A properly drafted Series LLC Operating Agreement begins with a certain number of established protected series associated with the LLC. When a Series LLC goes to file a Certificate of Division and adopt a Plan of Division under this new legislation, the Series LLC members have a head start compared to a traditional LLC because in a series LLC the assets are already separated into protected series buckets, making for a cleaner break. When drafting the Plan of Division and allocating assets and liabilities to the new LLCs, the Series LLC members and managers should already have a good record of what each spin-off series owns and what known and unknown creditors may have rights to access.