This post was also written by Aaron Bourke.
Most secured lenders have experience taking a security interest in limited liability company (“LLC”) interests. Indeed, such arrangements are so common that lenders can easily fall into the trap of using shorthand (such as “membership interests”) to describe their collateral. However, depending on the state of formation of the issuing LLC, such shorthand descriptions may be inadequate to protect the lender’s interests or, even worse, completely meaningless. Lenders should be particularly careful when taking as collateral LLC interests of an LLC formed in Delaware because Delaware law contains a number of nuances that must be taken into account.
Nature of Limited Liability Company Interests Under Delaware Law
First, the term “membership interest” does not appear in the Delaware Limited Liability Company Act (the “DE LLC Act”). Instead, the DE LLC Act defines a “limited liability company interest” as “a member’s share of the profits and losses of a limited liability company and a member’s right to receive distributions of the limited liability company’s assets” – a definition that only includes economic rights and does not include control rights (such as the rights to manage the LLC, access information, review the LLC’s books and records, and compel dissolution).
A secured lender should therefore ensure that its collateral description covers (i) economic rights, (ii) control rights and (iii) the right to be admitted as a member upon foreclosure (which may be, but is not necessarily, correlated with control rights). However, this objective is complicated by provisions of the DE LLC Act, which provide in relevant part as follows:
- Economic rights (i.e., LLC interests) are assignable in whole or in part except as provided in an LLC’s operating agreement (an “LLC Agreement”). §18-702(a).
- The assignment of an LLC interest does not entitle the assignee to control rights except as provided in the LLC Agreement or upon the affirmative vote or written consent of all of the members of the LLC. §§18-702(a).
- An assignee of an LLC interest may only become a member as provided in the LLC Agreement or upon the affirmative vote or written consent of all of the members of the LLC. §§18-702(b)(1), 18-704(a).
- Notwithstanding any other provision of the LLC Agreement, a member may pledge all of its right, title and interest in the LLC, whether derived under the Certificate of Formation, the LLC Agreement, the DE LLC Act, or otherwise, and upon foreclosure, the secured party or other successful bidder will automatically succeed to all of such pledged right, title and interest, including without limitation: (i) its “limited liability company interest” (as such term is defined in section 18-101(8) of the DE LLC Act); (ii) its right to participate in the management of the business and affairs of the LLC; and (iii) its status as a “member” (as such term is defined in section 18-101(11) of the DE LLC Act).
- Notwithstanding any other provision of the LLC Agreement, a secured party or other successful bidder at a foreclosure sale or other disposition will automatically be deemed admitted as a member of the LLC immediately before the debtor ceases to be a member.
“All of the Pledgor’s interest in XYZ, LLC, a Delaware limited liability company, including without limitation all of the Pledgor’s limited liability company interests in XYZ, LLC, all of the Pledgor’s right to participate in the management of the business and affairs of XYZ, LLC or otherwise control XYZ, LLC, and all of the Pledgor’s rights as a member of XYZ, LLC.”These actions are, of course, in addition to other standard steps that a secured lender takes to protect and perfect a security interest in LLC collateral under Delaware law.