BLOG: Why Government Contractors Should Know About the Delaware LLC Division Statute

August 20, 2019

By Kathryn L. Hickey
Practice Areas: Business & Corporate Law and Government Contracts Law

Relatively often in the government contracting industry a business finds itself in the position where, for one reason or another, it needs to split, fracture, or otherwise reorganize its operations by separating one line of business or division into a separate entity. When prime federal contracts are transferred from one entity to another, it often necessitates a novation agreement with the contracting government agency.  Many government contractors discover the novation process to be relatively lengthy and burdensome, with the potential to delay or hinder the ultimate business objectives, and traditional corporate restructurings can be cumbersome and inefficient.  The Delaware Limited Liability Company Act (DLLCA)1 LLC Division Statute provides a potential streamlined path to entity reorganization.  
 
Common Reasons for Entity Restructuring
  1. Perhaps the enterprise services both government and commercial customers, and it has become apparent that the two business lines are taking different paths and would be easier to manage under separate entities.  
  2. In some cases, a small business enterprise may be approaching its size standard and is seeking to preserve its small business status by fracturing off a portion of its business into a separate, unaffiliated entity.  
  3. In other instances, entity reorganization may be necessary for asset protection, tax, or other business reasons.  
Whatever the reason, these types of restructurings often are accomplished via the creation of new sister companies or subsidiaries, with multiple steps involving distributions, contributions, and/or transfers of assets to achieve the ultimate structuring goal.  
 
How Divisive Mergers Could Streamline the Process 
 
Effective on August 1, 2018 the DLLCA was amended to include a new § 18-217 which provides for the “division” of a Delaware limited liability company, or a “divisive merger” as the concept is described in the parallel Texas statute.  Under the Delaware divisive merger statute, an existing Delaware LLC can adopt a plan of division and divide its assets and liabilities among itself and one or more new LLCs.  Similar to a merger, the reorganization of assets and liabilities among the dividing LLCs is not considered a transfer or an assignment.  This could prove useful in various scenarios, not the least of which is the fact that it could provide support for the argument that any prime federal contract assumed by a new entity via a Delaware LLC division would not require a novation agreement because it was not transferred in the traditional sense, but rather was assumed by operation of law, similar to a merger transaction.  In this way, the Delaware LLC division can be a tool that, in the right circumstances, permits a more streamlined and efficient path to entity reorganization.   In all cases, please consult with your tax and government contracts legal advisors before entering into any plan for a divisive merger or other business restructuring.
 
If you have questions related to business reorganizations, restructurings, conversions, or contract novations, please contact a member of PilieroMazza’s Business & Corporate Law Group
 
Kathryn Hickey, the author of this blog, is a Partner in the Firm’s Business & Corporate Law and Cybersecurity & Data Privacy practicce groups.

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1Note that a similar statute exists in Texas (Texas Business Organizations Code Sections 1.002(15) and 10.008).  Under Texas law, divisive mergers are permitted for corporations and partnerships as well as limited liability companies.
 
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