Pledges of Delaware LLC interests

Pledges of Delaware LLC interests

February 20, 2018 | By Keith Martin in Washington, DC

Pledges of interests in Delaware limited liability companies are being mishandled in some transactions.

Lenders require borrowers to pledge shares or other interests in any company they own that is a source of revenue to repay the loan. The owners of the borrower must also pledge their interests in the borrower to give the lenders more options for how to foreclose on collateral if the borrower defaults on the loan. These pledges become part of the collateral package securing the loan.

Delaware limited liability companies are the most common form of US business entity used in project finance transactions. Owners of LLCs are called “members.”

Pledge agreements usually recite that the economic and voting rights and member status are being pledged, but this is not enough for an effective pledge, says Christine Brozynski with Norton Rose Fulbright in New York. Rather, the operating agreement of the LLC being pledged must be amended to say that the voting rights and member status are assignable, notwithstanding anything to the contrary in the Delaware LLC statute.

“The reason for this is the Delaware statute specifically states that although economic rights are freely assignable, control rights and member status are not, unless the LLC agreement expressly permits such an assignment or the assignment is otherwise approved by all the members other than the one making the pledge,” Brozynski said.

The Uniform Commercial Code does not override the laws of the state of incorporation, meaning any restrictions on assignment under Delaware law cannot be overridden in the pledge agreement. Due to some additional quirks under Delaware law, it is best practice to amend the LLC agreement even when the pledge entity has only a single owner.