Third Party Claims to Divisive Mergers in Texas and Delaware

Delaware is widely recognized as the leading state for business incorporation, due largely to its comprehensive and well-established legal framework. Texas, however, was the first mover in one important area: divisive mergers. Divisive mergers are a statutory mechanism that allow businesses to divide into multiple entities and allocate assets and liabilities among them without, among other benefits, triggering contractual restrictions on assignment. They can facilitate restructurings, acquisitions, divestitures, or allocation of assets or liabilities, but must be approached carefully to avoid potential fraudulent claims and third-party challenges.

Background

A divisive merger is the statutory reverse of a traditional merger: instead of entities combining into one surviving entity, a single entity divides into two or more.

Texas codified divisive mergers in 1989 under the Texas Business Organization Code (“TBOC”) by expanding the definition of a “merger” to include the division of one entity into two or more domestic entities.[1] The revisions were intended to provide greater flexibility in structuring business combinations. The TBOC allows all entities, including corporations, partnerships, and LLCs to divide into one or more entities of any type.[2] For example, a corporation may divide into two LLCs, and vice versa.

The existence and use of Texas’ divisive merger laws created a competitive landscape and likely influenced Delaware to follow suit. Delaware adopted a similar statute in 2018, allowing Delaware LLCs to divide into multiple LLCs and in 2019 extended the rule to limited partnerships.[3] Unlike the Texas statute, Delaware limits divisions to LLCs and LPs, and the resulting entities must be of the same type as the dividing entity.

A divisive merger can be a beneficial tool when a company wants to sell certain assets while retaining others without triggering the anti-assignment provisions tied to those assets. Because both Texas and Delaware statutes expressly provide that a divisive merger is deemed not to be an assignment of assets or liabilities, businesses can transfer contracts, debt, or other property into a new entity without violating anti-assignment clauses.[4] This avoids the often time-consuming process of obtaining waivers or consents.

Effects of Division: Fraudulent Transfer Considerations

For businesses considering a divisive merger, a critical next question is how assets and liabilities are divided, since improper allocation can create unintended exposure or disputes under fraudulent transfer law, particularly from creditors concerned about losing access to assets.

Both Texas and Delaware statutes allow parties to determine the allocation in the plan of merger or division.[5] If a plan does not specify the allocation of a particular asset or liability, both states provide that such asset or liability becomes the joint and several responsibility of all resulting entities.[6] This default rule ensures creditors and owners are not left uncertain about ownership or repayment obligations.

Even with clear statutory allocation rules, divisive mergers can still face scrutiny. Both Texas and Delaware fraudulent transfer statutes recognize two types of fraudulent transfers – actual fraud, where a transfer is made with the intent to hinder or defraud creditors, and constructive fraud, where no intent is required by the transfer but leaves the debtor undercapitalized or unable to meet obligations.[7] Courts apply solvency-based tests, including the balance sheet test, which compares the fair value of assets against liabilities, to determine whether a transfer is constructively fraudulent. As a result, even if a divisive merger is authorized by statute, it can still be challenged if it unfairly strips creditors of recourse.[8]

The TBOC makes clear that divisive mergers “do not abridge any right or rights of any creditor under existing laws.”[9] Creditors may challenge a divisive merger under the Texas Uniform Fraudulent Transfer Act if they believe assets were improperly moved away from their reach. Similarly, Delaware law provides that if a court determines that a division constitutes a fraudulent transfer pursuant to the Delaware Uniform Fraudulent Transfer Act, both the dividing and resulting entities are jointly and severally liable for the obligations.[10] Notably, in both states, ongoing litigation against the dividing entity may continue against the surviving entity, or against the new entity that assumes the relevant obligation or asset under the plan of merger.

Judicial Scrutiny in Practice

Texas courts have examined the use of divisive mergers to manage liabilities. In DBMP LLC,[11] CertainTeed Corporation used the Texas statute to place its asbestos liabilities into a newly created entity (DBMP LLC) with minimal assets, while transferring its operations, assets, and non-asbestos creditors into a separate company (CertainTeed LLC). DBMP LLC then filed for bankruptcy. The court recognized that while the Texas law permits divisive mergers, creditors are not without remedies. Fraudulent transfer laws act as a safeguard against abuse. As the court noted, “…if a corporation uses a divisional merger to dump its liabilities into a newly created ‘bad’ company which lacks the ability to pay creditors while its ‘good’ twin corporation walks away with the enterprise’s assets, a fraudulent transfer avoidance action lies.”[12] In DBMP, no fraudulent transfer claim was ultimately made, but the case underscores that courts will closely scrutinize divisive mergers to ensure they do not unfairly prejudice creditors or circumvent established protections under fraudulent transfer law.

Although Delaware courts have not yet ruled on fraudulent transfer challenges to a divisive merger, companies should assume the existing Delaware framework applies.[13] In practice, this means courts are likely to focus on whether the division unfairly deprives creditors of recourse, and they may be willing to unwind or reallocate liabilities if it resembles an actual or constructive fraudulent transfer.

Effects of Division: Anti-Assignment Provisions

Another important consideration in divisive mergers is how they interact with contractual anti-assignment provisions. One of the principal advantages of a divisive merger is that it may allow parties to reallocate assets and liabilities without triggering these clauses. If a contract prohibits assignments but does not expressly cover divisive mergers or assignments by operations of law, both Texas and Delaware statutes provide that a divisive merger will not, by itself, violate the restriction.

Texas and Delaware, however, take slightly different approaches. In Texas, a divisive merger allocates assets and liabilities pursuant to a plan of merger, to the new or surviving entities without triggering anti-assignment provisions. The TBOC reflects the Texas legislature’s intent that only clear contractual language can restrict the statutory effect of a divisive merger.[14]

In Delaware, when an LLC or LP divides, the assets and liabilities allocated to each resulting entity are not considered assigned or transferred by operation of law.[15] However, for entities formed and entered into a contract before August 1, 2018 (LLCs) or August 1, 2019 (LPs), pre-existing contractual restrictions on mergers, consolidations, or asset transfers apply equally to divisions, effectively treating a divisive merger as an assignment that may be restricted.[16]

Judicial Scrutiny in Practice

Texas courts have confirmed that divisive mergers do not, by default, trigger anti-assignment provisions. In Plastronics Socket Partners, Ltd. v. Dong Weon Hwang,[17] the court referenced TXO Prod. Co. v. M.D. Mark, Inc,[18] where the disputed contract was silent on whether a divisive merger would violate the anti-assignment provision of the contract. The court held that unless a contract specifically states that a divisive merger triggers an anti-assignment clause, a divisive merger does not constitute a prohibited transfer. The decision underscores that courts will enforce clear contractual drafting, but will not imply restrictions beyond the contract’s terms.

Although Delaware courts have not yet ruled on anti-assignment issues in a divisive merger context, businesses should expect them to apply Delaware’s traditional deference to enforcing contracts as written, with the Court of Chancery in particular emphasizing freedom of contract and struct adherence to unambiguous terms. As the Delaware Supreme Court explained in Nemec v. Shrader, “parties have a right to enter into good and bad contracts, the law enforces both.”[19] As a result, parties should assume that Delaware courts will scrutinize the language of their contracts closely, particularly for entities formed after the 2018 and 2019 statutory amendments.

Both Texas and Delaware generally allow divisive mergers to bypass contractual assignment restrictions, but they remain subject to judicial scrutiny and creditor protections. Divisive mergers can be a valuable mechanism for restructuring, but they carry risks that require careful planning. Businesses should pay close attention to how assets and liabilities are allocated, the potential for fraudulent transfer claims, and whether contractual anti-assignment provisions may be implicated. For any additional guidance, please reach out to a member of the Sidley Austin LLP team and we would be happy to assist.

[1] See TBOC § 1.002(55)(A).

[2] See TBOC §§ 1.002(55 and 62).

[3] See Title 6 §17-220.

[4] See § 18-217(l)(8) and § 17-220(l)(8) and TBOC § 10.008(a).

[5] See TBOC §10.008(a), § 18-217(l)(2), and § 17-220(l)(2).

[6] See TBOC §10.008(b), § 18-217(l)(6), and § 17-220(l)(6).

[7] See Del. Code Ann. tit. 6, § 1302; Tex. Bus. & Com. Code § 24.003

[8] See 11 U.S.C. § 101(32)(A); Del. Code Ann. tit. 6, § 1302; Tex. Bus. & Com. Code § 24.003.

[9] See TBOC §10.008(a)(2) and §10.901.

[10] See § 18-217(l)(5) and § 17-220(l)(5).

[11] DBMP LLC v. Those Parties Listed on Appendix A to Complaint (In re DBMP LLC), No. 20-30080, Adv. No. 20-03004, 2021 WL 3552350 (Bankr. W.D.N.C. Aug. 11, 2021).

[12] See DBMP LLC v. Those Parties Listed on Appendix A to Complaint (In re DBMP LLC), No. 20-30080, Adv. No. 20-03004, 2021 WL 3552350 (Bankr. W.D.N.C. Aug. 11, 2021).

[13] See Del. Code Ann. tit. 6, §§ 1301–1311

[14] See “[t]he Texas Legislature intended by its amendments to the Business Corporations Act that a prohibited transfer would not be implied by merger but would only occur in the event the parties agreed that merger specifically violated an anti-assignment provision.” TXO Prod. Co. v. M.D. Mark, Inc., 999 S.W.2d 137, 143 (Tex. App.—Houston [14th Dist.] 1999).

[15] See § 18-217(l)(8) and § 17-220(l)(8).

[16] See § 18-217(o) and § 17-220(o).

[17] Plastronics Socket Partners, Ltd. v. Dong Weon Hwang (June 11, 2019).

[18] See TXO Prod. Co. v. M.D. Mark, Inc., 999 S.W.2d 137, 143 (Tex. App.—Houston [14th Dist.] 1999).

[19] Nemec v. Shrader, 991 A.2d 1120, 1126 (Del. 2010).

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