Strategic Use of the Divisive Merger in Texas
The Texas Business Organizations Code offers a unique option to divide the assets of a Texas company called a divisional or divisive merger.[i] A divisive merger can be useful when a company wants to transfer a business line, contracts, real estate or certain assets into a new company to isolate risk or as a restructuring step in the sale of all or a portion of the business. A company electing to engage in a divisive merger chooses what assets and liabilities to retain and what assets to divide off into a new company or companies.[ii] The merging company can elect to survive the divisive merger and continue to operate as a going concern or the assets of the company can be divided into two or more totally new or existing companies.[iii] The multiple and flexible restructuring options made possible by a divisive merger make it a useful planning tool. The divisive merger is not available for entities organized in other jurisdictions, including Delaware.
A divisive merger can be used when a company wants to transfer a contract that would otherwise be unassignable because of anti-assignment or anti-transfer provisions, as long as the contract does not have a specific provision that addresses change of control, merger or change in corporate form. If none of these provisions are present, a divisive merger, much like a forward merger, will not trigger an anti-assignment provision in a contract.[iv] But keep in mind that if a company engages in a divisive merger as a means to avoid creditors or allocates liabilities in such a way that triggers insolvency, then the divisive merger’s segregation of assets and liabilities could be characterized as a fraudulent transfer and voided.[v]
The process for approving and documenting a divisive merger is similar to that of a traditional merger. The company or companies engaging in the merger negotiate how the assets and liabilities and the equity interests in the various companies will be divided, obtain the required approvals from their management and owners, prepare a plan of merger and then file a certificate of divisional merger with the Texas Secretary of State.
A company should closely examine its lender agreements before entering into a divisive merger, because engaging in a divisive merger without lender consent may trigger an event of default under its loan documents. In addition, it is important for a company to consult with its tax advisors and carefully consider the tax consequences before entering into a divisive merger.
The diagram below shows a straightforward divisive merger with certain assets being transferred to a new company created in a divisive merger to isolate the risks of the ranching operations from the real estate assets:
Step 2: LLC engages in a divisive merger with Newco to separate its ranching operations from its real estate.
[i] See Tex. Bus. Orgs. Code § 1.002(55)(A) (defining Merger as “the division of a domestic entity into two or more new domestic entities . . . or a surviving domestic entity and one or more new domestic entities”); There is no similar provision under Delaware law.
[ii] Id. § 10.008(b).
[iii] Id. § 1.002(55)(A); 10.002.
[iv] § 10.008(2)(C); TXO Prod. Co. v. M.D. Mark, 999 S.W.2d 137, 143 (Tex. App.—Houston [14th Dist.] 1999, pet. denied).
[v] Tex Bus. & Comm. Code §§ 24.005, 24.006; see also Hahn v. Love, 321 S.W.3d 517, 525-26 (Tex. App.—Houston [14th] 2009, pet. denied) (“In general, an ‘insider’ is an entity whose close relationship with the debtor subjects any transactions made between the debtor and the insider to heavy scrutiny.”)