Assuming that the lender`s intention is to obtain and perfect a security right in all rights arising from an interest in an LLC, economic and management rights must be adequately described in the lien or security agreement and adequately disclosed in the UCC`s financing statement. An example of such a warranty descriptor is as follows: In terms of knowing your warranty, it is also important that the secured party ensures that the security in question remains the same type of security after the security has been perfected. To protect itself, the secured party should certainly include restrictive covenants in the security document, but also, to the extent permitted by the applicable Alternative Entities Act, the secured party should firmly incorporate safeguards into the relevant documents of the other entity. Therefore, a provision prohibiting the company from amending the relevant document in order to render the opt-in or opt-out of Article 8, as the case may be, should be added to the relevant document. In addition, a company governed by Delaware law may expressly provide in its management document that the secured party must accept any change that would alter the status of an interest as title or non-title. In the context of secured financing, counsel for the secured party should first determine the type of security right with which it deals in order to determine how to perfect its security right in that security. Unlike shares of companies, interests in an alternative entity may not always be the same type of collateral for UCC purposes. Investments in limited liability companies and partnerships can be "general intangible property" or "investment property". UCC §§ 9-102(a)(49) and 9-102(a)(42). Unless the alternative entity has taken positive steps to treat its assets as "securities" within the meaning of Article 8 UCC, such holdings are likely to be general intangible assets. UCC § 8-103(c). Therefore, a secured party must examine the relevant document and the certificate of interest of the alternative undertaking, if any, in order to determine whether the alternative undertaking concerned has opted for its holdings to be treated as securities, in which case those shares are investment properties and not general intangible assets.
To summarize briefly, investments in alternative companies can be "investment property" or "general intangible assets", and the type of collateral determines the methods of perfection allowed. All of this sounds relatively simple, but now let`s briefly describe some of the mistakes made by practitioners in dealing with these types of safeguards. As a general premise, it is imperative that the practitioner realizes that he or she is not dealing with company shares and therefore what might apply to company shares will not apply in the world of alternative companies. Therefore, it will not be enough to simply follow the same procedures that such a practitioner has followed to perfect an interest in the company`s shares. For example, under Delaware law, unlike shares of corporations, an interest in a limited partnership or limited liability company consists of different economic rights and governance rights, and the two rights are not legally related. Ultimately, a secured party wants the right to take control of equity investments in the event of late payment and to have the opportunity to obtain or transfer the economic benefits of equity participation as well as governance rights. Therefore, it is essential that the secured party correctly describes the guarantee in order to ensure that the description of the guarantee is sufficiently broad to establish a safeguard interest in economic and governance rights. Security: However, an LLC may choose to classify its membership interests as securities in accordance with Section 8 of the UCC. In general, it should be expressly stated in organizational documents that the interests of members should be treated as safeguards.
If members` interests are securitized, they are also considered securities. As a secure party, you should review organizational documents to determine if the "opt-in" label is included or if the interests of members are certified to properly enhance your safety. In recent years, the use of alternative companies such as limited liability companies, limited partnerships and general partnerships (hereinafter collectively referred to as "alternative companies") has exploded. In addition, limited liability companies have become the preferred vehicle for the creation of bankrupt remote entities in many financing transactions, which may also include mezzanine financing agreements where stakes in the limited liability company are the main guarantee of the mezzanine secured part. Therefore, it is imperative that commercial finance lawyers understand the consequences of using investments in alternative companies as collateral. Although practitioners may be inclined to treat holdings in alternative companies as shares in companies, the provisions of the Uniform Commercial Code (UCC) regarding the use of holdings in alternative companies as collateral are different from those relating to the use of shares in companies as collateral. Therefore, practitioners cannot approach the problem of perfecting a hedging interest in equity investments in alternative companies in the same way that they or she would approach perfection in company shares. This article describes (1) methods for perfecting a hedging interest in equity investments in alternative companies, (2) the mistakes practitioners often make when using equity investments in alternative companies as collateral, and (3) some useful tips that practitioners should keep in mind when using equity investments in alternative companies as collateral.
This article will focus primarily on the relevant provisions of the UCC regarding the use of investments in alternative companies as collateral, but to the extent that reference is made to the laws governing alternative companies, it will refer to the Delaware Limited Liability Company Act and the Delaware Revised Uniform Limited Partnership Act. However, the concepts discussed will also apply to other jurisdictions that may have similar laws. Generally unimportant: Most often, members` participation in an LLC is considered generally intangible. To complete a security right in a general intangible asset, you must file a UCC-1 financing statement with the Office of the Secretary of State in the state where the person resides or where the entity was formed, depending on whether the borrower is a natural or legal person. Once you have submitted the statement of financing, your security is considered perfected. In general, among other things, the time of filing determines the order of precedence between several secured parties, with the first to file the application having priority [...].