Secured Transactions

Equity interests, such as stock, partnership interests and limited liability company (“LLC”) interests, have been valuable as collateral for borrowers looking to obtain additional liquidity, particularly in mezzanine financings, where the primary lender to a project or operating borrower is often unwilling to allow second liens on its collateral, no matter how “silent.” Residing at the intersection of organizational law, contract law and securities law, partnership and LLC interests have always presented challenges as collateral. Changes over the past several years in states’ entity laws indicate a trend toward making it more difficult for debtors to pledge partnership and LLC interests. An example of this is the adoption of amendments to Texas’s Business Organizations Code that became effective last month (see the discussion below). Under these amendments, restrictions on pledges or transfers of partnership or LLC interests set forth in a partnership agreement, certificate of formation or LLC agreement, will be given effect and not be overridden by the anti-assignment provisions of UCC Sections 9-406 and 9-408.¹ In this regard, Texas is following the lead of Colorado, Delaware, Kentucky and Virginia in giving priority to contractual provisions of LLC and partnership agreements restricting pledges or transfers (hereinafter, collectively “assignments”) of equity interests over UCC provisions that might otherwise override such restrictions.

Background

In general, shares of corporate stock are “securities” under Article 8 of the UCC, but interests in LLCs or partnerships can constitute either a “general intangible” under Article 9 of the UCC or a “security” under Article 8.² To be categorized as a “security,” an LLC or partnership interest must be (or be of a type) traded on a securities exchange or in a securities market, its terms must expressly provide that it is a security governed by Article 8 or it must be an “investment company security.”³ How the collateral is properly categorized determines which rules govern perfection, priority and restrictions on assignment.