LLC Conversions Can Create Lender Problems
Many of our local jurisdictions have statutes that enable a sole proprietorship, partnership or corporation to “convert” to a limited liability company (LLC) by operation of law. That means by filing Articles of Conversion with the state or DC, the former entity becomes an LLC, and all assets of the former entity are owned by the LLC without the need to execute a deed or bill of sale (although confirmatory deeds typically are recorded to evidence in the land records the change in entity and change of name).
A conversion can create problems with a lender’s security interest. If the LLC borrows money with a new lender, and that lender searches only under the LLC name, the prior lender’s financing statement may not be discovered. To avoid losing priority, the prior lender must record an amendment to its financing statement.
While most loan documents prohibit transfers and mergers, they do not always address the situation of a conversion.
Rather than taking a chance that a conversion might not be considered a merger or transfer, and therefore not trigger a lender’s remedies upon a conversion to an LLC without the lender’s consent, we recommend including a conversion in the same provision of the loan documents that restricts mergers and dissolutions.
Larry Lerman is a commercial lending and real estate attorney at Lerch, Early & Brewer in Bethesda, Maryland who structures and documents complex commercial lending arrangements and represents parties who are buying, selling, leasing and financing commercial real estate. For more information on LLC conversions, contact Larry at (301) 657-0163 or firstname.lastname@example.org.