Tag Archives: corporate governance

September 13, 2016

Delaware Bankruptcy Court Holds LLC Operating Agreement Provisions Placing Sole Power in the Company’s Lender to Prevent a Bankruptcy Filing are Void as Against Public Policy

In an important decision for debtors and creditors alike, the United States Bankruptcy Court for the District of Delaware has ruled that provisions in a limited liability company operating agreement, granting the company’s lender absolute power to prevent the company from filing a bankruptcy petition are unenforceable as against public policy. In re: Intervention Energy Holdings, LLC, 2016 WL 3185576 (Bankr. D. Del. 2016).

The facts involved in the case are straight-forward. The debtors—a parent limited liability company and its subsidiary—found themselves in financial straits compelling them to seek a forbearance agreement with their lender. The lender agreed to forbear, but only on the condition that the debtors amend their respective operating agreements to include a provision admitting the lender as a member of the parent and further requiring the unanimous consent of the members of the parent for any voluntary filing for bankruptcy by either the parent or the subsidiary. The debtors filed chapter 11 petitions without the consent of the lender, and the lender filed a motion to dismiss the petitions as filed without authority.

The bankruptcy court noted that the issue of whether debtors and creditors are free to contract away bankruptcy rights was one of first impression in Delaware. However, the court determined that it need not decide this issue, as it determined public policy considerations provided an alternate ground for its decision. The court concluded such a provision violates public policy and is unenforceable, stating its conclusion in the strongest of terms:

“A provision in a limited liability company governance document obtained by contract, the sole purpose and effect of which is to place into the hands of a single, minority equity holder the ultimate authority to eviscerate the right of that entity to seek federal bankruptcy relief, and the nature and substance of whose primary relationship with the debtor is that of creditor-not equity holder-and which owes no duty to anyone but itself in connection with an LLC’s decision to seek federal bankruptcy relief, is tantamount to an absolute waiver of that right, and, even if arguably permitted by state law, is void as contrary to federal public policy.”

The court relied on opinions from various courts to the effect that contractual provisions restricting the right to a bankruptcy discharge and the right to file bankruptcy are unenforceable as against public policy. Klingman v. Levinson, 831 F.2d 1291 (7th Cir. 1987) (“for public policy reasons, a debtor may not contract away the right to a discharge in bankruptcy.”). MBNA Am. Bank. N.A. v. Trans World Airlines, Inc. (In re Trans World Airlines, Inc.), 275 B.R. 712 (Bankr. D. Del. 2002) (“prepetition agreements purporting to interfere with a debtor’s rights under the Bankruptcy Code are not enforceable.”). In re Pease, 195 B.R. 431 (Bankr. D. Neb. 1996) (“the Bankruptcy Code pre-empts the private right to contract around its essential provision.”). The court believed such provisions would frustrate the object of the Bankruptcy Code and be repugnant to its purposes.

The concluded its opinion with the following strongly-worded language:

“Under the undisputed facts before me, to characterize the Consent Provision here as anything but an absolute waiver by the LLC of its right to seek federal bankruptcy relief would directly contradict the unequivocal intention of [the lender] to reserve for itself the decision of whether the LLC should seek federal bankruptcy relief. Federal courts have consistently refused to enforce waivers of federal bankruptcy rights.”

This decision, along with the recent decision of the U.S. Bankruptcy Court for the Northern District of Illinois in In re Lake Michigan Beach Pottawatamie Resort LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016), which found a similar provision violated applicable state corporate law, should be instructive to creditors’ counsel of the need to carefully craft these types of restrictive agreements in ways which comport with public policy and applicable state law.

June 7, 2016

Lenders Beware: Make Sure Your Borrower’s Organizational Documents’ Blocking Director Provisions Comply With State Law

Many lenders attempt to render their borrower bankruptcy remote by requiring the borrower to have on its board a director, known as a “blocking director,” whose consent is required for any bankruptcy filing. However, in doing so, the lender needs to make sure the organizational documents which impose this condition on the buyer comply with requirements of the law of the state in which the borrower is organized. If they don’t, a lack of the blocking director’s consent may not prevent the borrower from filing bankruptcy. This harsh lesson was learned by the lender in In re: Lake Michigan Beach Pottawattamie Resort, LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016).

In Lake Michigan Beach, the debtor was organized under the laws of the state of Michigan. It owed a loan to BCL-Bridge Funding, LLC secured by real property comprising a resort on Lake Michigan. When the borrower ran into financial trouble, the lender agreed to forbear, but required certain amendments to the borrower’s Operating Agreement under which the borrower added a fifth member (the “Special Member”). The amended Operating Agreement required the Special Member’s consent for the borrower to file bankruptcy. This Special Member had no right to distributions and was not required to make capital contributions. Essentially, the Special Member was kept separate from the borrower for all purposes other than to vote on filing bankruptcy. Further, the amended Operating Agreement provided that the Special Member, in voting on a bankruptcy filing, was not obligated to consider any interests or desires other than its own and had “no duty or obligation to give any consideration to any interest of or factors affecting the Company or the Members.”

After the borrower’s default and lender’s commencement of foreclosure proceedings, the borrower’s members—with the exception of the Special Member—voted to cause the borrower to file a chapter 11 petition. The lender filed a motion to dismiss, contending the filing was not authorized. The bankruptcy court denied the motion, finding the provisions in the amended Operating Agreement did not comply with applicable Michigan corporate governance law. The court stated that, under Michigan law, members of a limited liability company have a duty to consider the interests of the entity and only their own interests in the decisions they make for the company. Specifically, the Michigan statute relied on by the court stated: “A manager shall discharge the duties of manager in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner the manager reasonably believes to be in the best interests of the limited liability company.” As a result, the court held the Special Member provision unenforceable.