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.