Robert Downey 2017-03-10 03:34:31
Bankruptcy decisions limit the ability of lenders to acquire LLC membership interests in order to prohibit a voluntary bankruptcy filing.
What Is a Golden Share?
As part of a post-default forbearance agreement with a corporate or limited liability company obligor, a lender may require that the obligor grant the lender an equity interest in the obligor by admitting the lender as a shareholder or member, as the case may be, and amending its organizational documents to provide that unanimous consent of the obligor’s shareholders or members is required to approve the obligor’s voluntary bankruptcy filing. Essentially, going forward the lender gets a veto over the obligor’s decision to file bankruptcy as a bankruptcy court is required to decline to hear a bankruptcy petition if the petitioner failed to adhere to its own organizational documents in reaching its decision to file bankruptcy. The lender’s equity interest is sometimes referred to as a “golden share.”
Are There Limits to a Golden Share?
A pair of 2016 bankruptcy cases make clear that there are limits to a golden share. Although these cases concern limited liability companies, the rulings are equally applicable to corporations. In each case, the court voided the lender’s ability to vote its golden share in its best interest. Prior to discussing these cases, we should note that an agreement between a lender and an obligor that the obligor will not file bankruptcy without the consent of the lender has long been held to be unenforceable. As was stated by the bankruptcy court in the 1996 decision of In re Pease, “It has long been settled that contractual provisions prohibiting the filing of a bankruptcy case are not enforceable.” What distinguishes the cases discussed below from this rule is that in these cases there is no contract with another entity. Rather, it is the obligor’s own organizational documents that give rise to the issue. For the courts that decided the cases discussed below, this is a distinction without a difference.
In In re Lake Michigan Beach Pottawattamie Resort LLC, the obligor defaulted to its lender and in exchange for the lender’s waiver of the default the obligor’s operating agreement was amended to add the lender as a “Special Member” of the LLC. As the Special Member, the lender had no other rights or duties than to vote on whether the obligor could merge with another entity, sell substantially all of its assets, commence litigation or file for bankruptcy. In deciding whether to approve any of those actions the amended operating agreement stated the lender would not be “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 [obligor] or [its Members].’” The obligor subsequently filed bankruptcy without obtaining the consent of the Special Member.
The court looked to state law to answer the question of whether the obligor’s bankruptcy filing was effective without the lender’s consent. Here the obligor was a Michigan limited liability company so the court looked to the Michigan LLC statute. The court stated that lender’s “argument is grounded in the well-established commercial practice of using ‘blocking directors.’ A blocking director is the lynchpin that holds together a bankruptcy remote special purpose entity, formed to ring fence assets from creditors other than a secured creditor … for whom the structure is made.” The court further noted, however, that a director has to adhere to its general fiduciary duties to the obligor. This means that the director may have to vote in favor of bankruptcy if that is best for the obligor even if contrary to the wishes of the lender.
The lender’s equity interest is sometimes referred to as a “golden share.”
The court determined that under the Michigan LLC statute an LLC member had fiduciary duties similar to a corporate director. “The essential playbook for a successful blocking director structure is this: the director must be subject to normal director fiduciary duties and therefore in some circumstances vote in favor of a bankruptcy filing, even if it is not in the best interests of the creditor that they were chosen by. [Lender’s] playbook was, unfortunately, missing this page.” As quoted above, the obligor’s amended operating agreement specifically disclaimed any obligation of the Special Member to consider the interests of the obligor or its members. Presumably, had the operating agreement acknowledged the Special Member’s fiduciary duty, the court would have upheld the Special Member text.
The court in In re Intervention Energy Holdings, LLC voided the LLC operating agreement’s requirement that the obligor’s member appointed by the lender had to approve a bankruptcy filing as a matter of federal public policy. The obligor breached its loan agreement with a lender and as part of the forbearance agreement it modified its operating agreement to give the lender the right to approve any voluntary bankruptcy filing. Unlike the Lake Michigan Beach case, this language did not disclaim any fiduciary duty of the new member with respect to the obligor or the other members. As next discussed, that omission was not material.
The court avoided the fiduciary question by relying on the “axiomatic” principle that a “debtor may not contract away the right to discharge in bankruptcy.” This court also did not draw the distinction between a waiver contained in a third party contract as compared to a waiver in the obligor’s operating agreement. The court noted that the “intent of the parties is unmistakable” and therefore, “[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 Intervention Energy decision does conflict with the 2010 unpublished bankruptcy appellate panel decision of In re DB Capital Holdings, LLC, and the Intervention Energy court does not attempt to reconcile the decisions (it simply states that it disagrees with the DB Capital Holdings decision). It is worthwhile noting that the DB Capital Holdings limited liability company added the prohibition on filing bankruptcy to its operating agreement at its own volition and without any suggestion that a lender required that language be added to the operating agreement.
It seems likely that due to In re Intervention Energy Holdings, LLC’s reliance on longstanding federal policies, it will be more influential than In re Lake Michigan Beach Pottawattamie Resort LLC. Rather than a discussion of the scope of a member’s fiduciary duty under state law to the limited liability company and whether that duty, if it exists, can be waived, as we saw in Lake Michigan, Intervention Energy stands for the simple precept that a contractual prohibition on the right to file bankruptcy cannot trump the federal policy of making bankruptcy relief available to all business entities. In any event, a lender considering a golden share has to factor these cases into its decision as to the merits of pursuing a golden share.
Bob Downey is General Counsel-North America Corporate and Asset Finance at Macquarie Group Limited.
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