Lenders Cannot Prevent Borrowers From Filing Bankruptcy By Owning Minority Equity With Veto Power Over Borrower’s Decision To File Bankruptcy
In a recent decision, the U.S. Bankruptcy Court for the District of Delaware refused to enforce a provision in the debtor’s LLC operating agreement requiring a unanimous vote of the debtor’s members to authorize the debtor to file for bankruptcy. In re Intervention Energy Holdings, LLC, et al., 2016 Bankr. LEXIS 2241 (Bankr. D. Del. June 3, 2016). The provision at issue required the consent of all the debtor’s LLC members to file for bankruptcy, including the consent of a member that was a secured creditor holding one unit of ownership in the debtor’s LLC which it bargained for and received pursuant to a forbearance agreement. In refusing to dismiss the debtor’s bankruptcy case, the Court concluded that such an arrangement giving the secured lender a so-called “golden share” was “tantamount to an absolute waiver” of the debtor’s right to seek bankruptcy protection and therefore void as a matter of federal public policy.
In Intervention Energy, two companies, Intervention Energy, LLC (“Intervention Energy”) and its parent company, Intervention Energy Holdings, LLC (“Holdco”), were established under the laws of Delaware to engage in oil and natural gas exploration and production. In January 2012, the companies entered into a Note Purchase Agreement with an institutional investor (“Secured Lender”). In October 2015, the Secured Lender declared an event of default based on the companies’ failure to comply with certain covenants under the Note Purchase Agreement. In December 2015, the companies and the Secured Lender entered into a forbearance agreement, pursuant to which the Secured Lender agreed to waive all defaults and Holdco was required to amend its LLC operating agreement to (i) admit the Secured Lender as a member of Holdco holding one common unit and (ii) require the approval of each holder of common units of Holdco prior to any bankruptcy filing. Concurrently with entry into the forbearance agreement, Holdco amended its operating agreement to give effect to the forgoing requirements.
In May 2016, both companies filed voluntary chapter 11 petitions. Thereafter, the Secured Lender filed a motion to dismiss Holdco’s bankruptcy filing on the ground that Holdco did not have the requisite authority to file for bankruptcy because it failed to obtain the prior consent of the Secured Lender, as the holder of one common equity unit, as required by Holdco’s LLC operating agreement.
The parties raised a number of arguments under Delaware corporate law regarding the ability of an LLC to abrogate its fiduciary responsibilities and contract away the right to file bankruptcy. The Court found it unnecessary to address these arguments because it viewed the federal public policy issue as case dispositive. To that end, the Court held that the provision requiring the unanimous consent of the equity holders was unenforceable as it violated the federal public policy prohibiting “agreement[s] to waive the benefit of bankruptcy.” Specifically, the Court explained that:
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 case is a reminder that certain provisions restricting a borrower’s ability to file bankruptcy, particularly those that grant equity positions to lenders without any corresponding fiduciary duty owed to the borrower, are often held to be unenforceable. At the same time, the case highlights the importance of thoughtful structuring of lending transactions, and careful drafting of loan documents, to minimize the risk of loss or otherwise account for such risk when negotiating pricing.