In a case of first impression, DLA Piper argued before the US Bankruptcy Court for the District of Delaware that a consent provision in a Delaware LLC operating agreement effectively granting a creditor a veto right over a debtor’s decision to file for bankruptcy was void because it was contrary to federal public policy.
Given the significant protections provided by the US Bankruptcy Code to debtors, creditors have historically sought ways to circumvent bankruptcy laws. Pre-bankruptcy agreements that interfere with a debtor’s rights under the Bankruptcy Code have been held to be unenforceable. There has been a recent trend of creditors demanding entity structures which require a unanimous vote on the decision as to whether a company may file for bankruptcy, coupled with a provision allowing such creditor to appoint a member to the board of directors or granting equity shares such that the creditor’s consent is required pursuant to the debtor’s corporate governance documents.
On June 3, 2016, in the case of Intervention Energy Holdings, LLC (Holdings), Bankruptcy Judge Kevin J. Carey ruled that a consent provision in a debtor’s LLC agreement, the sole purpose and effect of which was to grant a creditor the right to eviscerate the debtor’s right to seek bankruptcy protection, was tantamount to an absolute waiver. Therefore, such consent provision was void as contrary to the federal public policy of ensuring the right of a person (including a business entity) to seek bankruptcy relief as authorized by the US Constitution and as enacted by Congress.
In late December 2015, Holdings and its subsidiary, Intervention Energy, LLC (IE) entered into a forbearance agreement with their secured noteholders, a group of funds under EIG Global Energy Partners (EIG) that required the grant to EIG of a single common unit (referred to as the “Golden Share”) in Holdings (out of 22,000,001 total common units). The parent of Holdings held the other 22,000,000 common units. As a condition to the effectiveness of the forbearance agreement, the Holdings LLC operating agreement was to be amended to require approval from each holder of a common unit (such as EIG) in order for Holdings to file for bankruptcy protection.
On May 20, 2016, Holdings and IE commenced voluntary bankruptcy cases (the Chapter 11 cases) in the United States Bankruptcy Court for the District of Delaware.
Immediately after the bankruptcy filing, EIG filed a motion to dismiss the Chapter 11 cases, stating, among other things, that Holdings lacked the corporate authority to file a bankruptcy petition without EIG’s consent pursuant to Holdings’ LLC operating agreement.
On June 3, 2016, the court held that the provision in the LLC operating agreement that required EIG’s consent to file a bankruptcy petition, even if arguably permitted by state law, was tantamount to an absolute waiver of the debtor’s constitutional right to seek bankruptcy relief and, therefore, was void as contrary to federal public policy.
The court explained that the federal public policy being guarded aims to assure the right of a person, including a business entity, to seek federal bankruptcy relief as authorized by the Constitution and as enacted by Congress. The court relied on the history of bankruptcy jurisprudence, which has held that prepetition agreements that interfere with a debtor’s rights under the Bankruptcy Code are unenforceable and recognized that the parties here have attempted to do the same by contracting away Holdings’ right to seek bankruptcy relief absent EIG’s consent.
Resourceful creditor attorneys continue to invent new ways for parties to circumvent bankruptcy laws and the protections they provide to debtors. The court’s decision relies on the purpose and effect of pre-bankruptcy provisions that seek to interfere with a debtor’s bankruptcy rights and thus elevates substance over the form of these types of agreements. This case stands for the proposition that courts are loath to deny access to bankruptcy courts for corporate entities, as well as individuals, regardless of pre-bankruptcy agreements. Accordingly, this decision will likely have a significant impact on the landscape of negotiations between creditors and lenders, especially as it relates to a lender’s ability to control a debtor’s right to file for bankruptcy. Furthermore, the decision will likely cause draftspersons of “due authority” legal opinions to reconsider such considered opinions.