The term “golden shares” is often referred to equity interests held by a specific party—commonly a lender or investor—that authorize such party to block or prevent a corporate entity from filing bankruptcy. Such shares are often negotiated by a party that wants to ensure that its consent is obtained before any bankruptcy is commenced. Without such consent, the party holding the golden shares can seek to dismiss to a corporate bankruptcy filing by based on a lack of corporate authority.
Provisions in corporate governance documents authorizing the issuance of golden shares are relatively new. Such provisions are often blamed for attempting to circumvent the well-established principle, based on public policy, that a company cannot waive, through contract, its unfettered right to file bankruptcy. The reason why golden shares have been permitted is that they convert the main issue—contractual waiver—into one of corporate governance.
But, not all courts that have addressed the enforceability of golden shares agree that they can be used to block a bankruptcy filing. The latest court to address the issue was the Bankruptcy Court for the Southern District of Mississippi in In re Franchise Services of North America, Inc., Case No 17-02316-EE (Bankr. S.D. Miss. December 18, 2018), where Judge Ellington determined that golden shares were enforceable under the specific facts of the case.
Franchise Services of North America, Inc. (“Franchise Services” or “Debtor”) operated one of North America’s largest franchise car rental companies in more than 650 locations in the United States.
Macquarie Capital (USA) Inc. (“Macquarie”), through its subsidiary, Boketo LLC (“Boketo”), invested $15 million in Franchise Services to fund the acquisition of Advantage Rent-A-Car from The Hertz Corporation. In exchange for the investment, Boketo received a 49.76% interest in Franchise Services in the form of Class A Preferred Stock. This made Boketo the largest shareholder of Franchise Services.
In connection with the Advantage Rent-A-Car acquisition, Franchise Services also agreed to pay Macquarie a $500,000 financial advisory fee and $2,500,000.00 arrangement fee. However, neither of these fees were ever paid, leaving Macquarie as a creditor of Franchise Services.
The Advantage Rent-A-Car acquisition never proved to be successful and, in 2013, Franchise Services’ subsidiary sought to sell these assets in a bankruptcy sale process.
Several years later, on June 26, 2017, Franchise Services separately filed its own bankruptcy, seeking to sell its remaining assets.
Shortly after Franchise Services’ filing, Macquarie and its subsidiary, Boketo, filed motions to dismiss the bankruptcy, arguing that the Debtor lacked corporate authority to file, because Franchise Services had not obtained the consent of the majority of its Class A Preferred Stock (of which Boketo was a holder) as required by its certificate of incorporation. In response, the Debtor primarily argued that the relevant provision in its certificate of incorporation was unenforceable as a matter of public policy.
The issue of whether to give effect to Boketo’s golden shares was thus left to the Bankruptcy Court.
Judge Ellington started his opinion with the well-established premise that a bankruptcy petition filed on behalf of a corporation may only be filed by those who have authority to act for the corporation under applicable state law. Citing Price v. Gurney, 324 U.S. 100 (1945). If corporate authority is lacking, a bankruptcy court does not acquire jurisdiction over a bankruptcy case and such case must be dismissed. Id.
In this respect, the Court found that the golden shares authorized under the Certificate of Incorporation of Financial Services were permissible under applicable Delaware law. According to the Court, “the [Debtor’s] Board made the decision to take the authority for filing bankruptcy out of its hands and give it to Boketo” and “[t]he Debtor has not cited to a case which holds that a golden share or blocking provision given to an equity holder contravenes Delaware law.”
The Court next reviewed the last seven court opinions that were asked to enforce golden shares. See In re Global Ship Systems, LLC, 391 B.R. 193 (Bankr. S.D. Ga. 2007); In re Bay Club Partners-472, LLC, Case No. 14-30394, 2014 WL 1796688 (Bankr. D. Or. May 6, 2014); In re Lake Michigan Beach Pottawattamie Resort, LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016); In re Intervention Energy Holdings, LLC, 533 B.R. 258 (Bankr. D Del. 2016); In re Tara Retail Group, LLC, Case No. 17-bk-57, 2017 WL 1788428 (Bankr. N.D. WV May 4, 2017); In re Squire Partners Limited Partnership, 574 B.R. 701 (Bankr. E.D. Ark. 2017); In re Lexington Hospitality Group, LLC, Case No. 17-51568, 2017 WL 4118117 (Bankr. E.D. Ky. Sept. 15, 2017). Demonstrating the novelty of golden shares, only one of the cases was decided before 2014.
All seven of the cases reviewed involved similar fact patterns, i.e., a creditor directly or indirectly held a blocking position in corporate governing documents that allowed it to prevent a bankruptcy filing by the debtor. Sometimes the creditor also held a meaningful equity position in the debtor. See Global Ship Systems, 391 B.R. at 203; Squire Court Partners, 574 B.R. at 707. Sometimes the creditor only held a blocking position and no meaningful equity in the debtor. See Bay Club Partners, 2014 WL 1796688 at *5 (no equity); Lake Michigan Beach, 574 B.R. at 904 (token equity interest); Intervention Energy, 553 B.R. at 262 (token equity interest); Tara Retail, 2017 WL 1788428 at *2 (no equity). In only one of the prior cases did the court invalidate a blocking position when a creditor also held a significant equity interest in the debtor. Lexington Hospitality, 2017 WL 4118117, at *6 (50% membership interest). But, the Lexington Hospitality case appeared to be a case where the lender structured its equity position as part of its loan to the debtor.
Judge Ellington concluded that in all of the prior case law, when a creditor held a meaningful equity interest, its golden shares were validated, and in cases where a creditor did not hold a meaningful equity interest, its blocking positions were invalidated. Based largely on this analysis, the Court held that Boketo, who held a meaningful and genuine equity interest in Franchise Services, was entitled to have its blocking position enforced under Delaware law.
The Court further addressed whether Boketo owed a fiduciary duty to the Debtor, similar to the fiduciary duty owed by the Debtor’s board of directors. In this respect, the Court found that Boketo did not owe such duty, because it only held a minority equity position (49.76%) in the Debtor and there was no evidence demonstrating that it controlled the Debtor.
Direct Appeal to Fifth Circuit
While the Franchise Services Court dismissed the bankruptcy case and ruled in favor of upholding the golden shares, it also recognized the importance of the issues involved in the case. Accordingly, it certified the issues raised in the case for a direct appeal to the Fifth Circuit, pursuant to 28 U.S.C. § 158(d)(2)(A), thereby facilitating a higher court’s ability to opine on the novel issues raised.
Courts appear to struggle on how to address golden shares or blocking positions granted to creditors of a debtor. On the one hand, there exist important public policy reasons for why a creditor should not be able to cause a debtor to waive its right to file for bankruptcy protection. On the other hand, golden shares endorsed by governance documents are consistent with the Supreme Court long-standing precedent that state corporate governance laws should dictate whether a debtor has proper authority to file bankruptcy.
The primary distinction for validating golden shares in Franchise Services was that Macquarie was not acting as a creditor when it decided to invest in the Debtor; rather it was acting like a typical investor who could expect to negotiate and enforce certain rights arising from a debtor’s corporate governance documents. Indeed, Macquarie only became a creditor after it had decided to invest in the Debtor. In the other cases that Judge Ellington distinguished, the creditors appeared solely to structure blocking provisions simply to protect their rights as creditors (not equity interest holders) against the debtor.
The Fifth Circuit Court of Appeals will ultimately have a chance to decide whether the distinction in Franchise Services is a determinative factor in all future cases. And, given the importance of this issue, credit markets assuredly will be waiting to see what the Court of Appeals decides.