The Bankruptcy Code impairs lenders’ rights in various ways. Accordingly, lenders have long attempted to devise methods of preventing borrowers from filing for bankruptcy protection. Such attempts generally have not been successful -- courts hold that as a general matter, a borrower’s pre bankruptcy waiver of the right to file bankruptcy is against public policy and is void. See, e.g., Klingman v. Levinson,831 F.2d 1292, 1296 n.3 (7th Cir. 1987) (“For public policy reasons, a debtor may not contract away the right to a discharge in bankruptcy.”). Courts have rejected such waiver provisions in many forms. See, e.g., In re Madison, 184 B.R. 686, 688 (Bankr. E.D. Pa. 1995) (refusing to enforce debtor’s oral bankruptcy waiver made on the record in prior bankruptcy case); In re Tru Block Concrete Prods. Inc., 27 B.R. 486, 492 (Bankr. S.D. Cal. 1983) (refusing to enforce bankruptcy waiver provision in forbearance agreement); In re Peli, 31 B.R. 952, 956 (Bankr. E.D.N.Y. 1983) (refusing to enforce bankruptcy waiver provision in personal injury settlement agreement).
In light of these rulings, lenders began to look for other ways to prevent borrowers from filing bankruptcy cases. Increasingly, they focused on borrowers’ corporate structure and organizational documents. Prior to 2009, it was widely believed that an entity could be made “bankruptcy-remote” by creating a special purpose entity (“SPE”) whose organizational documents appoint a lender friendly director to vote against any bankruptcy filing. The effectiveness of SPEs as bankruptcy-remote entities was called into question when the Bankruptcy Court for the Southern District of New York refused to dismiss bankruptcy petitions filed by several solvent, and supposedly bankruptcy-remote, SPEs. See In re General Growth Properties Inc., 409 B.R. 43 (Bankr. S.D.N.Y. 2009).
In a similar vein, the Bankruptcy Court for the District of Oregon recently held that a bankruptcy waiver in a borrower’s LLC operating agreement is ineffective to prevent the borrower from filing for bankruptcy protection. See In re Bay Club Partners-472, LLC, Case No. 14-30394, 2014 WL 1796688 (Bankr. D. Or. May 6, 2014). In Bay Club, the debtor was a manager-managed LLC formed to acquire and operate a large apartment complex. The LLC’s key formational document, the operating agreement, gave the LLC’s manager broad powers to direct and bind the LLC. At the insistence of the borrower’s lender, however, the operating agreement included a separate provision purporting to bar the LLC from instituting or consenting to a bankruptcy proceeding. Despite this provision, the LLC filed for bankruptcy protection, but did so with the consent of only 3 out of 4 of its members.
The lender moved to dismiss the case under Bankruptcy Code § 1112(b) on the basis that the case was filed in bad faith and without necessary consent. The Bankruptcy Court (Judge Dunn) denied the motion to dismiss. It relied on prior cases in the Ninth Circuit, most notably In re Huang, 275 F.3d 1173 (9th Cir. 2002). That case, like the others cited above, held that a debtor’s prepetition waiver of the right to file a bankruptcy case is unenforceable because it is a violation of public policy. Id. at 1177.
The Bay Club court explained that a bankruptcy waiver is unenforceable whether it is found in loan documents or in an entity’s organizational documents. Nor did the court concern itself, in the opinion, with the intricacies of Oregon law -- according to the court, federal law and public policy control the analysis.
In light of the Bay Club case and the Ninth Circuit cases it cites, lenders in the Ninth Circuit should approach each deal with a healthy skepticism that any borrower is truly bankruptcy-remote.