We’ve all seen it. The business opportunity looks enticing but is laced with risk about a potential bankruptcy filing down the road. As bankruptcy lawyers we are often asked how deals can be structured to prevent a potential bankruptcy filing. One approach (really, about the only approach, and it has its own risks) has been to structure the deal requiring unanimous member/manager/director consent to place the entity into bankruptcy but meanwhile adding a member/manager/director who may vote against taking the entity into bankruptcy in the future, or who may have interests and motives other than those of insiders.
Two recent bankruptcy court decisions have called this practice into question, especially when this corporate structure is implemented when the company is in distress. The Bankruptcy Court for the District of Delaware ruled in an opinion you can read here that a provision requiring unanimous consent of a company’s equityholders to seek bankruptcy protection was void as against public policy. Meanwhile, the Bankruptcy Court for the Northern District of Illinois (here is that opinion) did not find that this that type of provision would be void against public policy but did rule that fiduciary duties owed to a company cannot be obviated. These cases provide insight into (i) the enforceability of unanimous consent provisions in differing jurisdictions and (ii) how such provisions may be drafted (or not) to enhance the likelihood of enforceability if subsequently called into question.
In re Intervention Energy Holdings, LLC
In re Intervention Energy Holdings, LLC filed its bankruptcy case in the Delaware Bankruptcy Court. A creditor holding a single “common unit” of the LLC filed a motion to dismiss the case, stating that it did not consent to the bankruptcy filing. The creditor claimed that the bankruptcy filing was unauthorized because a unanimous vote in favor of bankruptcy was required under the Debtor’s LLC agreement. The court ruled that this unanimous consent provision was void as against well-established federal public policy because a debtor may not waive its right to seek bankruptcy protection. The court extended this protection to business entities including LLCs.
Notably, the creditor in question, EIG Energy Fund XV-A, L.P. (“EIG”), had purchased a single common unit of Intervention Energy Holdings, LLC (“Intervention”) during negotiations of a forbearance agreement. While EIG held one common unit, Intervention’s parent company owned the remaining 22 million common units. EIG filed a motion to dismiss Intervention’s bankruptcy case. EIG argued that Intervention needed EIG’s consent to seek bankruptcy protection because by owning its one common unit EIG was able to veto a bankruptcy filing, per the specific terms of Intervention’s corporate documents.
The court overruled EIG’s motion to dismiss. The court held that a provision in Intervention’s prepetition operating agreement which allowed EIG to veto any voluntary bankruptcy filing by Intervention contravened public policy. In reaching this decision the court relied on many prior rulings which found parties’ prepetition agreements to waive future bankruptcy protections to be unenforceable.
In re Lake Michigan Beach Pottawatamie Resort LLC
The Bankruptcy Court for the Northern District of Illinois took a more narrow approach in In re Lake Michigan Beach Pottawatamie Resort LLC. There, the court considered the balance between unenforceable blanket bankruptcy prohibitions in agreements versus permissible “blocking director” provisions which allow directors to vote against putting the entity into bankruptcy but still require the blocking director to uphold its fiduciary duties to the entity. (The latter are very common in structured finance matters.) The court found that public policy and fiduciary duty concerns involving “blocking director” provisions for corporations also extended to LLCs.
In the Lake Michigan case, before filing its bankruptcy case the debtor defaulted on its obligations to its lender, BCL-Bridge Funding LLC (“BCL”), which resulted in a forbearance agreement between the parties. As part of the forbearance agreement, the debtor agreed to amend its operating agreement to add BCL as a “special member” of the debtor. As a special member BCL had a right to approve or disapprove any “material action” by the debtor which included filing a bankruptcy case. However, the amended operating agreement also provided that in acting as a special member BCL was only required to consider its own interests, rather than the interests of the debtor.
Ultimately, the debtor filed for bankruptcy protection. All of the debtor’s members, except BCL, supported the bankruptcy filing. BCL moved to dismiss the bankruptcy case asserting that the debtor did not have authority to file because BCL, as a special member, did not consent. The debtor argued that the amended operating agreement requiring BCL’s consent to bankruptcy was void against public policy as a prohibition on a party’s right to seek bankruptcy protection. The court did not find this provision void as against public policy. Instead, the court held that the blocking member provision in the amended operating agreement contravened the fiduciary duties that BCL owed to the debtor under Michigan law. Thus, the amended operating agreement provision which only required BCL to consider its own interests, not the debtor’s, was void. This rendered the remaining directors’ votes in favor of the bankruptcy filing sufficient corporate authority.
These cases emphasize that unanimous consent provisions will not always be enforceable. The language and structure of such provisions are crucial, as is the timing of when the provision is added to any organic documents. Agreements limiting the fiduciary duties of a member/manager/director or limiting the ability of an entity to seek bankruptcy protection should be scrutinized – or rejected outright, frankly – to avoid future enforceability concerns.