Two bankruptcy courts recently have issued opinions that invalidated “golden share” provisions in a bankruptcy-remote entity’s organizational documents. See In re Lake Michigan Beach Pottawattamie Resort LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016); and In re Intervention Energy Holdings, LLC, No. 16-11247, 2016 WL 3185576 (Bankr. D. Del. June 3, 2016). In both cases the bankruptcy-remote limited liability company at issue had provisions in its operating agreement requiring the consent of a special member as a condition to filing bankruptcy, in both cases the bankruptcy-remote entity filed bankruptcy and in both cases the court declined to enforce the operating agreement provisions requiring the consent of the special member to the bankruptcy filing.
Although waivers by debtors of a right to file bankruptcy are unenforceable as being contrary to the public policy of permitting persons and corporate entities to take advantage of bankruptcy, the use of “bankruptcy-remote” or “special-purpose” entities with an independent director (in the case of a corporation) or an independent member (in the case of a limited liability company) have become fairly common. In many loan or similar transactions, a creditor or other party in the transaction may require, as a condition to making a loan or entering into the transaction, that the debtor or counterparty be organized as a bankruptcy-remote entity. Such an entity is typically a newly created entity and its organizational documents limit its purpose to the particular transaction at issue and require that such entity have an independent director or an independent member. The equity interest held by an independent member is often referred to as a “golden share” or “blocking share” and is often a non-economic interest. The organizational document of such a bankruptcy-remote entity will prohibit certain material actions, including a voluntary bankruptcy filing, without obtaining the unanimous consent of its equity holders and the consent of the independent director or independent member.
A creditor or other participant in a transaction may require a bankruptcy-remote entity to be organized in order to isolate certain assets serving as collateral into an entity whose bankruptcy is a remote possibility, rather than assuming the credit risk of the bankruptcy-remote entity’s parent company. The existence of a bankruptcy-remote entity would also permit such a creditor, if necessary, to exercise remedies solely against the bankruptcy-remote entity and its assets, rather than possibly becoming entangled in a bankruptcy case filed by or against the bankruptcy-remote entity’s parent company. In many transactions, the use of a bankruptcy-remote entity also increases the economic benefit to such entity and its parent through a lower rate of interest based on a reduced bankruptcy risk, through a higher credit rating in transactions that are rated, or through the participation of parties in the transaction that would not otherwise participate if the parent company were the debtor or counterparty.
The nature of particular independent director or independent member provisions may differ depending on the parties and the transaction. In many cases the independent director or independent member is required by the organizational documents to be an independent or disinterested third party. In other cases the position of independent director or independent member is held by the bankruptcy-remote entity’s principal or only creditor.
In re Lake Michigan Beach Pottawattamie Resort LLC
In the In re Lake Michigan Beach Pottawattamie Resort LLC case, BCL-Bridge Funding LLC (“BCL”) made a loan to Lake Michigan Beach Pottawattamie Resort LLC, a Michigan limited liability company (the “Michigan SPE”). After a default on the loan, the parties entered into a forbearance agreement requiring, among other things, an amendment of the Michigan SPE’s operating agreement to add a “special member” provision. The provision required the Michigan SPE to have a special member and to obtain the consent of the special member as a condition to a voluntary bankruptcy filing. The provision also provided that the special member had “no duty or obligation to give any consideration to any interest of or factors affecting the [Michigan SPE] or the Members.” In re Lake Michigan Beach Pottawattamie Resort LLC, 547 B.R. at 904. The special member held no economic interest in the Michigan SPE. In the transaction at issue in the In re Lake Michigan Beach Pottawattamie Resort LLC case, BCL itself served as the special member. In addition, the court also noted that BCL was an over-secured creditor of the Michigan SPE.
The Michigan SPE subsequently filed bankruptcy with the consent of all of its members, except the consent of BCL as the special member. BCL filed a motion to dismiss the case, arguing that the Michigan SPE did not follow corporate formalities and was not authorized by its operating agreement to file bankruptcy.
The bankruptcy court declined to dismiss the bankruptcy case of the Michigan SPE. The court did not reject the concept of a special member or golden share in its entirety. However, the court found that the special member provision at issue in the Michigan SPE’s operating agreement was invalid and unenforceable because it failed to require the special member to comply with its fiduciary obligations under Michigan law. The court stated:
The essential playbook for a successful blocking director structure is this: the director must be subject to normal director fiduciary duties and therefore in some circumstances vote in favor of a bankruptcy filing, even if it is not in the best interests of the creditor that they were chosen by.
BCL’s playbook was, unfortunately, missing this page.
Id. at 913. The court further explained that under the Michigan limited liability company act, members of a limited liability company have a duty to consider the interests of the limited liability company, not only their own interests. In the court’s view, the special member provision at issue was invalid because it eliminated any obligation of BCL, as the special member, to consider the interests of the Michigan SPE, but instead purported to allow BCL to consider only its own interests. Thus, the court stated that the special member provision at issue:
expressly eliminates the only redeeming factor that permits the blocking director/member construct. The [operating agreement] provision that BCL’s consent was required in order for the [Michigan SPE] to petition for bankruptcy relief is, therefore, unenforceable, both as a matter of Michigan corporate governance and bankruptcy law.
Id. at 914.
In re Intervention Energy Holdings, LLC
The facts of the In re Intervention Energy Holdings, LLC case are very similar to those presented in In re Lake Michigan Beach Pottawattamie Resort LLC. In In re Intervention Energy Holdings, LLC, EIG Energy Fund XV-A, L.P. (“EIG”) made a loan to Intervention Energy Holding, LLC, a Delaware limited liability company (the “Delaware SPE”). After a default on the loan, the parties entered into a forbearance agreement requiring, among other things, an amendment of the Delaware SPE’s operating agreement. The operating agreement was amended to issue an equity interest in the Delaware SPE to EIG, which was one of 22,000,001 common units issued by the Delaware SPE, in exchange for a $1.00 capital contribution by EIG. The amendment also added a provision requiring the approval of all holders of the Delaware SPE’s common units, including EIG, as a condition to a voluntary bankruptcy filing by the Delaware SPE.
The Delaware SPE subsequently filed bankruptcy with the consent of all of its common unit holders, except EIG as holder of its single common unit. EIG filed a motion to dismiss the case, arguing that the Delaware SPE did not follow corporate formalities and was not authorized by its operating agreement to file bankruptcy. In response, the Delaware SPE cited the In re Lake Michigan Beach Pottawattamie Resort LLC case summarized above. The Delaware SPE asserted that the golden share provision in its operating agreement should be invalid because the provision gave EIG the ability to block a voluntary bankruptcy filing and, in effect, failed to maintain the fiduciary duty of equity owners of a Delaware limited liability company to consider the best interests of the Delaware limited liability company.
The bankruptcy court declined to dismiss the bankruptcy case of the Delaware SPE. However, unlike the court in In re Lake Michigan Beach Pottawattamie Resort LLC, the court in In re Intervention Energy Holdings, LLC did not assess the scope of a member’s duties under the Delaware limited liability company act, whether a Delaware limited liability company could modify such duties in its operating agreement, or whether the golden share provision at issue was consistent with applicable state law duties. Instead, the court denied EIG’s motion to dismiss on federal public policy grounds.
After summarizing the “well settled principal” that a waiver of the right to file bankruptcy is void as against public policy, the court stated, “Yet, to contract away the right to seek bankruptcy relief is precisely what both parties here have attempted to accomplish.” In re Intervention Energy Holdings, LLC, 2016 WL 3185576, at *5. The court reasoned:
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 [a Delaware SPE’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. Under the undisputed facts before me, to characterize the [applicable provision] here as anything but an absolute waiver by the [Delaware SPE] of its right to seek federal bankruptcy relief would directly contradict the unequivocal intention of EIG to reserve for itself the decision of whether the [Delaware SPE] should seek federal bankruptcy relief.
Id. at *6 (citations omitted).
Last, when presented with decisions in other jurisdictions that arguably favored the enforceability of golden share provisions, the court either distinguished such cases from the facts presented in In re Intervention Energy Holdings, LLC or simply stated “I disagree.” Id. at *6 fn.25.
It is important to recognize that the holders of the “golden shares” in both the In re Lake Michigan Beach Pottawattamie Resort LLC and In re Intervention Energy Holdings, LLC decisions were creditors of the related debtor. The court in In re Intervention Energy Holdings, LLC, in the quote set forth above, was careful to limit its decision to those facts. Thus, neither case addressed the enforceability of a provision in a special-purpose entity’s organizational documents appointing an independent or disinterested third party as an independent director or independent member and which does not purport to limit the duties of such independent director or independent member solely to the consideration of creditor’s interests. However, even if a court were to uphold the enforceability of a golden share or independent director provision, whether a creditor or an independent third party is the independent member or independent director, the court may still review and require the actions of the independent member or independent director to be consistent with its state law fiduciary duties under the circumstances.1
It also may be worth noting that neither case examined the duties of an equity holder under applicable state law, or whether the golden share provision at issue was consistent with such duties, in the context of an insolvent debtor. The court in the In re Lake Michigan Beach Pottawattamie Resort LLC described the creditor’s loan as being over-secured, and the court in In re Intervention Energy Holdings, LLC did not address applicable state law duties of a member of a limited liability company based on the facts presented and its view of public policy considerations. Thus, the cases potentially may be distinguishable from an instance in which a debtor is insolvent and the duties of its members or directors under applicable state law may include consideration of creditor interests. State law will vary on the nature and scope of a member’s or director’s duties in the case of a debtor which becomes insolvent or, in some cases, which is in a zone of insolvency.2
In both of the foregoing cases the equity interest of the creditor in the related debtor was either a non-economic interest or a de minimus interest and was viewed by the respective court as intended solely for the purpose of blocking a bankruptcy filing by the debtor. A different result could possibly be reached if a lender to a special-purpose entity or other debtor held a more significant economic equity interest in a debtor, as an investment or for a purpose other than to block a bankruptcy filing, which equity interest is separate from the lender’s loan. In such a case, it may be possible for a creditor to argue that its equity interest and related right to consent to a bankruptcy filing are not solely intended to block a bankruptcy filing of the debtor, but relate to its equity investment in the debtor.3
1 See, e.g., In re Gen. Growth Props., Inc., 409 B.R. 43 (Bankr. S.D.N.Y. 2009) (holding that replacement of independent directors of special-purpose entities on the eve of a bankruptcy filing with directors experienced in the applicable business and who voted in favor of bankruptcy did not constitute a bad faith filing or warrant dismissal).
2 A recent example of such a case is In re AWTR Liquidation, Inc., 2016 548 B.R. 300 (Bankr. C.D. Cal. 2016) (holding that the scope of duties of a corporation’s directors includes the interests of creditors upon the corporation’s insolvency).
3 See, e.g., In re Global Ship Sys., LLC, 391 B.R. 193, 199-203 (S.D. Ga. 2007) (examining a creditor who also held a 20% equity interest in a debtor and the possibility that such creditor could “wear two hats”).
For additional information, please contact your Kutak Rock attorney, a member of our Bankruptcy group, or the author of this client alert.
For a Printer-Friendly version of this Bankruptcy Client Alert, click on the file below.