A creditor objected to the bankruptcy filing of a limited liability company on the basis that the filing was unauthorized. Specifically, under the LLC’s operating agreement unanimous approval of the common members was required and the vote was not unanimous.
The creditor had provided up to $200 million in senior secured notes. The terms of the note purchase agreement were amended several times. Eventually the creditor declared an event of default based on the debtors’ failure to comply with certain financial covenants which was addressed by negotiation and execution of Amendment No. 5, Forbearance Agreement and Contingent Waiver. The forbearance agreement provided that the creditor would waive all defaults if the debtors raised $30 million of equity capital to pay down a portion of the secured notes by a certain deadline.
As a condition to effectiveness of the forbearance agreement, the debtor was required to (1) admit the creditor or its affiliate as a member with one common unit, and (2) amend the debtor’s operating agreement to require approval of all holders of common units for a bankruptcy filing. In fact (i) the debtor issued one common unit to the creditor for a capital contribution of $1.00, with the result that the debtor’s parent held 22 million common units and the creditor held one common unit, and (ii) the debtor’s operating agreement was amended to require “approval of all Common Members… [to] commence a voluntary case under any bankruptcy.”
The creditor did not approve the bankruptcy filing, and it was undisputed that the filing would have been authorized if the LLC operating agreement had not been amended in accordance with the forbearance agreement.
The creditor argued that “an LLC that has abrogated its fiduciary responsibilities to the extent permitted by Delaware law may contract away its right to file bankruptcy at will.” The debtor responded that the abrogation of fiduciary duties was fatal and a member “must retain a duty to vote in the best interest of the potential debtor to comport with federal bankruptcy policy.” Although the parties raised as an issue the scope of LLC members’ right to contract under state law, the court declined to take up the question because it was unnecessary given its ruling on the effect of federal law.
Instead the court agreed with the debtor that a debtor may not contract away its right to file bankruptcy. Prepetition agreements that interfere with a debtor’s rights under the Bankruptcy Code are unenforceable. The court noted that this concept is not new – citing precedent under the Bankruptcy Code’s predecessor, the Bankruptcy Act. “Even so long ago as 1912, the United States Supreme Court was forced to address parties attempting to circumvent the bankruptcy laws by ‘circuitry of arrangement.'”
In its motion to dismiss the creditor was clear that the bargained for provisions were meant to block any voluntary bankruptcy filing. It contended that it “bought and paid for” the common unit and all related rights. So, the court was not hesitant to conclude that this was a case of interfering with the debtor’s right to file bankruptcy:
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 an LLC’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.
The court joined other courts in refusing to enforce a waiver of federal bankruptcy rights, and concluded that the debtors had the necessary authority to commence their bankruptcy filings.
Given that the creditor acquired one unit out of 22,000,001 for $1 and was adamant that the whole purpose was to give it the right to block a bankruptcy filing by the debtor, the result is not terribly surprising. However, if the facts had not been so egregious there might have been a different result.
Vicki R Harding, Esq.