We use cookies to give you the best online experience. By using our website you agree to our use of cookies in accordance with our cookie policy. Learn more here.Close Me
It has long been the law that creditors are rarely entitled to
contractually prohibit a debtor from filing for bankruptcy, whether
such restriction is contained in the debt instruments or in the
corporate governance documents. In contrast, governance provisions
which condition a bankruptcy filing on the vote or consent of
certain equity holders that are unaffiliated with any creditor are
frequently enforced. Many equity sponsors, for example, wear two
hats: they are both shareholders and lenders to their portfolio
companies. In that hybrid case, where the shareholder is also a
creditor, can the shareholder enforce corporate governance
provisions which restrict the ability of the company to file for
bankruptcy? A recent decision from the Fifth Circuit Court of
Appeals has answered that question in the affirmative - with
caveats.
Blocking Provisions
Aggressive lenders have long sought to block or restrict the
ability of their borrowers to file for bankruptcy. Under
decades-old case law, the general rule as a matter of public policy
has been that a waiver of the right to file for bankruptcy is
unenforceable. On the other hand, it has also been the rule that
equity holders are generally entitled to enforce the requirements
of corporate governance documents in determining whether a
bankruptcy filing is authorized, unless they contain an outright
prohibition of any bankruptcy filing.
The Fifth Circuit Weighs In
In Franchise Services of North America, Inc. v. Macquarie
Capital (USA), Inc. (In re Franchise Services of North America,
Inc.), 891 F.3d 198 (5th Cir. 2018), the debtor's
corporate governance documents had been amended, in consideration
for a loan, to provide that the debtor could not file for
bankruptcy without the consent of a minority preferred shareholder,
who was also controlled by the lender. Overruling a motion to
dismiss the bankruptcy filing, the Fifth Circuit held that state
law determines who has the authority to file a voluntary bankruptcy
petition on behalf of a corporation, and bankruptcy law does not
strip a minority equity holder of its voting rights to prevent a
filing merely because it is also a creditor.
The decision came with some caveats. The court stated that there
might be a different result if there were evidence that the
creditor had caused the shareholder to block a filing solely as a
ruse to collect the debt. In addition, the court noted that, if the
shareholder had voting or management control of the corporation, it
would have a fiduciary duty to consider whether bankruptcy was
appropriate, and could be sued for breach of that duty. Even so,
the remedy in that suit would be monetary damages, and would not
include allowing an otherwise unauthorized bankruptcy filing to
continue.
The Franchise Services case is only binding in the 5th
Circuit, and contains a number of caveats. Nevertheless, it should
give some comfort to hybrid equity holders/creditors that their
corporate governance documents mean what they say.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
To print this article, all you need is to be registered on Mondaq.com.
Click to Login as an existing user or Register so you can print this article.
Draft legislation included in the Finance Bill 2019-2020 will potentially make directors and certain other individuals closely connected to a company jointly and severally liable for a company's...
On September 11, 2019, the Delaware district court affirmed the bankruptcy court's decision to expunge a proof of claim filed by a claims trader in the Woodbridge Group of Companies,...
Kramer Levin continues to be a leader in the retail restructuring space. Building off significant recent representations in, among other retail matters, Nine West, Payless, Neiman Marcus
The US Bankruptcy Court for the District of Delaware addressed a developing area of the law related to the attorney-client and work-product privileges and the transfer of any such privileges to liquidation trustees ...
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Webcast: Getting Ready For The Next Cycle: Recent Trends And Developments In DIP Financings (Video)
