Can Equity Investors or Creditors Prevent a Debtor from Filing for Bankruptcy – Two Recent Circuit Level Decisions Shed Some Light. Federal bankruptcy law generally governs who is eligible to file for bankruptcy. See 11 U.S.C. § 109. Assuming a debtor is eligible, any purported waiver of the right to file is generally unenforceable as a matter of federal bankruptcy policy. See, e.g., Bank of China v. Huang (In re Huang), 275 F.3d 1173, 1177 (9th Cir. 2002). But while this rule is straight-forward for individuals, it raises complicated questions for corporations and other business entities. This is because of another, well-established principle of federal bankruptcy law—while federal law governs whether a company is eligible to file for bankruptcy, state law governs who has the authority to file a voluntary bankruptcy petition on behalf of the company. Price v. Gurney, 324 U.S. 100, 106-07 (1945).
Creditors have attempted to use state-law rules of corporate governance to effectively render their borrowers ineligible for bankruptcy. This has included requiring a borrower to include in its operating agreement or charter (i) an outright prohibition on filing for bankruptcy, or (ii) approval mechanisms that require the creditor’s (or someone loyal to it) consent to a filing through its vote as a member, shareholder, or director. Although a few courts have upheld these structures, see, e.g., DB Capital Holders, LLC v. In re DB Capital Holdings, LLC v. Aspen HH Ventures, LLC (In re DB Capital Holdings, LLC), 2010 WL 4925811 (10th Cir. BAP 2010), more often than not they have not been enforced if implemented at the behest of a
creditor. See, e.g., In re Intervention Energy Holdings, LLC, 553 B.R. 258 (Bankr. D. Del. 2016), In re Bay Club Partners–472, LLC, 2014 WL 1796688 (Bankr. D. Or. 2014).
A recent Circuit court case sheds some further light on the circumstances in which a creditor or investor can restrict a debtor’s right to file for bankruptcy protection through provisions in the debtor’s organic corporate documents. See In re Franchise Services of North America, Inc., 891 F.3d 198 (5th Cir. 2018) (“FSNA”). A second case illustrates an alternative path that may be available in some cases—seeking the appointment of a receiver who can wrest authority to file away from the debtor’s existing board or management. See In re Sino Clean Energy, Inc., 901 F.3d 1139 (9th Cir. 2018) (“Sino Clean Energy”).
In re Franchise Services of North America, Inc., 891 F.3d 198 (5th Cir. 2018). In FSNA, the Fifth Circuit held that a shareholder could exercise its approval rights to prevent a corporation from filing for bankruptcy, even though that shareholder was controlled by a creditor of the company. The debtor in that case (“Franchise”) was a rental car company that had sought to expand its business by buying Advantage Rent a Car. Franchise retained an investment bank (“Macquarie”), which in turn created a subsidiary (“Boketo”) to invest $15 million in Franchise in exchange for 100% of Franchise’s preferred stock. As a condition of Boketo’s investment, Franchise reincorporated in Delaware, and adopted a new certificate of incorporation that provided that it could not file for bankruptcy unless it had approval of the holders of a majority of the preferred shares (i.e. Boketo).
Franchise’s acquisition of Advantage was ill-fated. Advantage filed for chapter 11 bankruptcy within a year, and Franchise followed a couple of years later. Franchise did not, however, obtain Boketo’s approval of its chapter 11 filing—notwithstanding the requirement in its certificate of incorporation. At the time, Macquarie was an unsecured creditor of Franchise that was allegedly owed $3 million in unpaid transaction fees.
Boketo and Macquarie moved to dismiss Franchise’s chapter 11 case on the ground that the bankruptcy petition was filed without corporate authority. In response, Franchise argued, among other things, that (i) the blocking provision was an invalid bankruptcy...
