Relating to Real Estate

On June 3, 2016 Bankruptcy Judge Kevin J. Carey of the Delaware Bankruptcy Court held in the case of In re Intervention Energy Holdings, LLC, 553 B.R. 258 (Bankr. D. Del. 2016) that a provision in an operating agreement of a Delaware limited liability company (the “LLC”) requiring the consent of all members to a bankruptcy filing was void as contrary to federal public policy.  

In this matter, the LLC filed a Chapter 11 case on May 20, 2016, approximately five months after it entered into a forbearance agreement with the lender.  The forbearance agreement mandated that the LLC amend its operating agreement to require the unanimous consent of all members to a bankruptcy filing, and to also issue a single common membership unit (or “golden share”) to the lender, making the lender a member.  The lender did not consent to the filing of bankruptcy, and immediately moved to dismiss the filing on the basis that the bankruptcy was not authorized by the LLC’s operating agreement.  

In his opinion denying the motion, Judge Carey equated the operating agreement provision requiring the consent to a bankruptcy filing by all members, including the lender, to a waiver of a right to file for bankruptcy.  Under well-established case law, a waiver of bankruptcy is unenforceable.  

The Delaware Bankruptcy Court’s decision is the second case decided within sixty days on the issue on whether a court will enforce an operating agreement provision requiring the lender’s consent to the debtor’s filing for bankruptcy.  On April 5, 2016 the Bankruptcy Court for the Northern District of Illinois, in the case of In re Lake Michigan Beach Pottawattamie Resort LLC, 547 B.R. 899 (Bankr. N.D. Ill 2016), upheld a debtor’s bankruptcy filing notwithstanding the lender’s failure to consent in its capacity as a “special member” of the debtor.  The Illinois court held that such a provision was contrary to state and federal public policy.  

These recent decisions indicate that a lender’s effort to prevent a borrower’s bankruptcy filing by requiring the borrower to add a blocking director or member that owes a fiduciary duty to the lender, as opposed to the business entity, violates public policy and is unenforceable.  While the decisions dealt with provisions added to operating agreements at a lender’s insistence in connection with a distressed loan workout, the reasoning of these cases could be extended to the terms of a new loan made to a single purpose entity (SPE).  It is common for lenders who lend to a SPE to include in their loan terms a requirement that the SPE add an independent director or member whose vote is necessary for a bankruptcy filing by the SPE borrower.  So long as the independent director or member is not relieved of the fiduciary duty to act in the best interest of the borrower, and has no duty to the lender, such provisions should not be held to run afoul of the public policy discussed by the Delaware and Illinois decisions.  

For questions, please contact Larry Coppel (410) 576-4238.