Delaware Court Voids LLC Agreement Provision Giving Creditor Veto Over Bankruptcy

June 7, 2016

A Delaware bankruptcy court has joined what appears to be a recent trend toward invalidating limited liability company operating agreement provisions that effectively afford lenders veto power over the LLC’s authority to file for bankruptcy protection; the court found one such provision void as contrary to federal public policy. In re Intervention Energy Holdings, LLC, et al., Case No. 16-11247 (KJC) (D.I. 69), 2016 W.L. ___________ (Bankr. D. Del. June 3, 2016).

The debtor in the case, Intervention Energy Holdings, LLC, a Delaware limited liability company, filed a voluntary Chapter 11 bankruptcy petition in May 2016. Just days later, the debtor’s senior secured lender, an institutional investor focusing its investments in global energy projects and companies, filed a motion to dismiss the case as an unauthorized filing. Approximately six months before the bankruptcy filing, the debtor defaulted on the loan and, in connection with a forbearance agreement negotiated between the parties, the debtor issued the lender a single common equity unit in the debtor and adopted an amended LLC operating agreement that required the unanimous consent of every holder of common units as a prerequisite to any voluntary bankruptcy filing. Based on the amended LLC agreement and its status as a holder of a common unit, the lender sought dismissal of the bankruptcy case as unauthorized under the applicable governing documents.

Delaware Bankruptcy Judge Kevin J. Carey denied the lender’s motion to dismiss, finding the unanimous consent provision of the operating agreement to be equivalent to an unenforceable contractual waiver by the debtor of the right to file for bankruptcy.

Although the lender argued that, under Delaware statute, limited liability companies may choose to abrogate fiduciary responsibilities, the court declined to address state law issues that might well be questions of first impression.

Instead, the court focused on federal public policy in favor of assuring persons the right to seek “federal bankruptcy relief as authorized by the Constitution and enacted by Congress.” Relying upon, among other things, a recent bankruptcy court decision out of the Northern District of Illinois −In re Lake Michigan Beach Pottawattamie Resort LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016) − Judge Carey held in In re Intervention Energy Holdings that the same rule against waiver of access to bankruptcy relief applies to corporations or business entities, including LLCs.

It is important to note that Judge Carey’s decision turned, in part, upon his conclusion that the relationship between the objecting unit holder/ lender and the debtor was primarily that of debtor and creditor and that the lender had disavowed fiduciary obligations to the debtor. Judge Carey held, in relevant part:

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.
(Emphasis supplied.)

The decision reflects an apparently growing trend among bankruptcy courts to prevent lenders from enforcing operating agreement provisions that afford the lender veto power over the borrower’s ability to file for bankruptcy protection, while insulating the lender from any concomitant fiduciary responsibility to the borrower. Lenders should be aware that such provisions may be deemed a contractual and unenforceable waiver of the borrower’s right to seek bankruptcy protection. Only time will tell whether this court’s view will be applied to other business enterprises and whether careful drafting will alter the results.