Bankruptcy Judge Kevin J. Carey slammed the door on creditors trying to use corporate structures that would prevent borrowers from filing bankruptcy petitions, even if the arrangements were otherwise permissible under Delaware corporate law.
A limited liability company filed a chapter 11 petition. A secured lender, which was also an equity holder, filed a motion to dismiss, claiming that the company’s operating agreement required its consent to file bankruptcy. Judge Carey of Delaware denied the motion to dismiss in an opinion on June 3.
Faced with default on the debt owing to the lender, the LLC signed a forbearance agreement giving the lender one unit of equity ownership. The forbearance agreement also contained an amendment to the LLC’s operating agreement that required unanimous approval from the equity holders to a bankruptcy filing. The LLC filed bankruptcy without consent from the lender, who by that time was also a part owner.
Urging dismissal of the petition for lack of required consent, the lender contended that the limitation on the LLC’s ability to file a bankruptcy petition was permissible under Delaware law. Judge Carey declined to reach the state law issue, saying it might have been a question of first impression.
Even though the lenders said it “bought and paid for” its ownership interest and the accompanying veto right, Judge Carey upheld the filing based on federal common law of bankruptcy.
Reduced to essentials, Judge Carey said the lender attempted to “contract away the [debtor’s] right to seek bankruptcy relief.” Even if the operating agreement were valid under Delaware law, he said it is “beyond cavil” that a state cannot deny an individual’s right to file bankruptcy. He cited cases to the effect that the same rule protects corporations.
Judge Carey’s holding bears quoting at length. He said:
A provision in an LLC’s operating agreement, “obtained by contract, the sole purpose ... 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 ... whose primary relationship with the debtor is that of a creditor — not equity holder — and which owes no duty to anyone but itself ..., is tantamount to an absolute waiver of that right [to file bankruptcy], and, even if arguably permitted by state law, is void as contrary to federal policy.”