On direct appeal from a bankruptcy court in Mississippi, the Fifth Circuit was being asked to hand down a blockbuster opinion saying whether a creditor or shareholder could use a so-called golden share or blocking provision to preclude a company from filing bankruptcy.
An opinion directly answering the certified questions would have allowed the New Orleans-based appeals court to adopt, reject or significantly expand the idea that no one can contract away the ability to file bankruptcy or the right to a discharge.
To avoid issuing an advisory opinion, Circuit Judge Carolyn Dineen King instead answered a narrow question closely tailored to the facts. Based on Supreme Court authority from 1945, Judge King held in her May 22 opinion for the Fifth Circuit that a bankruptcy court must dismiss a bankruptcy petition if the filing was not authorized in accordance with the corporate charter.
Judge King took pains to ensure that her opinion would not be interpreted too broadly. She said, for instance, that the result might be different if the ability to block bankruptcy were held by a creditor “with no stake in the company” or if a creditor took an equity interest as a “ruse” to guarantee payment of a debt.
The Bankruptcy Court Opinion
The debtor owned a car rental company. To finance an acquisition, the debtor received a $15 million investment from a diversified financial group. In return, the investor was given 100% of the debtor’s preferred equity convertible into 49.76% of the equity. The preferred shareholder was the single largest investor in the company.
An investment bank helped arrange the acquisition. The bank was an affiliate of the preferred shareholder. The investment bank had a $3 million unpaid claim for its services. In his opinion in December, Bankruptcy Judge Edward Ellington of Jackson, Miss., said that the preferred shareholder controlled the affiliated investment bank creditor.
As part of the transaction, the debtor reincorporated in Delaware and provided in the certificate of incorporation that a majority of all classes of equity, voting separately, must approve a “liquidation event” such as bankruptcy.
Without holding a vote of common and preferred shareholders, the company filed a chapter 11 petition. The preferred shareholder responded by filing a motion to dismiss for lack of proper corporate authorization. In opposition, the debtor argued that the creditor, acting through its controlled affiliate, the preferred shareholder, could not bar a bankruptcy filing and thus realize a result it could not achieve directly.
Judge Ellison granted the dismissal motion, holding that the preferred shareholder had the “unquestioned right” to block a voluntary bankruptcy, even though it was controlled by the creditor with the $3 million disputed claim.
In January, Judge Ellison certified three questions for direct appeal to the Fifth Circuit: (1) Is a blocking provision or golden share, held by either a creditor or equity holder, invalid as a violation of public policy if it prevents a corporation from filing bankruptcy; (2) if the holder is both a creditor and shareholder, is barring bankruptcy invalid as a violation of public policy; and (3) under Delaware law, may a certificate of incorporation contain a blocking provision or golden share, and if permissible, does Delaware law impose fiduciary duties on the holder in exercising its power?
On February 8, the appeals court granted the petition and expedited the appeal. Oral argument took place on May 2.
To read ABI’s report on the bankruptcy court’s decision and the certified question, click here.
Judge King’s Cautious, Narrow Opinion
Addressing the concepts of golden shares and blocking provisions, Judge King said they are not identical. A blocking provision could be one of several contractual provisions a creditor might use to prevent a debtor from filing bankruptcy. In the bankruptcy context, she said that a golden share is stock that gives a creditor the right to prevent a voluntary bankruptcy.
The case on appeal did not fit within either definition, Judge King said. In any event, opining on the legality of blocking provisions or golden shares would amount to issuing an advisory opinion, which she was unwilling to do.
Instead, Judge King narrowed the question to decide whether the parties could “amend a corporate charter to allow a non-fiduciary shareholder fully controlled by an unsecured creditor to prevent a voluntary bankruptcy petition.”
Judge King said that the Bankruptcy Code does not specify who has the right to file a petition for a corporation. In substance, she based her decision on Price v. Gurney, 324 U.S. 100, 106 (1945), where the Supreme Court held that state law determines who has authority to file a voluntary petition for a corporation.
Judge King found “no reason to depart from that general rule in this case.” She also found no statute or “binding caselaw” that would allow the court “to ignore corporate foundational documents, deprive a bona fide shareholder of its voting rights, and reallocate corporate authority to file for bankruptcy just because the shareholder also happens to be an unsecured creditor.”
Cases relied upon by the debtor were “not controlling and not to the contrary,” Judge King said. They involved “creditors’ attempts to appoint non-fiduciary officers and directors with the ability to prevent a bankruptcy filing.”
Exploring the facts, Judge King said she found no evidence that the requirement for shareholder approval “was merely a ruse” to ensure that the debtor would pay the investment bank’s $3 million claim, even if the banker and the preferred shareholder were treated as a single entity. In other words, Judge King’s holding might not apply in another case where the corporate charter was being used to ensure payment of a debt.
On the other hand, the opinion also means that a creditor and shareholder theoretically can be one entity without disabling the right to vote as a shareholder.
Stressing the limited nature of the holding, Judge King said that the case entailed a bona fide shareholder and “goes no further.” She said the case did not involve a creditor who “somehow contracted for the right to prevent a bankruptcy or where the equity interest is just a ruse.”
Having determined that nothing in federal bankruptcy law precluded enforcement of the corporate charter under the facts of the case, Judge King then analyzed whether the charter was enforceable under Delaware law.
Judge King found no Delaware cases saying whether shareholders could be given the right to decide for or against filing bankruptcy. Fortunately, the debtor abandoned the argument on appeal, so she was not called on to make a so-called Erie guess. Therefore, Judge King assumed that Delaware law would allow such a provision.
Next, Judge King examined whether the preferred shareholder violated fiduciary duties. In the first place, the record did not establish that the preferred shareholder was a controlling shareholder and therefore did not have fiduciary duties under Delaware law.
Even if the shareholder were controlling and therefore did have fiduciary duties, Judge King found “a more fundamental defect” in the debtor’s argument: The proper remedy for violation of fiduciary duties would “not allow a corporation to disregard its charter and declare bankruptcy without shareholder consent.”
Even if the shareholder had violated fiduciary duties, “the proper remedy is not to deny an otherwise meritorious motion to dismiss the bankruptcy petition.”
“Instead,” Judge King said, the debtor “must seek its remedy under state law” if the shareholder has “breached a fiduciary duty.”
Judge King’s opinion does not indicate whether a bankruptcy court through some procedural construct would have jurisdiction to determine whether a shareholder had violated a fiduciary duty and thus enable a company to file bankruptcy voluntarily without corporate authorization. For example, it is not clear one way or another whether a company could file a petition and answer a motion to dismiss by contending that the shareholder was violating fiduciary duties.