In Franchise Servs. of N. Am. v. U.S. Trs. (In re Franchise Servs. of N. Am.),[1] the Fifth Circuit Court of Appeals, on direct appeal from the U.S. Bankruptcy Court for the Southern District of Mississippi, affirmed the dismissal of a bankruptcy case where the debtor company failed to obtain the requisite consent from shareholders as required under its corporate charter. The opinion, which may have significant impact upon pre-filing negotiations with equity constituencies, is perhaps more notable for the issues that the Court of Appeals declined to address, including (1) whether the lack of consent deprives the bankruptcy court of jurisdiction and (2) whether “blocking rights” or “golden shares” are prohibited under federal law.
The Facts
The Franchise Services of North America (FSNA) bankruptcy resulted from FSNA’s unfortunate purchase of Advantage Rent-A-Car from Hertz Corp.[2] The purchase was financed through a series of transactions with Macquarie Capital (U.S.A.), Inc. and certain special-purpose entities established for the transaction. As part of the financing, Boketo, LLC, one of the Macquarie subsidiaries, made a $15 million investment in FSNA in exchange for 100 percent of FSNA’s preferred stock. As additional consideration, FSNA agreed to amend its certificate of incorporation to require that the company obtain consent from a majority of each class of its shareholders, voting separately, before commencing a “liquidation event” — including the preparation and filing of a bankruptcy case.[3]
Within six months after the purchase, Advantage filed a chapter 11 bankruptcy proceeding. Advantage sold substantially all of its assets and, following the sale, its chapter 11 case was dismissed in January 2016. FSNA filed its own bankruptcy the next year. Doubtful of its ability to obtain shareholder approval, FSNA prepared and filed its chapter 11 petition without the approval of its shareholders as required under the new certificate of incorporation.[4]
The Bankruptcy[5]
FSNA filed its petition for relief on June 26, 2017, and filed various first-day pleadings on June 27, 2017. Preferred stockholder Macquarie filed a Notice of Appearance and Request for Notices on June 27, 2017, and appeared at a hearing on June 28, 2017, to consider the first-day motions.[6]
At a status conference on July 11, 2017, Macquarie raised concerns over whether FSNA had obtained the necessary shareholder consents. On Aug. 10, 2017, Macquarie filed a motion to dismiss the chapter 11 case, arguing that because the debtor lacked corporate authority to file its chapter 11 petition, the bankruptcy should be dismissed for lack of jurisdiction. On Aug. 31, 2017, Boketo filed a two-page joinder to its parent company’s motion.[7]
FSNA challenged the dismissal motion on the grounds that, as the sole preferred shareholder, Boketo’s voting power should be considered a “blocking right” or a “golden share” and that the bankruptcy court should find such to be invalid as being against public policy. The debtor also argued that, having participated in the bankruptcy case without immediately raising the challenge to FSNA’s authority to file, Macquarie and Boketo had waived such arguments.[8]
Ultimately, the bankruptcy court agreed with Macquarie and Boketo that FSNA lacked corporate authority to file its petition and that the lack of authority deprived the bankruptcy court of jurisdiction over the matter. Accordingly, the bankruptcy court dismissed the bankruptcy case.[9]
FSNA appealed, and, at its request, the bankruptcy court certified a direct appeal to the Fifth Circuit Court of Appeals. The bankruptcy court certified three questions:
1. Is a provision, typically called a blocking provision or a golden share, which gives a party (whether a creditor or an equity holder) the ability to prevent a corporation from filing bankruptcy valid and enforceable or is the provision contrary to federal public policy?
2. If a party is both a creditor and an equity holder of the debtor and holds a blocking provision or a golden share, is the blocking provision or golden share valid and enforceable or is the provision contrary to federal public policy?
3. Under Delaware law, may a certificate of incorporation contain a blocking provision/golden share? If the answer to that question is yes, does Delaware law impose on the holder of the provision a fiduciary duty to exercise such provision in the best interests of the corporation?[10]
The Fifth Circuit Affirms
Taking the matter on review, the Fifth Circuit Court of Appeals initially narrowed the scope of its opinion — declining to answer whether “golden shares” or “blocking rights” were generally permissible.[11] The appeals court began by defining a “golden share” as “[a] share that controls more than half of a corporation’s voting rights and gives the shareholder veto power over changes to the company’s charter” and a “blocking right,” in the bankruptcy context, as “the issuance to a creditor of a trivial number of shares that gives the creditor the right to prevent a voluntary bankruptcy petition, potentially among other rights.”[12] Finding that the facts of the instant case did not neatly match either definition, the Court of Appeals declined to issue what it deemed an advisory opinion.[13]
Having declined to opine generally regarding the legality of “golden shares,” the Court of Appeals turned to the remaining issue: whether U.S. or Delaware law permits a company to require the consent of each class of shareholders prior to filing bankruptcy. Easily answering “yes” as to both, the appeals court affirmed the dismissal of FSNA’s bankruptcy case.[14]
Though the appeals court appeared to avoid the “golden share” or “blocking right” issue, the opinion may provide more insight to drafters attempting to gain the ability to forestall a corporate bankruptcy filing than is initially observed. In refusing to answer the bankruptcy court’s certified questions as drafted, the appeals court appears to endorse narrowly tailored definitions of the potentially prohibited “golden share” or “blocking right.” In doing so, the appeals court has seemingly endorsed the ability of preferred shareholders to enforce provisions prohibiting a corporate bankruptcy filing without preferred shareholder approval.
Other Unanswered Questions
Less conspicuously, the appeals court also failed to address whether a lack of corporate authority deprives a bankruptcy court of jurisdiction or is merely cause for dismissal. As noted by the bankruptcy court, there exist seemingly conflicting precedents on this issue in the Fifth Circuit. On the one hand, the Fifth Circuit has held that the lack of corporate authority deprives the bankruptcy court of subject-matter jurisdiction.[15] However, seemingly inconsistent with this concept, the Fifth Circuit has held that a party may waive its ability to challenge whether a debtor had authority to file.[16]
The determination of whether subject-matter jurisdiction requires adequate corporate authority may have a significant impact upon a party’s strategy in challenging a petition. For example, in the Franchise Servs. bankruptcy case, the debtors — relying on the holdings in Atlas Supply Corp. and Alexander — argued that movants had waived their right to seek dismissal. Agreeing with the movants, the bankruptcy court determined that, because a lack of corporate authority deprives the bankruptcy court of subject-matter jurisdiction, the argument could not be waived. Although the appeals court affirmed dismissal, the court’s opinion does little to close the argument one way or another.
In what will likely be interpreted as an endorsement of the view that corporate authority is a question of subject-matter jurisdiction, the appeals court cited the U.S. Supreme Court’s decision in Price v. Gurney[17] favorably for the proposition that “[a]bsent a duly authorized petition, the bankruptcy court has no power ‘to shift the management of a corporation from one group to another, to settle intracorporate disputes, and to adjust intracorporate claims.’”[18] Yet, it should be noted that rather than affirmatively holding that the lack of corporate authority would establish a jurisdictional defect, the court (again quoting Price) observed: “If the petitioners lack authorization under state law, the bankruptcy court ‘has no alternative but to dismiss the petition.’”[19]
Lacking a clear statement one way or another, the issue remains unsettled. Thus, while a debtor’s failure to obtain approval from its shareholders may be fatal to a petition, the possibility that dissenting shareholders may waive the right to challenge such failure on these grounds by participating early in a case remains.[20] As such, a dissenting shareholder opposing a bankruptcy filing on grounds that the debtor lacked corporate authority should move for dismissal in a timely manner.
[1] No. 18-60093; 2018 U.S. App. LEXIS 13332; 2018 WL 2325909 (5th Cir. May 22, 2018).
[2] Franchise Servs., 2018 U.S. App. LEXIS 13332 at *3-6.
[3] Id.
[4] Id.
[5] The case is styled In re Franchise Servs. of N. Am., Case No. 17-02316 in the U.S. Bankruptcy Court for the Southern District of Mississippi.
[6] In re Franchise Servs. of N. Am., No. 1702316EE, 2018 Bankr. LEXIS 105, at *24-25 (Bankr. S.D. Miss. Jan. 17, 2018).
[7] Id.
[8] Id.
[9] Id.
[10] Franchise Servs., 2018 U.S. App. LEXIS 13332 at *6-7.
[11] Id. at *8-11.
[12] Id. at *8-9.
[13] Id. at *9.
[14] Id. at *11-22.
[15] See Treen v. Orrill, Cordell, & Beary LLC (In re Delta Starr Broad. LLC), 422 Fed. Appx. 362, 368 (5th Cir. 2011).
[16] See Peterson v. Atlas Supply Corp. (In re Atlas Supply Corp.), 857 F.2d 1061, 1064 (5th Cir. 1988) (delay in seeking dismissal of 14 months from petition date) (citing Alexander v. Farmer's Supply Co. (In re Farmers' Supply Co.), 275 F. 824 (5th Cir. 1921) (delay in seeking dismissal of only four months)).
[17] 324 U.S. 100, 106, 65 S. Ct. 513, 89 L. Ed. 776 (1945).
[18] Franchise Servs., 2018 U.S. App. LEXIS 13332 at *12 (emphasis added.)
[19] Id.
[20] Notably, the U.S. Bankruptcy Court for the Southern District of Texas recently held in In re Castex Energy Partners LP (Case No. 17-35835), that a finding of subject-matter jurisdiction included in a final order in a bankruptcy case that is not appealed is res judicata as to the debtor’s authority to file. In re Castex Energy Partners LP, Hearing Transcript, 80:6-19 (Feb. 26, 2018). Although the issue was not squarely addressed, the Fifth Circuit’s affirmation in Franchise Servs. may cast doubt upon this ruling, as several final orders were entered in the bankruptcy case prior to dismissal.