A recent opinion, In re Franchise Services of North America, Inc.,1 is the latest decision to address the enforceability of a blocking provision or "golden share" construct in bankruptcy. Such provisions attempt to circumvent the general prohibition against an entity contracting away the right to file bankruptcy. The "golden share" or blocking provision - usually added to the entity's organizational documents, such as articles of incorporation, LLC agreements, or partnership agreements - typically requires a unanimous vote of all shareholders, members, or partners (or a particular class thereof) for the entity to voluntarily file for bankruptcy protection. The holder of a minority, or even one (commonly called the golden share), of the entity's equity interests can therefore seek to veto a bankruptcy filing. The Court in Franchise Services concluded that such provisions are enforceable if the golden share or blocking provision is held by a substantial equity holder, but not if held by an entity that is otherwise merely a creditor.
In this case, Boketo, a subsidiary of Macquarie Capital (USA), was formed to make an investment in the debtor to help fund the debtor's acquisition of a business from Hertz. In exchange, Boketo received Series A preferred stock, thereby becoming the debtor's largest single shareholder.2 The debtor's formation documents provided that filing bankruptcy required a majority vote of both the common and preferred holders, each voting separately as a class. Based on Boketo's holdings of preferred stock, debtor's formation documents required Boketo's affirmative vote to file bankruptcy.3 Distressed and unable to pay its debts, the debtor's board passed a resolution for the debtor to file chapter 11. The debtor did not, however, obtain Boketo's consent to the filing. In response, Boketo, the preferred stockholder, and its parent, Macquarie, a creditor owed unpaid investment banking fees, jointly moved to dismiss the bankruptcy as being unauthorized. The Bankruptcy Court denied the motion to dismiss as to Macquarie, a creditor, but granted the motion to dismiss as to Boketo, an equity holder.
In reaching this decision, the Court analyzed seven court opinions on this issue,4 noting that all seven opinions start with the general premise that the waiving or contracting away of the right to file bankruptcy is void as a matter of public policy. The Bankruptcy Court also concluded, however, that based on these seven decisions a blocking provision should be enforceable if it is held by a significant equity holder. Recognizing the lack of circuit-level authority on the issue, the Bankruptcy Court asked the Fifth Circuit to accept a direct review of its ruling, thereby bypassing the district court's intermediate review, and to decide the following three issues:
"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?"5
If accepted as certified, we can expect the Fifth Circuit to provide important guidance on the validity of golden share provisions generally, and whether their enforceability changes if held by equity, a creditor, or a capital provider that is both. The Bankruptcy Court also asked the Fifth Circuit to provide guidance on fiduciary duties under Delaware law and whether those duties require the holder of a golden share to vote in the best interest of the company, which may not always be in the holder’s own self-interest.
1 In re Franchise Services of N. Am., Inc., Case No. 17-023166 (Bankr. S.D. Miss. Dec. 18, 2017) [Docket No. 253] (Memorandum Opinion); see also, In re Franchise Services of N. Am., Inc., Case No. 17-023166, 2018 WL 485959, at *8 (Bankr. S.D. Miss. Jan. 17, 2018) [Dkt. No. 272] (Order on Debtors’ Motion for Certification of Direct Appeal to Fifth Circuit Court of Appeals; including Memorandum Opinion attached as Exhibit A thereto).
2 Memorandum Opinion at p. 4.
3 Id. at pp. 9-10 (“Boketo is the holder of the Debtor’s Preferred Stock, and if [the bankruptcy voting provision in Debtor’s certificate of incorporation] is valid and enforceable, Boketo would have to approve the filing of a bankruptcy petition by the Debtor.”
4In re Global Ship Systems, LLC, 391 B.R. 193, 203 (Bankr. S.D. Ga. 2007) (dismissing the bankruptcy case and enforcing a golden share/blocking provision held by an entity that was both a creditor and a 20% equity holder); In re Bay Club Partners-472, LLC, Case No. 14-30394, 2014 WL 1796688, at *5 (Bankr. D. Or. May 6, 2014) (denying motion to dismiss and holding that provision included in LLC agreement, at creditor’s request, seeking to block bankruptcy prior to payment in full of creditor’s loan was void); In re Lake Mich. Beach Pottawattamie Resort, LLC, 547 B.R. 899, 911-12 (Bankr. N.D. Ill. 2016) (denying motion to dismiss, finding golden share/blocking provision void under Michigan Law where creditor holding special member interest (and associated bankruptcy consent right) was not required to act in interest of debtor); In re Intervention Energy Holdings, LLC., 553 B.R. 258, 262 (Bankr. D. Del. 2016) (denying motion to dismiss filed by creditor that was also a holder of one “golden share,” reasoning that “[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.”); In re Tara Retail Group, LLC, Case No. 17-00057, 2017 WL 1788428, at *2 (Bankr. N.D. W. Va. May 4, 2017), appeal dism’d. 2017 WL 2837015 (N.D. W.Va. June 30, 2017) (denying a motion to dismiss where unanimous director vote was required to file bankruptcy; creditor-designated independent director refused to vote or take a position on bankruptcy filing, despite possessing adequate information to do so, and thus found to have ratified the filing through his silence); In re Squire Court Partners Ltd. P’ship, 574 B.R. 701, 707 (E.D. Ark. 2017) (dismissing case filed by general partner where limited partners, holding substantial equity, who expressly retained and did not delegate authority to file bankruptcy, did not consent); In re Lexington Hosp. Grp., LLC, Case No. 17-51568, 2017 WL 4118117 (Bankr. E.D. Ky. Sept. 15, 2017) (denying motion to dismiss where creditor’s wholly-owned subsidiary held 30% membership interest in debtor, reasoning that creditor, acting through its controlled subsidiary, had no fiduciary duties to the debtor “that might limit self-interested decisions that ignore the best interests of the [debtor].”).
5 In re Franchise Services of N. Am., Inc., 2018 WL 485959, at *5.