Guest Post: Bankruptcy Proofing Lessons
Today's guest post is by fellow Stites attorney Bob Goodrich, Jr., who has been designated by the American Bankruptcy Board of Certification and the State of Tennessee as a specialist in business bankruptcy. For more then 25 years, Bob has represented creditors, creditors' committees, landlords, and other interested parties in bankruptcy and insolvency related matters in state and federal courts. If you have questions, you can contact Bob by email or phone at (615) 782-2231.
Bankruptcy lawyers are often asked to “bankruptcy proof” a transaction, and they often explain that an agreement not to file bankruptcy or under which property is forfeited or a contract terminated by a bankruptcy filing is likely unenforceable. There are, however, bankruptcy proofing tactics which have some degree of success, as illustrated by In re DB Capital Holdings, LLC, BAP No. CO-10-046, Bankr. No. 10-23242 (10th Cir. BAP December 6, 2010).
In this case the Debtor was a Colorado LLC that owned a condominium project, encumbered by a mortgage loan in favor of WestLB AG (“WestLB”). The Debtor’s manager attempted to put it into bankruptcy. The Debtor’s operating agreement originally did not expressly empower the manager to file bankruptcy for the LLC and stated that the manager must cease operating as manager “upon dissolution or bankruptcy,” necessitating a change in management if a bankruptcy were filed. The LLC agreement also prohibited the manager from doing any act that would make it impossible to carry on the ordinary business of the LLC. Citing previous authority, the bankruptcy court and the appellate court agreed that filing a bankruptcy prevented the LLC from carrying on the ordinary course of business. Both courts found that the manager was not authorized to place the LLC in bankruptcy. Additionally, an amendment to the LLC agreement, inserted after some negotiations with WestLB, expressly prohibited the filing of a bankruptcy. The court found no evidence of coercion but found it did not need to opine on that issue because it concluded the LLC was not eligible for bankruptcy under the original LLC agreement.
The case is a reminder that an entity’s ability to act, including its power to file bankruptcy, is based on state law and the authorizing documents that empower the entity to act. To the extent that such authorization is not present, the entity cannot file bankruptcy, but it can be placed into bankruptcy involuntarily by its creditors. Also, so long as the members vote to change the LLC agreement, it can be amended to empower the filing of a bankruptcy. If, however, the requisite voting is not there, no amendment can be made. Lenders sometimes control a vote or votes so that the requisite votes cannot be obtained to empower the entity to file bankruptcy, but these arrangements sometimes raise breach of fiduciary duty issues with respect to the holder of the vote who is acting at the direction of the lender.
Wrong. The issue is not so simple. Courts have treated pre-petition waivers differently and inconsistently throughout the country. The courts generally fall into the following categories:
