RECENT BANKRUPTCY REMOTE ENTITY CASES SECURED LENDING AND SECURED TRANSACTIONS JOINT SUBCOMMITTEE MEETING SEPTEMBER 8, 2016

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1 RECENT BANKRUPTCY REMOTE ENTITY CASES SECURED LENDING AND SECURED TRANSACTIONS JOINT SUBCOMMITTEE MEETING SEPTEMBER 8, 2016

2 Bankruptcy Remote Entity Cases In re Lake Michigan Beach Pottawattamie Resort LLC, 547 B.R In re Intervention Energy Holdings, LLC et al., Debtors, 2016 WL

3 Bankruptcy Remote Entities Generally Primary function of the bankruptcy remote entity structure is to: Decrease the likelihood of a voluntary filing; and Decrease the likelihood that a debtor s or its affiliates creditors will force it into an involuntary bankruptcy. 3

4 In re Lake Michigan Beach Pottawattamie Resort LLC 4

5 In re Lake Michigan Beach Pottawattamie Resort LLC (cont d) Debtor, a Michigan LLC, owned 15.5 acres on the shore of Lake Michigan in Coloma, Michigan. Debtor obtained financing from BCL-Bridge Funding LLC in 2014, and granted a security interest and mortgage in real and personal property to the secured lender. In 2015, the parties entered into a forbearance agreement, pursuant to which the debtor promised to pay the defaulted monetary amount. 5

6 In re Lake Michigan Beach Pottawattamie Resort LLC (cont d) In connection with the forbearance agreement, the parties entered into the third amendment to the Debtor s LLC Agreement, which provided for the following: The admission of the secured lender as the fifth member of the debtor. The grant by secured lender of the right to approve or disapprove of any voluntary bankruptcy by the debtor. The inclusion of the following provision eliminating any fiduciary duties of the secured lender as a member of debtor: Notwithstanding anything provided in the Agreement (or any provision of law or equity) to the contrary, in exercising its rights under this Section, [the secured lender] shall be entitled to consider only such interests and factors as it desires, including its own interests, and shall to the fullest extent permitted by applicable law, have no duty or obligation to give any consideration to any interests of or factors affecting the Company or the Members. 6

7 In re Lake Michigan Beach Pottawattamie Resort LLC (cont d) Debtor files a voluntary petition for relief under Chapter 11 of the Bankruptcy Code without the consent of secured lender as required by the amendment to the debtor s LLC Agreement. Secured lender filed a motion to dismiss the bankruptcy filing alleging, among other things, that the filing was unauthorized under applicable state law. 7

8 In re Lake Michigan Beach Pottawattamie Resort LLC (cont d) The court denied secured lender s motion to dismiss the debtor s bankruptcy petition because the blocking member structure used by debtor lacked the only redeeming factor that enables the enforceability of the blocking director / member construct. An absolute prohibition against filing for bankruptcy will likely be void against public policy. This is the case whether such prohibition is included in a typical contract or a corporate control document. A blocking director / blocking member concept is acceptable so long as the director must be subject to normal director duties and therefore in some circumstances vote in favor of a bankruptcy filing, even if it is not in the best interests of the creditor that they were chosen by. 8

9 In re Intervention Energy Holdings LLC Debtor was a Delaware limited liability company that held 100% of the equity in an upstream oil and gas company focused primarily on the Bakken formation in North Dakota. Secured lender, EIG Management, an asset manager provided debtor financing in the form of up to $200 million in senior secured notes, and debtor granted secured lender liens in certain collateral of the debtor. 9

10 In re Intervention Energy Holdings LLC (cont d) Debtors entered into a forbearance agreement on December 28, As a condition precedent to the effectiveness of the forbearance agreement, the debtors were required to admit secured lender as a member and execute an amendment to the debtor s LLC Agreement, that would provide for: The issuance to secured lender of a single common unit in the debtor for a capital contribution of $1.00. A provision requiring the unanimous consent of all members of the debtor (including the secured lender) to file for bankruptcy. 10

11 In re Intervention Energy Holdings LLC (cont d) In spite of the unanimous member consent provision, the debtor and its wholly-owned subsidiary filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code on May 20, 2016 without the consent of secured lender. Secured lender filed a motion to dismiss the bankruptcy filing alleging, among other things, that the filing was unauthorized under applicable state law. 11

12 In re Intervention Energy Holdings LLC (cont d) The court denied secured lender s motion to dismiss the debtor s bankruptcy petition. The court emphasized the unenforceability of a contractual provision prohibiting a voluntary bankruptcy filing. The court clearly interpreted the blocking member structure as the secured lender s attempt to have the debtor contract away the right to seek voluntary bankruptcy relief. 12

13 In re Intervention Energy Holdings LLC (cont d) The court found that when a blocking director / member concept is used that has the characteristics below, the relevant consent provision will be deemed to be tantamount to an absolute waiver: The consent is set forth in a governance document; The sole purpose of the relevant provision is to: place in the hands of a single, minority equity holder; the ultimate authority to deny the right to seek federal bankruptcy; the primary relationship of the person holding such blocking vote is that of a creditor not an equity holder; the blocking person owes no duty to anyone but itself in connection with the decision to file for bankruptcy. 13

14 Interesting Issues Emphasis on traditional fiduciary duties. Query What fiduciary duties does a non-managing member owe to the limited liability company and its members? See Feeley v. NHAOCG, LLC, 62 A.3d 649, 662 (Del. Ch. 2012)(stating that passive members do not owe default fiduciary duties). 14

15 Closing Thoughts There are limits to the contractual freedom provided by limited liability company acts. See for example: Milford Power Company LLC v. PDC Milford Power, LLC, 866 A.2d 738 (Del. Ch. 2004) (ipso facto clause in LLC Agreement preempted by bankruptcy law to the extent it deprived minority member of economic rights). The landscape for traditional bankruptcy remote entities using independent directors has not changed. 15

Haskins PARTNER Commercial Law Counseling (302) 351-9120 T thaskins@mnat.

16 Speaker Tarik is a partner in the Commercial Law Counseling Group. His practice covers a range of commercial transactions including mergers and acquisitions, secured financings, joint ventures, and business counseling. Tarik J. Haskins PARTNER Commercial Law Counseling (302) T thaskins@mnat.com Tarik also focuses on organizational and operational issues related to limited liability companies, limited partnerships and statutory trusts. He is involved in the preparation of third-party legal opinions in connection with a range of transactional matters, and he regularly counsels other attorneys domestically and internationally on matters relating to Delaware partnerships, limited liability companies and statutory trusts. Tarik also serves on the Firm s Executive Committee and Diversity Committee. 16

Creditors Cannot Contract Around Their Fiduciary Duties and Withhold Their Consent from a Debtor to File for Bankruptcy

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