Tuesday, April 12, 2016

Pigs Get Fat and Hogs Get Slaughtered: Bankruptcy Remote Structure Declared Invalid For Elimination of Fiduciary Duties

Pigs Get Fat and Hogs Get Slaughtered:  Bankruptcy Remote Structure Declared
Invalid For Elimination of Fiduciary Duties


            In a recent decision from Illinois, a bankruptcy remote structure was declared void on the basis that the fiduciary duties of the person inserted by the creditor were eliminated.  In re: Lake Michigan Beach Pottawattamie Resort LLC, Case No. 15bk42427, 2016 WL 1359697 (N.D. Ill. April 5, 2016).

Lake Michigan Beach Pottawattamie Resort LLC (“LMBPR”) was a debtor to BCL-Bridge Funding, LLC (“BCL”).  In the course of entering into certain forbearance and related agreements, LMBPR amended its operating agreement to provide for a “Special Member” to be appointed by BCL.  The amended operating agreement would go on to provide that (i) the Special Member would owe no fiduciary duties to LMBPR or its constituents and (ii) the no bankruptcy or similar filing could take place without the consent of the Special Member.

LMBPR was unable to perform on its various financing commitments.  BCL filed a complaint against LMBPR, and published a notice of a  non-judicial foreclosure sale.  On the eve of that sale LMBPR filed a voluntary Chapter 11 bankruptcy, it having been approved by all members save and except the Special Member appointed by BCL.  BCL challenged the filing on the basis that (1) it was done for an improper purpose and (2) was in violation of the blocking rights of the Special Member.

The court assessed the purpose of the Chapter 11 petition under the test set forth in In re Tekena USA, LLC, 419 B.R. 341, 346 (Bankr. N.D. Ill. 2009) and determined that BCL had not met its burden of showing it to have been in bad faith.

As for the lack of authority to make the bankruptcy filing, LMBPR (here described as the “Debtor”) asserted:

The Debtor argues, in response, that the provision in the Third Amendment requiring BCL’s consent for the filing of a bankruptcy petition by the Debtor, is void as against public policy because it amounts to a prohibition of the Debtor’s right to exercise its right to bankruptcy relief and, alternatively, is not valid under Michigan law.  2016 WL 1359697, *7.

            The court then provided a review of the bankruptcy remote structure and the role of the independent director, noting that the format is permissible because the independent director has a fiduciary obligation to, on appropriate facts, vote in favor of the bankruptcy that would be against the interests of the creditor appointing that director.  Specifically:

Even though the blocking director structure described above impairs or in operation denies a bankruptcy right, it adheres to that wisdom. It has built into it a saving grace: the blocking director must always adhere to his or her general fiduciary duties to the debtor in fulfilling the role. That means that, at least theoretically, there will be situations where the blocking director will vote in favor of a bankruptcy filing, even if in so doing he or she acts contrary to purpose of the secured creditor for whom he or she serves. 2016 WL 1359697, *10.

In contrast, the court here focused upon the fact that the operating agreement amendment that added the Special Member as well eliminated any fiduciary obligations of that member. Specifically:

The Third Amendment limits BCL duties as the Special Member to those “rights and duties expressly set forth in this Agreement.” Third Amendment, Article 12.2(viii), p. 2. Those rights and duties are then limited by Article 12.4(iv):

Notwithstanding anything provided in the Agreement (or other provision of law or equity) to the contrary, in exercising its rights under this Section, the Special Member 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.

Id. at Article 12.4(iv), p. 2–3 (emphasis added). This language results in BCL as the Special Member having no duties to the Debtor, despite otherwise being a member of the Debtor.  2016 WL 1359697, *11 (footnote omitted).

            From there the court was able to determine that the provision requiring the consent of the Special member appointed by BCL before LMBPR may seek bankruptcy protection is unenforceable.  Hence the case may proceed.

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