Another Hog Gets Slaughtered: Delaware Bankruptcy Court Invalidates Lender's Efforts to Preclude Debtor's Bankruptcy

Another Hog Gets Slaughtered: Delaware Bankruptcy Court Invalidates Lender's Efforts to Preclude Debtor's Bankruptcy

      In a decision rendered on June 3, 2016, the United States Bankruptcy Court for Delaware invalidated certain requirements requested by a lender that had the effect of rendering its debtor incapable of filing bankruptcy. In re: Intervention Energy Holdings, LLC, Case No. 16-11247 (KJC) (Bankr. De. June 3, 2016).

      Intervention Energy Holdings, LLC and its wholly-owned subsidiary, Intervention Energy, LLC were jointly indebted to EIG Energy Fund X V-A, L.P. EIG had purchased senior secured notes issued by Intervention; those notes were secured by various liens. Over time, various amendments have been made to the relevant note purchase agreements, including with respect to certain coverage covenants. Certain of those coverage covenants were ultimately violated. Those violations led to Intervention and EIG entering into a Forbearance Agreement and Contingent Waiver (the “Forbearance Agreement”) pursuant to which, assuming EIG would raise $30 million of equity capital to pay down the secured notes, the coverage violations would be waived. However, as a condition to the effectiveness of that Forbearance Agreement, EIG required Intervention to amend its operating agreements to provide:

·         that a single unit would be issued to EIG, making it a member in Intervention; and

·         requiring the unanimous approval of the members before any filing for bankruptcy could take place.

      Ultimately Intervention would file for bankruptcy protection notwithstanding that it did not have the consent of EIG to it doing so. That led to a motion to dismiss, brought by a EIG against Intervention, on the basis that Intervention lacked the authority to file for bankruptcy protection. In its decision, the Bankruptcy Court would reject that motion to dismiss. As such, the bankruptcy will proceed.

      EIG, in support of its motion to dismiss, argued that, under the LLC Act, there is essentially full freedom of contract, including to set the requisite threshold for filing a petition in bankruptcy. intervention relied upon the fact that a waiver of the capacity to file for bankruptcy is invalid and as well the recent decision rendered in In re Lake Michigan Beach Pottawatamie Resorts LLC in which a bankruptcy remote structure relying upon a “independent director” who lacked fiduciary duties was held to be unenforceable.

      Obviously the arguments of Intervention would prevail.  After string citing numerous decisions rejecting the notion that the right to file bankruptcy can be waived by contract, including a decision from the United States Supreme Court, it was observed:

A provision in a limited liability company governance documents 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.  Slip op. at 9 (citations omitted).

      From there, in light of the factual background of the mechanism by which EIG acquired its single interest in Intervention and the amendment of the LLC agreement requiring unanimity in order to file bankruptcy, it found those to be “the unequivocal intention of EIG to reserve for itself the decision of whether the LLC should seek federal bankruptcy relief.” Following the other federal bankruptcy courts, it was the determination of the Intervention court that it would not enforce a waiver of the right to seek bankruptcy protection and, from there, it concluded that Intervention had the necessary authority to commence its Chapter 11 proceeding.

      Decisions such as this as well as the In re Lake Michigan Resort decision (HERE IS A LINK to my review of that decision) identify outlier structures that will not be enforced with respect to bankruptcy remoteness. They do not stand for the proposition that bankruptcy remoteness is itself either improper or unattainable. The proper structuring of these relationships can be achieved, but that structuring should begin at the beginning of the debtor/creditor relationship.