Coal Instead of Golden Shares: The Enforceability of Bankruptcy Filing Consent Rights.

• Author: Archambault, Patrick J.

TABLE OF CONTENTS I. INTRODUCTION II. A HISTORY OF INVESTORS AND LENDERS SEEKING TO CONTROL THE DECISION TO PETITION FOR BANKRUPTCY A. Bankruptcy Waivers B. Golden Shares 1. Contrasted with Bankruptcy Waivers 2. Case Law Has Created a Spectrum of Enforceability of Golden Shares a. Lenders b. Minority Equity Holders c. Majority Equity Holders 3. Fiduciary Duties 4. Federal Public Policy C. Enter In re Pace III. QUESTIONING THE CORRECTNESS OF In re Pace A. Is the Bankruptcy-Consent Right Valid Under Delaware Law? B. Were the Macquarie Investors Fiduciaries? C. Did Public Policy Favor Voiding the Macquarie Investors' Golden Shares? D. Implications of In re Pace and Other Structuring Avenues IV. Conclusion "Even so long ago as 1912, the United States Supreme Court was forced to address parties attempting to circumvent the bankruptcy laws by 'circuity of arrangement." Today's resourceful attorneys have continued that tradition." (1)

1. INTRODUCTION

   When countries around the globe entered into lockdown to fight the novel Coronavirus disease ("COVID-19"), the U.S. economy stalled, placing companies in severe economic distress. (2) With business operations ruthlessly disrupted across sectors and revenue streams upended, many companies faced sharp liquidity shortages. (3) Consequently, the number of chapter 11 bankruptcies filed in 2020 increased and are expected to continue increasing in future years because of the economic downturn caused by COVID'19. (4) As U.S. companies endure their worst earnings season since the Great Recession, well-advised investors constantly seek ways to structure their transactions with certain protections, both to minimize the risk of losing control over the decision to file for bankruptcy and to preserve the value of their investment in distressed scenarios. (5) One way to secure such protections is by obtaining a consent right to approve voluntary bankruptcy filings through "golden shares." (6)

   A golden share refers to an equity interest in a company that affords the owner certain consent rights, including the right to block a company from filing for bankruptcy. (7) Typically, investors will seek an amendment to the company's organizational documents to obtain the blocking vote as a condition precedent to their investment. (8) Investors seeking a golden share can vary from the entity's lenders, which hold no economic or governance rights, to traditional private equity investors, which are not creditors but hold only an equity interest in the entity. (9)

   Courts are divided over whether golden shares are enforceable as a matter of federal public policy or under applicable state law. (10) In the most recent case, In re Pace Industries, LLC ("In re Pace"), the Delaware bankruptcy court refused to dismiss on the motion of a preferred equity holder, despite the fact that the movant possessed a bankruptcy-veto right and did not consent to the filing. (11) In so ruling, the court examined the parties' relationship, fiduciary duties, and federal public policy surrounding what the court purported to be debtors" constitutional right to seek bankruptcy relief, noting that "there is no case directly on point, holding that a blocking right by a shareholder who is not a creditor is void as contrary to [such] federal public policy." (12) However, given the facts, the judge in In re Pace was willing to be the first to do so. (13)

   The In re Pace court denied the motion without a written opinion after issuing its ruling from the bench. (14) In her bench decision, the judge held, "The provision in the charter of one of the debtors that bars the filing by that debtor and all its subsidiaries I believe violates public policy and is void as it is exercised by a minority shareholder." (15) The court also found that "a blocking right, such as exercised in the circumstances of this case, would create a fiduciary duty on the part of the shareholder; a fiduciary duty that, with the debtor in the zone of insolvency, is owed not only to other shareholders, but to all creditors." (16)

   The In re Pace decision disrupted a spectrum of developing case law on golden-share enforceability. On one side of the spectrum is a lender that acquires a single unit of equity with the right to exercise ultimate consent over a bankruptcy filing, which right courts typically refuse to enforce. On the other side of the spectrum is a bona fide investor that receives the consent right as an inducement for a capital contribution, which right initially seemed more likely to pass muster but, with In re Pace, is now subject to a split of authority. (17)

   When a lender obtains the consent right, courts consistently have hesitated to validate the golden share. (18) In this context, lenders seek to preserve the value of a borrower's assets in a downside scenario and to maximize their collection efforts by avoiding the automatic stay triggered by a bankruptcy filing. (19) If lenders and borrowers negotiate a deal, particularly if they intend the terms to provide relief to a distressed company (e.g., to reset economic terms, extend a forbearance, or fund additional capital needs), lenders risk agreeing to the deal only to have the borrower toss it away later by seeking bankruptcy protection. (20) To offset this risk, such lenders have negotiated inclusion of golden shares directly into the borrower's organizational documents. (21) This approach was tested in In re Intervention Energy Holdings, LLC, in which the lender waived all of the borrower's existing events of default in exchange for receipt of a consent right for a bankruptcy filing through the issuance of a single common share. (22) Because, however, the lender's equity was merely nominal and its primary relationship to the borrower was as a creditor, the court ruled that the parties may not bypass the borrower's so-called constitutional right to seek bankruptcy relief, thus declaring the golden share unenforceable. (23)

   When, however, an investor obtains the consent right, courts have suggested a more deferential approach to enforcing the golden shareholder's right to consent, particularly when the shareholder is a traditional equity investor. (24) Such investors are concerned that a bankruptcy filing could render their equity worthless as part of an ex parte pre-packaged reorganization plan. (25) The Fifth Circuit's decision in In re Franchise Services of North America provides a prime example of this end of the spectrum. There, a "substantial equity holder" that sought to dismiss the bankruptcy filing had invested $15 million to become the largest single shareholder of the debtor, acquiring with its ownership a bankruptcy-consent right. (26) The bankruptcy court held that a bankruptcy-consent right owned by a bona fide, preferred equity holder was valid, and the case was properly dismissed because the filing was not authorized in accordance with the debtor's organizational documents, no federal public policy invalidated the bankruptcy-consent right, and the investor was not a fiduciary of the debtor. (27) The Fifth Circuit agreed. (28) Thus, notwithstanding nearly identical facts, In re Franchise Services and In re Pace have created a split concerning whether a bona fide investor holds a bankruptcy veto. (29)

   The substantive disagreements among the courts involve whether a creditor or bona fide investor holds the golden share, whether the consent holder owes any fiduciary duties to the debtor, and whether the federal public policy in favor of bankruptcy renders the consent right unenforceable. (30) Even when courts find that consent holders owe fiduciary duties, they are inconsistent in the construction of such duties, including whether minority golden shareholders exercise control sufficient to create a fiduciary duty. (31) Generally, courts recognize a federal policy that promotes access to bankruptcy so that they typically void commercial agreements that restrict a company's ability to file for bankruptcy protection. (32) Some courts, however, disagree on whether bankruptcy-consent rights violate federal public policy, finding limitations to the policy in the context of corporate governance. (33) After the Fifth Circuit's decision in In re Franchise Services, a bona fide equity investor might have felt safe to enforce a consent provision as a golden shareholder. (34) After In re Pace, however, prospective investors should take pause.

   This Article critiques the decision in In re Pace in light of other bankruptcy precedent and commercial practice. Section II provides a brief history of how lenders and investors have sought to limit the risk of bankruptcy by controlling a debtor's decision to file for such relief. Section III analyzes the In re Pace decision, arguing that the court incorrectly interpreted Delaware law because the investors neither were controlling shareholders nor did they have actual control over the debtor. The Article also posits that no federal bankruptcy law prevents an equity holder from exercising voting rights over a bankruptcy filing. (35) Lastly, Section III highlights the implications of In re Pace and discusses structuring options for investors to minimize the risks of bankruptcy beyond including bankruptcy-consent rights in a debtor's governing documents.

2. A HISTORY OF INVESTORS AND LENDERS SEEKING TO CONTROL THE DECISION TO PETITION FOR BANKRUPTCY

   The Constitution authorizes Congress to create a uniform system of bankruptcy law. (36) Some bankruptcy courts interpret the Bankruptcy Clause to imbue business entity debtors with a constitutional right to seek relief through bankruptcy. (37) A plain reading of the Constitution and the Supreme Court's holding in United States v. Kras, (38) however, indicates that no constitutional right exists for a business entity to access the bankruptcy process. (39)

   Bankruptcy's statutory scheme provides debtors with a fresh start through two primary mechanisms: the automatic stay and the discharge of debts...