Yes, says the Delaware Bankruptcy Court in the case of CII Parent, Inc., cementing the advice routinely given by bankruptcy counsel to borrowers in default. We always counsel borrower clients in default of the risk associated with lenders taking unilateral actions pre-filing, stripping debtors of valuable options and assets. Thus, we normally recommend to always obtain a forbearance and undertake the preparations required to file a bankruptcy petition immediately upon forbearance termination, although whether or not to file depends on variety of factors that should be considered. CII Parent vindicates this advice. 

Background

CII Parent is a Delaware corporation and wholly owns Community Investors Inc., which directly or indirectly owns several subsidiaries. Only CII Parent filed for bankruptcy. Prepetition CII Parent, Community Investors and their subsidiaries entered into a loan agreement with certain lenders and Twin Brook Capital Partners LLC as agent. The loan was secured by CII Parent’s equity in Community Investors and Community Investors’ equity in its subsidiaries. The borrowers also entered in an Irrevocable Proxy coupled with an Interest (Proxy). 

Upon the occurrence of certain defaults under the loan agreement, the parties entered into a forbearance agreement. While not specifically mentioned, it appears that the forbearance agreement expired (or the borrowers defaulted thereunder), and Twin Brook exercised its rights under the related collateral agreement and the proxy to (i) amend the corporate governance documents of Community Investors and the subsidiaries to remove certain directors/managers, (ii) change the size of the boards and (iii) appoint replacement directors/managers. 

A week later, CII Parent filed a chapter 11 petition with the express goal of re-obtaining control over its subsidiaries.  Thus, CII Parent brought a motion to enforce the automatic stay against Twin Brook, arguing that Twin Brook’s continuing, post-petition exercise of control over its corporate governance rights over Community Investors and the subsidiaries, violates the stay and sought rescission of the various changes made by Twin Brook. 

Decision 

In its motion to enforce, CII Parent argued that Twin Brook is violating sections 362(a)(3), (4) and (6) of the automatic stay because it is exercising control over property of the estate, specifically, CII Parent’s rights to control its subsidiaries, or stated differently, the voting rights that are coupled with its ownership of the equity in its subsidiaries. The Delaware bankruptcy court disagreed.

The court found that the underlying documents were clear in giving Twin Brook the right to take the actions it took and that these actions are not in violation of Delaware law. The court also found that Delaware law recognizes several different interests in stock that may be transferred: voting rights, economic ownership, and full ownership (encompassing both voting rights and economic ownership). Here, CII Parent retained its ownership of Community Investors’ stock, but not its associated voting rights. 

Next, CII Parent failed to identify a single act allegedly taken by Twin Brook post-petition. Since the proxy rights were properly exercised pre-petition, the property at issue was no longer property of CII Parent when it filed its chapter 11 petition resulting in no post-petition actions that could violate the automatic stay. 

While not mentioned in the opinion, it appears consistent with the Supreme Court’s decision in City of Chicago v. Fulton, 141 S.Ct. 585 (2021), that the mere retention of property seized pre-petition is not a stay violation. Of course, in Fulton, the property remained property of the estate after its seizure, so the issue was whether the City’s refusal to return it and passive retention of it violated the stay; In CII Parent the property, according to the court, was no longer property of the estate.  Yet an analogy to Fulton seems proper: Creditors’ refusal to alter the pre-petition status-quo is not a stay violation. 

Conclusion

Circling back to the question posed at the outset, the lender that exercised its rights under the proxy pre-petition is good; the borrower, not so much. Timing is everything. Had CII Parent, Community Investors and the subsidiaries, filed for bankruptcy prior to Twin Brook’s exercise of its collateral and proxy rights, CII Parent would not have been in the predicament it found itself in. Twin Brook’s exercise of its rights would have been stayed by the automatic stay and invalidated if it did so nonetheless. Instead, it finds itself as a largely shell company with its business outside bankruptcy and controlled by its lenders. This case is a lesson for borrowers in default situations to remain vigilant ensuring that there is no gap in which lenders can exercise rights unimpeded. 

The CII Parent opinion is available here.