Bankruptcy Remoteness Going to a Court of Appeals (Progress Report No. 2)

by Patterson Belknap Webb & Tyler LLP
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Our February 22 post reported that the Franchise Services of North America, Inc. decision of Bankruptcy Judge Edward Ellington of the Southern District of Mississippi dismissing a Chapter 11 petition because a shareholder had not approved the filing as required by the debtor’s charter was going directly to the U.S. Court of Appeals for the Fifth Circuit on an expedited basis.  It is the first case concerning the merits of contractual or structural bankruptcy-remoteness in my memory to reach a Court of Appeals since the adoption of the Bankruptcy Code in 1978.  We promised to report on developments as they occur and reported on the filing of the debtor-appellant’s brief on March 19.

Last evening (April 16) a single brief was filed for all of the appellees other the Office of the United States Trustee (which is not expected to file one).  The appellees begin by agreeing with the debtor-appellant that contractual or structural arrangements requiring the consent of a creditor (or a representative of a creditor) for the commencement of a case under the Bankruptcy Code violate federal bankruptcy policy and are unenforceable.[1]  They also agree that a creditor does not immunize its consent right from unenforceability by disguising it as an equity interest held by the creditor or its affiliate. 

However, they argue, it does not violate federal bankruptcy policy for the consent of a bona fide shareholder to be required for the commencement of a voluntary case even if the shareholder is also a creditor, either directly or indirectly through an affiliate.  (The debtor-appellant’s initial brief seems to argue that the consent of a shareholder may lawfully be required only as long as it is not also, directly or through an affiliate, a creditor, regardless of the materiality or bona fides of that shareholder’s equity investment in the debtor.)  Appellees analyze the reported cases to show that the cases that have permitted a case to be commenced notwithstanding an unsatisfied consent requirement have involved either an overt or a disguised creditor’s consent, not what they characterize as an “owner consent.”[2]

The brief then goes on to rebut debtor-appellant’s contentions that in all events the decision whether an entity should commence a voluntary case must be made by persons having a fiduciary duty to make the decision in the best interest of the entity[3] and that the provisions of the debtor’s charter requiring shareholder consent for a petition are also unenforceable under Delaware corporate law.[4]

Appellant’s reply brief is due on April 23.


[1]  Appellees’ Brief at 14.

[2]  E.g. id. at 16 (“owner-consent provisions are valid but creditor-consent provisions are not”).

[3]  Id. at 27-34.

[4]  Id. at 34-49.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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