Bankruptcy Remoteness Going to a Court of Appeals

by Patterson Belknap Webb & Tyler LLP

Back in the day--say, the last two decades of the twentieth century--we bankruptcy lawyers took it largely on faith that the right structural and contractual provisions purporting to confer bankruptcy-remoteness[1] were enforceable and likely to be successful in preventing an entity from becoming, voluntarily or involuntarily, a debtor under the Bankruptcy Code.  During the latter part of the first decade of the twenty-first century, however, that faith began to erode as bankruptcy court case law began to accumulate which denied motions to dismiss petitions based upon remoteness provisions.  The cases were based on a variety of theories, some the application of doctrines of law of the jurisdiction of formation (usually fiduciary duty) and others that inched toward not giving full effect to the rule of Price v. Gurney.  To this blogger’s knowledge, none of those cases, nor any of the cases accumulating at the same time that refused to depart from a straightforward application of state law and strict adherence to Price v. Gurney, was ever dispositively dealt with on the merits by a federal Court of Appeals.

That may be about to change.

In In re Franchise Services of North America, Inc.,[2] Bankruptcy Judge Edward Ellington granted a motion to dismiss a Chapter 11 petition that had not been approved by a preferred stockholder of the debtor whose approval was required by the debtor’s certificate of incorporation.  Judge Ellington surveyed the accumulated bankruptcy case law as well as Delaware corporate law and summarized his understanding of the law that a petition-blocking shareholding position or other blocking right could be validly exercised by a holder of the debtor’s equity that was not also a creditor of the debtor, even if the holder was controlled by a creditor of the debtor.[3]  Since one of the movants to dismiss the petition was the preferred stockholder with blocking rights (and it had not approved the petition and was not itself a creditor, although its parent corporation was), Price v. Gurney required dismissal.

Then, on January 17, Judge Ellington granted the debtor’s request under 28 U.S.C. § 158(d)(2)(A) to certify the judgment of dismissal for direct appeal to the Court of Appeals for the Fifth Circuit,[4] and, on February 8, the Court of Appeals granted the debtor’s motions for permission for a direct appeal and to expedite the appeal.[5]

We will follow the case in the Fifth Circuit and report on it as it evolves.

[1]  Bankruptcy-remoteness is a condition of an entity that materially reduces, or perhaps even completely eliminates, the possibility that the entity--a corporation, a limited liability company or a partnership--could be liquidated or reorganized under Chapter 7 or Chapter 11 of the Bankruptcy Code.  That condition was created by one or more provisions of a constitutive document (the entity’s certificate of incorporation, LLC agreement or partnership agreement) and/or one or more provisions of a contract to which the entity was a party (e.g., a loan agreement).  A common provision was to require a determination to file a petition to be approved by a person (e.g., a special director) who could be counted upon never to approve it.  Such entities were often referred to as bankruptcy-remote vehicles (and therefore “BRVs”) and, since they were often specially created for the purpose of being bankruptcy-remote, special-purpose entities or vehicles (and therefore “SPEs” or “SPVs”).  The constitutive and contractual provisions were crafted in light of, and the faith that they would work was based upon, (a) the widely-held assumption that an outright prohibition on being or becoming a debtor would not be enforceable and (b) the Supreme Court’s holding in Price v. Gurney, 324 U.S. 100 (1945), that the issue whether the filing of a voluntary petition was duly authorized is to be determined under the law of the entity’s jurisdiction of formation, usually state law (and, if not duly authorized, it had to be dismissed).  This blogger’s first substantial engagement with Price v. Gurney was in In re Omega Trust, 110 Bankr. 665 (Bankr. S.D.N.Y. 1990).

[2]  Case No. 1702316EE (Bankr. S.D. Miss. Dec. 18, 2017).

[3]  Slip op. at 10-25.

[4]  In re Franchise Services of North America, Inc., 2018 Bankr. LEXIS 105 (Bankr. S.D. Miss. Jan. 17, 2018).

[5]  Franchise Services of North America, Inc. v. U.S. Trustee et al., No. 18-90006 (Order entered on the docket Feb. 8, 2018).

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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