Special Purpose Vehicles’ Authority to File for Bankruptcy Revisited

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In order to file for bankruptcy in the United States, a company needs to secure the appropriate corporate authorizations as required by its governing documents. What happens when a debtor does not obtain appropriate authorization to file its bankruptcy case? Recently, the Bankruptcy Court for the Northern District of West Virginia held in In re Tara Retail Group, LLC that an improper bankruptcy filing can be ratified when those who are required to authorize the filing remain silent. 

Background

Tara Retail Group, LLC (the “Debtor”) was a Georgia limited liability company that managed and operated a shopping center. In 2016, there was severe flooding and the only access to the shopping center was destroyed. As a result of the flood, the Debtor was unable to generate rents for the benefit of its secured lender (“Comm2013”). 

In order to file for bankruptcy, the Debtor needed to obtain approval of the bankruptcy filing from, among other parties, a special purpose entity who served as a manager of the Debtor (the “SPC Party”). As long as Comm2013’s mortgage lien remained in place on the Debtor’s property, the SPC Party was required to have at least one independent director who participated in any actions requiring the unanimous affirmative vote of the SPC Party’s board, including approving the filing of a bankruptcy petition. 

Prior to filing for bankruptcy, the Debtor’s counsel reached out to the independent director of the SPC Party (“Mr. Hosmer”), to obtain the necessary approval required to file its bankruptcy petition. Mr. Hosmer declined on such short notice. As a result, the Debtor’s counsel drafted a resolution purporting to remove the SPC Party as its manager and replacing it with new managers that would authorize the bankruptcy filing. The resolution also replaced Mr. Hosmer as independent director. Subsequently, the Debtor filed for bankruptcy in January 2017, and Comm2013 filed a motion to dismiss the bankruptcy filing.

In March-April 2017, the bankruptcy court convened multiple hearings to address the motion to dismiss. At one of the hearings, the court found that the Debtor’s effort to remove the SPC Party was void, the SPC Party remained the independent manager of the Debtor, and Mr. Hosmer remained the independent director of the SPC Party. The court, however, did not grant the motion to dismiss, explaining that the SPC Party may have ratified the petition by remaining silent. The court ordered that all directors of the SPC Party may appear and be heard at a subsequent hearing to consider the ratification issue. After such hearing, the Debtor provided Mr. Hosmer with a copy of the court order. Mr. Hosmer knew that his potential ratification was a key issue in the case, but neither Mr. Hosmer, nor anyone on his behalf filed anything with the court, appeared at a hearing, or otherwise attempted to participate in the Debtor’s bankruptcy case. 

The Court’s Analysis

The determination of who has the authority to file a bankruptcy petition is based on state law. Under Georgia law, an unauthorized act may be ratified by failing to properly disavow that act promptly upon its discovery. Thus, ratification by silence may be inferred when, despite obtaining full knowledge of the material facts relating to a transaction, the responsible party fails to promptly disavow the action.

The court found that there were only three facts relevant to Mr. Hosmer’s ratification: (1) the documents required his authorization to file for bankruptcy; (2) the Debtor filed for bankruptcy without such authorization; and (3) post-filing, he remained the independent director of the SPC Party. Mr. Hosmer was aware of each of those facts, and despite such knowledge, he took no action objecting to the filing. Indeed, after receiving notice of his opportunity to appear and that ratification was an issue in the case, he still elected to remain silent. The record in the case reflected that Mr. Hosmer had at least fifteen (15) days to act on the unauthorized filing, which the court found to be a reasonable time period and opportunity within which to make his objections. The court held that the sum of his conduct lead to the finding that the SPC Party ratified the filing of the bankruptcy petition and now had appropriate authorization to pursue its case. Thus, Comm2013’s motion to dismiss was denied.

Other courts have analyzed ratification in the context of bankruptcy filings made without proper authorization. The Fourth Circuit Court of Appeals held that under Virginia law, a filing, though initially deficient, was authorized by later ratification, where the proper authorizing party failed to object to the filing for twenty (20) months. Hager v. Gibson, 108 F.3d 35 (4th Cir. 1997). Moreover, the Hager court applied the relation-back principle to provide that the filing was authorized on the date of the filing. 

An Oregon Bankruptcy Court held that under Ohio law, when a bankruptcy petition is filed without proper authorization, a post-filing consent resolution by the required authorizing parties to ratify the filing satisfied the proper authorization requirement. In re Avalon Hotel Partners, LLC, 302 B.R. 377 (Bankr. D. Or. 2003). 

Implications

Lenders or purchasers transacting with SPVs should be aware that actions that are unauthorized when taken may be later ratified in appropriate circumstances by ensuing conduct of persons with power to have authorized it originally, including by choosing to remain silent after such unauthorized act. 

Read the decision »

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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