In In re CII Parent, Inc.,1 the Bankruptcy Court for the District of Delaware affirmed a secured lender’s prepetition exercise of its proxy rights and its subsequent removal and replacement of the directors/managers of the debtor’s non-bankrupt subsidiaries, effectively cutting off the debtor’s ability to pursue effective relief in the bankruptcy case. While it remains to be seen whether the bankruptcy case will be dismissed or converted to a liquidation under chapter 7, the decision is a reminder of how proxy rights can be a useful lender tool.
CII Parent, Inc. (CII or Debtor) was a holding company that owned 100% of the equity interests in its direct subsidiary, which itself owned all of the equity interests of CII’s non-direct subsidiaries (collectively, the Subsidiaries). In May 2019, prior to CII’s bankruptcy, CII, and its Subsidiaries, as borrowers, entered into a loan agreement with a group of lenders and agent Twin Brook Capital Partner LLC (Agent). The loan was secured by, among other things, a Guarantee and Collateral Agreement, which contained equity pledges of CII’s equity interest in the Subsidiaries, and an Irrevocable Proxy Coupled with an Interest for each Subsidiary. The Guaranty and Collateral Agreement appointed Agent as CII’s attorney-in-fact and proxy, effective immediately, and contained an im"mediate and irrevocable grant of voting rights to Agent. CII had the privilege to exercise the voting rights so long as a default did not exist. The 1-Page Proxy contained similar, albeit not identical, language meant to effect the broad proxy rights contained in the Guaranty and Collateral Agreement.
The borrowers ultimately defaulted under the loan agreement and, on December 21, 2022, Agent sent a proxy notice notifying the borrowers that Agent had, via written consent, amended the bylaws and other corporate governance documents of the Subsidiaries and removed and replaced certain of the Subsidiaries’ directors and officers. Shortly thereafter, CII filed its petition under chapter 11 of the United States Bankruptcy Code. CII then filed a motion to enforce the automatic stay, arguing that (1) the Agent’s exercise of its proxy rights was invalid and (2) the Agent was violating the automatic stay by continuing to exercise control over property of the estate, blocking CII from exercising control over the boards of the Subsidiaries, and attempting to recover a claim on a post-petition basis. Notably, both CII and Agent agreed that CII’s stock in the Subsidiaries was property of the estate. However, Agent argued that the voting interest associated with the stock was not property of the estate because it, not CII, controlled the right to vote the stock at the time the bankruptcy was filed.
After the court concluded that Agent’s exercise of its proxy rights was valid under Delaware law, the court considered CII’s argument that the Agent was violating the automatic stay by continuing to exercise control over CII’s corporate governance rights of the Subsidiaries and refusing to return control to CII. When pressed by the court to provide examples of Agent’s post-petition actions that allegedly violated the automatic stay, CII argued that the Agent was speaking with the Subsidiaries’ boards and refusing to allow CII to change them. CII argued that these acts were attempts by the Agent to collect or recover a debt on a post-petition basis and that Agent was required to take affirmative action to dismantle the board it had appointed and return control of the Subsidiaries to CII. In response, Agent argued that its refusal to rescind its actions could not be a violation of the automatic stay and that the boards of the Subsidiaries were independent and performing their duties as required. Interestingly, the Subsidiaries appeared before the court, seemingly for the purpose of reminding the parties and the court that they were not debtors in the bankruptcy case and asserting that their management was not subject to the automatic stay.
The court was unpersuaded by CII’s arguments. While recognizing that Agent’s prepetition act (i.e., its exercise of the proxy rights) was an attempt to collect or recover on its loan, the court clarified that this was not a post-petition act and thus did not violate the automatic stay. The court also explained that the right to vote stock can be (and, in this case, was) separate from the economic interest in the stock. So, while CII owned the stock and whatever economic benefit was associated with it, CII had given away the right to vote its stock, as well as the right to choose the management of the Subsidiaries, before the bankruptcy petition date. Consequently, the court concluded that the voting rights were not property of the estate and Agent’s actions did not violate the automatic stay.
1 Case No 22-11345-LSS, ECF No. 82 (Bankr. D. Del. April 12, 2023)