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 holder of “golden share” stock had not approved the petition 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.

On March 16, the debtor filed its initial brief in the Fifth Circuit.  It starts with the proposition that an outright contractual exclusion of a bankruptcy filing, whether in the form of a covenant or a waiver or in some other form, is categorically unenforceable.[i]  This is solid ground on which to begin, having been so held by courts at all levels since early in the twentieth century.  It then extends that principle by arguing that a veto on the commencement of a bankruptcy built into the prospective debtor’s constitutive documents and designed to trigger the rule of Price v. Gurney discussed in our original post should be equally ineffective for the same reasons when the veto power is vested in a creditor.[ii]  The support for this proposition is not as plentiful or venerable, consisting of some of the dozen or so cases that have been decided by lower courts on the point in the last two decades.  The brief refers to these structural mechanisms that seek to effect the outcome denied to contractual exclusions as “work arounds.”

The brief then posits that a creditor should not be able to do indirectly through an equityholding subsidiary what it could not do directly, at least when that equityholder in the prospective debtor disclaims any fiduciary duty to the debtor and claims the right to exercise its veto solely in the best interest of its parent, the creditor.[iii]  The arguments for this position again flow largely from the inequity of a creditor doing through corporate governance and an equityholding subsidiary what it could not do directly with a contractual exclusion.

The brief argues that its desired result should be reached solely on the basis of federal law.  However, in the event the Court of Appeals disagrees, it adds an argument that the law of Delaware, the debtor’s jurisdiction of incorporation, deems an equityholder with a bankruptcy veto to be a fiduciary for the debtor that is prohibited from acting in the interest of its creditor parent to the detriment of the debtor.[iv]

Appellees’ briefs are due on April 16.

[ii]  Id. at 17-19.  Or perhaps that’s the argument when the veto power belongs to a creditor that is not also an equityholder--there’s a bit of confusion about that; in this case the creditor was not also an equityholder and the veto power belonged to a subsidiary of the creditor that was a not-immaterial equityholder.

[iii]  Id. at 20-28.

[iv]  Id. at 29-34.