Insights

In Brief: Automatic Stay Does Not Bar Call for Shareholder Meeting

Principles of corporate governance that determine how a company functions outside of bankruptcy are transformed and in some cases abrogated once the company files for chapter 11 protection, when the debtor’s board and management act as a “debtor-in-possession” (“DIP”) that bears fiduciary obligations to the chapter 11 estate and all stakeholders involved in the bankruptcy case. Upon a bankruptcy filing, major corporate decisions, such as significant asset sales, are no longer subject to shareholder approval, except to the extent that any proposed restructuring must be approved by “impaired” creditors and shareholders pursuant to the chapter 11 plan-confirmation process. Instead, decisions involving nonordinary-course business transactions must be approved by the bankruptcy court as an exercise of the DIP’s sound business judgment. As illustrated by a ruling recently handed down by the Delaware Chancery Court, however, certain aspects of corporate governance are unaffected by a bankruptcy filing. In Fogel v. U.S. Energy Systems, Inc., the court held that the automatic stay did not preclude it from directing a chapter 11 debtor to hold a meeting of the corporation’s shareholders in the absence of any showing that the call for a meeting amounted to “clear abuse.”

U.S. Energy Systems, Inc. (“U.S. Energy”), an owner and operator of energy-producing facilities and properties in the U.S. and abroad, hired Asher Fogel as its chief executive officer in August 2005. Fogel eventually became chairman of U.S. Energy’s board of directors. The board consisted of Fogel and three other directors.

U.S. Energy encountered significant problems in 2007 with its operations and projects in the U.K. The company’s board resolved to meet on June 29, 2007, for the purpose of interviewing and hiring a financial advisor or restructuring officer. Convinced that Fogel was responsible for the problems, the remaining board members conferred before the meeting and decided to terminate Fogel’s employment. They accordingly confronted him at the June 29 meeting and demanded that he resign by the end of that day, failing which he would be fired. Fogel refused to resign and was informed by one of the remaining directors later that day by telephone that he had been terminated.

On July 1, 2007, Fogel exercised the right given to the CEO/chairman in U.S. Energy’s bylaws to demand that the board call for a special meeting of stockholders for the purpose of voting on the removal of the other directors and electing replacements. The board ignored the demand and formally terminated Fogel’s employment at a board meeting convened later that day. Fogel sued to compel the board to call the special meeting.

On December 13, 2007, the Delaware Chancery Court ruled that the June 29 meeting at which Fogel was given the option to resign or be fired did not qualify as a board meeting under Delaware law and that as a consequence, Fogel was authorized to exercise his right under the bylaws to call for a special shareholder meeting on July 1 because the board did not formally remove him until later that day. The court ordered U.S. Energy and its board to hold such a meeting.

Instead, the remaining directors moved first to modify the court’s order and then to have it re-argued. Concerned that the directors were trying to evade the court’s ruling, Fogel asked the court to order that the shareholder meeting be held on January 7, 2008. U.S. Energy filed for chapter 11 protection before the court could rule on the motion.

The bankruptcy filing, however, did not prevent the Delaware Chancery Court from ruling on Fogel’s request that a date be established for the meeting. Acknowledging that scheduling a shareholder meeting is not the sort of “ministerial act” that would be excepted from the automatic stay, the court concluded that the stay did not bar it from scheduling a meeting under the circumstances:

This Court is the proper forum for resolving the issue. Indeed, I have already resolved the question of whether a meeting should be held and need now only to set a date. Moreover, this Court, the Delaware Supreme Court, and federal bankruptcy courts have held that corporate governance does not cease when a company files a petition under Chapter 11 and that issues of corporate governance are best left to the courts of the state of incorporation.

According to the court, it is only in cases where the challenger to a call for a shareholder meeting can demonstrate that the party calling for the meeting is "guilty of clear abuse" - a determination that turns on "whether rehabilitation (of the debtor) will be seriously threatened, rather than merely delayed" - that bankruptcy law or bankruptcy courts will interfere with the “well-settled rule” that the right to compel a shareholder meeting for the purpose of electing a new board continues during a chapter 11 case. Concluding that the remaining directors had made no showing of clear abuse, the court directed that a shareholder meeting be convened by the end of January 2008.

U.S. Energy Systems is the second notable ruling from the Delaware Chancery Court in recent years on the effect of a bankruptcy filing on traditional corporate governance rules. In a 2006 ruling, Esopus Creek Value LP v. Hauf, the court determined that a board of directors’ decision to structure the corporation’s asset sale as a bankruptcy sale amounted to inequitable conduct because the corporation was financially sound, although delinquent in its Securities and Exchange Commission filings, and its single self-admitted purpose for seeking bankruptcy protection was to effect the asset sale transaction without complying with common-stock voting requirements.

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Fogel v. U.S. Energy Systems, Inc., 2008 WL 151857 (Del. Ch. Jan. 15, 2008).

Esopus Creek Value LP v. Hauf, 913 A.2d 593 (Del. Ch. 2006).
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