Fifth Circuit Rules That Corporate Charter Provision Requiring Shareholder Consent for Bankruptcy Filing Is Enforceable but Declines to Rule on Validity of "Golden Shares"

In a highly anticipated decision, the U.S. Court of Appeals for the Fifth Circuit recently affirmed a bankruptcy court order dismissing a chapter 11 case filed by a corporation without obtaining—as required by its corporate charter—the consent of a preferred shareholder that was also controlled by a creditor of the corporation. In Franchise Services of North America, Inc. v. Macquarie Capital (USA), Inc. (In re Franchise Services of North America, Inc.), 891 F.3d 198 (5th Cir. 2018), a Fifth Circuit panel ruled that: (i) state law determines who has the authority to file a voluntary bankruptcy petition on behalf of a corporation; (ii) federal law does not strip a bona fide equity holder of its preemptive voting rights merely because it is also a creditor; and (iii) the preferred shareholder-creditor was not a controlling shareholder under applicable state law such that it had a fiduciary duty to the corporation which would impact any decision to approve or prevent a bankruptcy filing.

However, to the disappointment of many observers, the Fifth Circuit declined to decide whether "blocking provisions" and "golden shares"—either generally or when wielded by a party that is both a creditor and an equity holder—are valid and enforceable. Therefore, the ruling does little to remedy the unsettled state of bankruptcy jurisprudence regarding this important issue.

Bankruptcy Risk Management by Lenders

Astute lenders are always looking for ways to minimize exposure, protect remedies, and maximize recoveries in connection with a loan, especially with respect to borrowers that have the potential to become financially distressed. Some of these efforts have been directed toward minimizing the likelihood of a borrower's bankruptcy filing by making the borrower "bankruptcy remote," such as by implementing a "blocking director" organizational structure. Others have involved attempts to structure a loan transaction to ensure as nearly as possible that, despite a bankruptcy filing by or against the borrower, the lender can exercise its remedies without unreasonable delay—by means of, for example, a pre-bankruptcy waiver of the automatic stay or an agreement not to contest a motion for stay relief—or can look to an alternate source for repayment under a "bad boy" or "springing" guarantee.

Depending on the jurisdiction involved and the particular circumstances, including the terms of the relevant documents, these mechanisms may or may not be enforceable.

Bankruptcy/Automatic Stay Waivers

The enforceability of prepetition waivers of the right to seek bankruptcy protection or specific bankruptcy benefits (such as the automatic stay) has been the subject of substantial litigation. Under case law dating back to at least the 1930s, the general rule as a matter of public policy has been that a waiver of the right to file for bankruptcy is unenforceable. See In re Weitzen, 3 F. Supp. 698 (S.D.N.Y. 1933); accord Continental Ins. Co. v. Thorpe Insulation Co. (In re Thorpe Insulation Co.), 671 F.3d 1011 (9th Cir. 2012); Wank v. Gordon (In re Wank), 505 B.R. 878 (B.A.P. 9th Cir. 2014); Nw. Bank & Trust Co. v. Edwards (In re Edwards), 439 B.R. 870 (Bankr. C.D. Ill. 2010); Double v. Cole (In re Cole), 428 B.R. 747 (Bankr. N.D. Ohio 2009); see also In re Madison, 184 B.R. 686 (Bankr. E.D. Pa. 1995) (the agreement not to file for bankruptcy for a certain time period is not binding). If the law were otherwise, "astute creditors would require their debtors to waive." Bank of China v. Huang (In re Huang), 275 F.3d 1173, 1177 (9th Cir. 2002).

Pre-bankruptcy waivers of the automatic stay, however, are sometimes enforceable. See, e.g., In re A. Hirsch Realty, LLC, 583 B.R. 583 (Bankr. D. Mass. 2018) (a prepetition bankruptcy waiver of the automatic stay contained in the debtor's prior confirmed chapter 11 plan is not per se enforceable; although the prepetition waiver is "cause" for stay relief, the court must conduct a fact-intensive examination to determine whether the waiver should be enforced); In re Bryan Road, LLC, 382 B.R. 844, 849 (Bankr. S.D. Fla. 2008) (setting forth factors for the court to consider in deciding whether to enforce a stay waiver agreement, including: (i) the sophistication of the waiving party; (ii) the consideration for the waiver, including the creditor's risk and the length of time covered by the waiver; (iii) whether other parties are affected; and (iv) the feasibility of the debtor's plan); In re Frye, 320 B.R. 786 (Bankr. D. Vt. 2005) (a prepetition waiver is neither unenforceable nor per se enforceable; a waiver would be enforced unless the debtor could show sufficient equity in the property, a sufficient likelihood of an effective reorganization, or sufficient prejudice to other creditors). But see In re Jeff Benfield Nursery, Inc., 565 B.R. 603 (Bankr. W.D.N.C. 2017) (concluding that such provisions, which effectively render the automatic stay meaningless, are unenforceable as a matter of public policy and noting that, even if they were not, the court would not enforce the waiver under the circumstances, including where there did not appear to be any bargained-for exchange with respect to the waiver language and the debtor did not receive significant consideration in return for its inclusion, as might be the case in a more specific forbearance agreement).

Courts have typically enforced prepetition stay waivers as part of forbearance agreements, as distinguished from original loan documentation, or as agreements that have been approved by courts in previous bankruptcy cases. See Bryan Road, 382 B.R. at 848; In re BGM Pasadena, LLC, 2016 BL 134299, *3 (Bankr. C.D. Cal. Apr. 27, 2016) ("While it is true that courts have generally treated waivers of the automatic stay as unenforceable when they are contained in prepetition agreements between a lender and a borrower (because the interests of third parties, such as unsecured creditors, for whose benefit the automatic stay exists were not considered at the time the agreement was made), the same cannot be said of waivers that are approved after notice and an opportunity for hearing in the context of an earlier bankruptcy case."); In re DB Capital Holdings, LLC, 454 B.R. 804, 816 (Bankr. D. Colo. 2011) (prepetition stay waivers may be enforced if they are part of a confirmed plan or stipulation resolving an earlier motion for relief but otherwise "appear to conflict with the policies and purposes of the Bankruptcy Code, and should not be enforced."); In re Atrium High Point Ltd. P'ship, 189 B.R. 599 (Bankr. M.D.N.C. 1995) (enforcing the waiver in a plan of reorganization confirmed in a previous chapter 11 case).

Bankruptcy Remoteness, Blocking Provisions, and Golden Shares

As a rule, corporate formalities and applicable state law must be satisfied in commencing a bankruptcy case. See In re NNN 123 N. Wacker, LLC, 510 B.R. 854 (Bankr. N.D. Ill. 2014) (citing Price v. Gurney, 324 U.S. 100 (1945); In re Gen-Air Plumbing & Remodeling, Inc., 208 B.R. 426 (Bankr. N.D. Ill. 1997)); In re Comscape Telecommunications, Inc., 423 B.R. 816 (Bankr. S.D. Ohio 2010). As a result, while contractual provisions that prohibit a bankruptcy filing may be unenforceable as a matter of public policy, other measures designed to preclude a debtor from filing for bankruptcy may be available.

Lenders, investors, and other parties seeking to prevent or limit the possibility of a bankruptcy filing have attempted to sidestep the public policy invalidating contractual waivers of a debtor's right to file for bankruptcy protection by eroding or eliminating the debtor's authority to file for bankruptcy under its governing organizational documents. See, e.g., DB Capital Holdings, LLC v. Aspen HH Ventures, LLC (In re DB Capital Holdings, LLC), 2010 WL 4925811 (B.A.P. 10th Cir. Dec. 6, 2010); NNN 123 N. Wacker, 510 B.R. at 862; In re Houston Regional Sports Network, LP, 505 B.R. 468 (Bankr. S.D. Tex. 2014); In re Quad-C Funding LLC, 496 B.R. 135 (Bankr. S.D.N.Y. 2013); Green Bridge Capital S.A. v. Ira Shapiro (In re FKF Madison Park Group Owner, LLC), 2011 BL 24531 (Bankr. D. Del. Jan. 31, 2011); In re Global Ship Sys. LLC, 391 B.R. 193 (Bankr. S.D. Ga. 2007); In re Kingston Square Associates, 214 B.R. 713 (Bankr. S.D.N.Y. 1997).

These types of provisions have not always been enforced, particularly where the organizational documents include an outright prohibition of any bankruptcy filing. See In re Lexington Hospitality Group, 577 B.R. 676 (Bankr. E.D. Ky. 2017) (where an LLC debtor's operating agreement provided for a lender representative to be a 50 percent member of the debtor until the loan was repaid and included various restrictions on the debtor's ability to file for bankruptcy while the loan was outstanding, the bankruptcy filing restrictions acted as an absolute bar to a bankruptcy filing, which is void as against public policy); In re Bay Club Partners-472, LLC, 2014 BL 125871 (Bankr. D. Or. May 6, 2014) (refusing to enforce a restrictive covenant in a debtor LLC's operating agreement prohibiting a bankruptcy filing and stating that the covenant "is no less the maneuver of an 'astute creditor' to preclude [the LLC] from availing itself of the protections of the Bankruptcy Code prepetition, and it is unenforceable as such, as a matter of public policy").

Many of these efforts have been directed toward "bankruptcy remote" special purpose entities ("SPEs"). An SPE is an entity created in connection with a financing or securitization transaction structured to ring-fence the SPE's assets from creditors other than secured creditors or investors (e.g., trust certificate holders) that provide financing or capital to the SPE.

Such an entity is generally designed to be bankruptcy remote in order to minimize exposure to a voluntary bankruptcy filing by limiting the circumstances under which the SPE's board or managing members can put the entity into bankruptcy. A common way of achieving this goal is to appoint an "independent," or "blocking," director to the SPE's governing body.

The organizational documents of an SPE typically will provide that a bankruptcy filing and certain other significant actions must be approved unanimously by the board of directors or other governing body. A director nominated by the lender then has the power to prevent a bankruptcy filing by withholding consent. The documents will further provide that actions requiring unanimity may not be taken if the director's seat is vacant and that the documents may not be amended without the consent of all directors.

Exposure to involuntary bankruptcy can be limited by specifically restricting the secured and unsecured debt that an SPE can incur, thereby limiting the pool of creditors eligible to file an involuntary bankruptcy petition. Finally, SPEs are typically structured to reduce the risk that the corporate structures of an SPE and related entities are disregarded (e.g., through veil piercing or substantive consolidation) by requiring the SPE to observe corporate formalities.

Court rulings have led to significant questions regarding the efficacy of the SPE model as a means of achieving bankruptcy remoteness. For example, in In re Gen. Growth Props., Inc., 409 B.R. 43 (Bankr. S.D.N.Y. 2009), the court denied a motion by secured lenders to dismiss voluntary chapter 11 filings by several SPE subsidiaries of a real estate investment trust. The lenders argued, among other things, that the loan agreements with the SPEs provided that an SPE could not file for bankruptcy without the approval of an independent director nominated by the lenders. The lenders also argued that, because the SPEs had no business need to file for bankruptcy and because the trust exercised its right to replace the independent directors less than 30 days before the bankruptcy filings, the SPE's chapter 11 filings had not been undertaken in good faith.

The court ruled that it was not bad faith to replace the SPEs' independent directors with new independent directors days before the bankruptcy filings because the new directors had expertise in real estate, commercial mortgage-backed securities, and bankruptcy matters. The court determined that, even though the SPEs had strong cash flows, bankruptcy remote structures, and no debt defaults, the chapter 11 filings had not been made in bad faith. The court found that it could consider the interests of the entire group of affiliated debtors as well as each individual debtor in assessing the legitimacy of the chapter 11 filings.

Among the potential flaws in the bankruptcy remote SPE structure brought to light by General Growth was the requirement under applicable Delaware law for independent directors to consider not only the interests of creditors, as mandated in the charter or other organizational documents, but also the interests of shareholders. Thus, an independent director or manager who simply votes to block a bankruptcy filing at the behest of a secured creditor without considering the impact on shareholders could be deemed to have violated his or her fiduciary duties of care and loyalty. See In re Lake Mich. Beach Pottawattamie Resort LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016) (a "blocking" member provision in the membership agreement of a special purpose limited liability company was unenforceable because it did not require the member to comply with its fiduciary obligations under applicable non-bankruptcy law).

Courts disagree as to the enforceability of blocking provisions and, in particular, a "golden share" that, as the term is used in a bankruptcy context, give the holder the right to preempt a bankruptcy filing. See, e.g., In re Lexington Hospitality, 577 B.R. at 684–85 (denying a motion to dismiss a bankruptcy case filed by a wholly owned entity of a creditor that held a golden share/blocking provision where the entity was not truly independent); Squire Court Partners v. CenterLine Credit Enhanced Partners (In re Squire Court Partners), 574 B.R. 701 (E.D. Ark. 2017) (where a partnership agreement required the unanimous consent of the partners before the limited partnership could "file a petition seeking, or consent to, reorganization or relief under any applicable federal or state law relating to bankruptcy," a bankruptcy filing by the managing partner without the consent of the other partners was properly dismissed); In re Tara Retail Group, LLC, 2017 WL 1788428 (Bankr. N.D. W. Va. May 4, 2017) (even though a creditor held a golden share or blocking provision, it ratified the debtor's bankruptcy filing by its silence), appeal dismissed, 2017 WL 2837015 (N.D. W. Va. June 30, 2017); In re Intervention Energy Holdings, LLC, 553 B.R. 258, 265 (Bankr. D. Del. 2016) ("A provision in a limited liability company governance document obtained by contract, the sole purpose and effect of which is to place into the hands of a single, minority equity holder [by means of a 'golden share'] the ultimate authority to eviscerate the right of that entity to seek federal bankruptcy relief, and the nature and substance of whose primary relationship with the debtor is that of creditor—not equity holder—and which owes no duty to anyone but itself in connection with an LLC's decision to seek federal bankruptcy relief, is tantamount to an absolute waiver of that right, and, even if arguably permitted by state law, is void as contrary to federal public policy.").

The Fifth Circuit was asked to weigh in on the validity of a golden share/blocking provision in Franchise Services.

Franchise Services

Franchise Services of North America ("FSNA") was once one of the largest car-rental companies in North America. In 2012, FSNA decided to acquire The Hertz Corporation's subsidiary Simply Wheelz, LLC, better known as "Advantage Rent-A-Car" ("Advantage"). FSNA retained an investment bank to assist in making the acquisition. The transaction involved: (i) the purchase by a subsidiary of the investment bank—Adreca Holdings Corp ("Adreca")—of Advantage, after which Adreca merged into FSNA; and (ii) a $15 million investment in FSNA by another bank subsidiary—Boketo, LLC ("Boketo")—in exchange for 100 percent of FSNA's convertible preferred stock, which would amount to a 49.76 percent equity interest if converted.

In addition, as a condition to the investment, FSNA reincorporated in Delaware. Its new certificate of incorporation provided that FSNA could not "effect any Liquidation Event" (defined to include a bankruptcy filing) without the approval of the holders of a majority of its preferred and common stock.

FSNA also agreed to pay the investment bank a $2.5 million arrangement fee and a $500,000 financial advisory fee for its services. FSNA never paid the latter, which the bank sued to collect in state court.

The Advantage acquisition proved to be improvident, and in June 2017 FSNA filed for chapter 11 protection in the Southern District of Mississippi. However, it did so without requesting or obtaining the consent of a majority of its preferred and common stockholders.

The investment bank and Boketo moved to dismiss the petition as having been filed without proper authorization. FSNA countered that the shareholder consent provision was an invalid restriction on its right to file for bankruptcy and that it violated Delaware law.

Finding that Boketo was an owner, rather than a creditor, of FSNA and ruling that the shareholder consent provision was not contrary to federal bankruptcy policy, the bankruptcy court opted to leave to Delaware state courts the determination as to whether the provision violated Delaware law. It accordingly dismissed FSNA's chapter 11 case.

FSNA appealed, and the bankruptcy court certified a direct appeal of the following three questions to the Fifth Circuit:

(i)         Is a blocking provision/golden share giving a party (whether a creditor or an equity holder) the right to prevent a bankruptcy filing unenforceable as a matter of federal public policy? 

(ii)        If a party benefiting from such a provision is both a creditor and an equity holder, is the provision valid and enforceable as a matter of public federal policy? 

(iii)       Under Delaware law, may a certificate of incorporation contain such a provision, and if so, does Delaware law impose on the beneficiary of the provision a fiduciary duty to exercise it in the best interests of the corporation?


The Fifth Circuit's Ruling

A three-judge panel of the Fifth Circuit affirmed the ruling.

Writing for the panel, circuit judge Carolyn King explained at the outset that, because the court cannot give advisory or hypothetical opinions, the certified questions must be narrowed to eliminate the question regarding the enforceability of blocking provisions and golden shares. Instead, she stated, the court's analysis would be confined to whether "U.S. and Delaware law permit the parties to . . . amend a corporate charter to allow a non-fiduciary shareholder fully controlled by an unsecured creditor to prevent a voluntary bankruptcy petition."

Judge King rejected FSNA's argument that, even if Delaware law authorized the corporate charter provision at issue, federal law forbids such a provision due to the public policy against waiving bankruptcy protections. She emphasized that, even assuming, as the bankruptcy court did, that the investment bank and Boketo should be treated as a single entity, "there is no evidence [as in the cases relied on by FSNA, such as Lexington Hospitality, Intervention Energy, Lake Michigan, and Bay Club Partners] that their arrangement was merely a ruse to ensure that FSNA would pay [the investment bank's] bill." According to the judge, "There is no prohibition in federal bankruptcy law against granting a preferred shareholder the right to prevent a voluntary bankruptcy filing just because the shareholder also happens to be an unsecured creditor . . . ."

Judge King also rejected FSNA's contention that, even if a shareholder-creditor can hold a bankruptcy veto right, such a right "remains void in the absence of a concomitant fiduciary duty." No statute or binding case law, she explained, "licenses this court to ignore corporate foundational documents, deprive a bona fide shareholder of its voting rights, and reallocate corporate authority to file for bankruptcy just because the shareholder also happens to be an unsecured creditor." The judge acknowledged in dicta, however, that a different result might be justified if: (i) a creditor with no stake in the company held the right; or (ii) a creditor took an equity stake simply as a ruse to guarantee a debt.

The Fifth Circuit panel also declined to resolve whether the shareholder consent provision in FSNA's charter violated Delaware law because FSNA expressly waived the argument in its submissions.

Judge King explained that, under Delaware law, a shareholder is generally free to act in its self-interest, unfettered by fiduciary obligations, unless it owns a majority interest in or exercises control over the corporation's business affairs. In this case, she noted, Boketo's preferred stock, if converted to common stock, fell just short of a majority interest in FSNA, and the evidence did not demonstrate that Boketo was a minority controlling shareholder. According to Judge King, the potential for control is insufficient under Delaware law—FSNA was obligated to "prove that Boketo actually dominated FSNA's corporate conduct." Boketo's inability to prevent FSNA's board from authorizing the bankruptcy filing despite Boketo's right to do so, she wrote, "disproves the existence of the type of 'potent voting power and management control' necessary to impose fiduciary obligations on a minority shareholder" (quoting Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304, 307 (Del. 2015)).

Finally, Judge King emphasized that, even if Boketo were a controlling shareholder, the proper remedy for a breach of fiduciary duty "is not to allow a corporation to disregard its charter and declare bankruptcy without shareholder consent," but to seek redress under state law. Accordingly, the Fifth Circuit panel affirmed the bankruptcy court's dismissal of FSNA's chapter 11 case.


The Fifth Circuit's ruling in Franchise Services may be welcome news to some, but it does little to resolve the dispute over the enforceability of blocking provisions, golden shares, and other provisions designed to manage access to bankruptcy protection. Because it involved a minority shareholder-creditor without any fiduciary obligations, the decision did not involve many of the more difficult questions posed by other cases involving these issues. Even so, the Fifth Circuit's conclusion that a shareholder cannot be stripped of its bankruptcy preemption rights merely because it is also a creditor is noteworthy, especially for private equity sponsors and other investors who take both equity and debt positions in a portfolio company.

Franchise Services also reinforces the importance of knowing what approach the courts have endorsed in any likely bankruptcy venue.

Jones Day publications should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at our discretion. To request reprint permission for any of our publications, please use our "Contact Us" form, which can be found on our website at The mailing of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship. The views set forth herein are the personal views of the authors and do not necessarily reflect those of the Firm.