A provision in an LLC operating agreement that prevented the company from filing for bankruptcy is deemed to be a “prepetition wavier” of bankruptcy protection, and thus void as a matter of public policy.

In In re Bay Club Partners, 2014 WL 1796688, 59 Bankr.Ct.Dec. 127 (Bankr. D. Or. 2014), the Bankruptcy Court for the District of Oregon held that the debtor, an Oregon limited liability company (“LLC”), had the authority to file for bankruptcy even though the LLC’s Operating Agreement specifically prohibited such a filing at that time. The Bankruptcy Court relied on well-established Ninth Circuit precedent that it is against public policy to allow a debtor to waive its pre-petition right to file for bankruptcy protection.

The debtor, Bay Club Partners-472, LLC (“Bay Club”), was an Oregon limited liability company formed to acquire, renovate, and operate a large apartment complex in Arizona in 2005. Legg Mason Real Estate CDO I, Ltd. (“Legg Mason”) loaned $24 million to Bay Club, which was secured by a deed of trust on the property. Loan terms were modified four times due to financial stress, but negotiations eventually broke down in 2012. Thereafter, Bay Club filed for chapter 11 bankruptcy protection. The chapter 11 petition was signed by the Manager of Bay Club on behalf of the LLC. A consent resolution, agreeing to the filing, was signed by three of Bay Club’s four members, representing 80% of the ownership interests. The fourth member refused to sign the consent resolution and opposed the bankruptcy petition.

Legg Mason, the secured lender, brought suit alleging that the bankruptcy petition should be dismissed because it was improperly filed. It argued that the Manager lacked the authority to file such a petition because the Operating Agreement of Bay Club specifically forbid such an action while the company still owed money on its secured loan.

Oregon law gives broad authority to the Manager of a “manager-managed” LLC to take action on its behalf. The Bay Club Operating Agreement, however, severely restricted the power of the Manager to make business decisions in certain instances. The relevant provision of the Operating Agreement stated that Bay Club “shall not institute proceedings to be adjudicated bankrupt or insolvent … or file a petition seeking … reorganization or relief under any applicable … law relating to bankruptcy” until the indebtedness on the property had been repaid. This provision was inserted into the Operating Agreement at the request of Legg Mason when the loan documents were signed.

The Bankruptcy Court first addressed standing. It noted that courts are currently split on whether creditors have standing to challenge a bankruptcy filing on the grounds that it was unauthorized. Nonetheless, the Ninth Circuit case of Fondiller v. Robertson (In re Fondiller), 707 F.2d 441, 442 (9th Cir. 1983) was persuasive in the instant case. Fondiller stated that standing is appropriate for any person or entity that is “directly and adversely affected pecuniarily”. The court adopted this proposition and held that standing was proper for Legg Mason because it was a secured creditor who clearly had a pecuniary interest in the outcome of the bankruptcy proceeding.

Second, the court addressed the restriction in the Operating Agreement. It again relied on controlling Ninth Circuit precedent, this time for the principal that a debtor’s prepetition waiver of the right to file for bankruptcy is unenforceable because it is a violation of public policy.

The Bankruptcy Court noted that, as part of the financing documents for the loan, the lender requested the “restriction on bankruptcy” provision be inserted into the Operating Agreement, and the members of the LLC agreed. Whether such a restrictive provision appears in the Operating Agreement or in the loan documents related to the financing made no substantive difference to the court. In either case, the court would refuse to enforce such a provision as a matter of public policy. Therefore, the Manager did have authority to file the chapter 11 petition, the debtor’s bankruptcy petition was proper, and the motion to dismiss was denied.