Delaware Bankruptcy Court Denies Motion to Dismiss Debtor’s Bankruptcy Case Despite Terms Under its Limited Liability Company Agreement Requiring Authorization of its Members – In re Intervention Energy Holdings, LLC, No. 16-11247 (KJC) (Bankr. D. Del. June 3, 2016).
On May 20, 2016, Intervention Energy Holdings, LLC (“IE Holdings”) and its operating subsidiary filed voluntary petitions for bankruptcy relief without the consent of all of IE Holdings’ common members. EIG Energy Fund XV-A, L.P. (“EIG”), IE Holdings’ principal creditor and one of its common members, filed a motion to dismiss the case because IE Holdings’ limited liability company agreement (the “LLCA”) required IE Holdings to seek EIG’s consent prior to filing for bankruptcy protection, and IE Holdings had neither sought nor obtained EIG’s consent. On June 3, 2016, Judge Kevin J. Carey of the Bankruptcy Court for the District of Delaware held that the LLCA’s requirement to seek consent of the common members could not bar IE Holdings from filing a petition for bankruptcy relief.
EIG held senior secured notes issued by IE Holdings under a note purchase agreement (the “NPA”), of which $140 million remained outstanding as of the filing of IE Holdings’ bankruptcy petition. IE Holdings had struggled to comply with financial maintenance covenants in the NPA, and in December 2015, the parties negotiated a forbearance arrangement under which EIG would waive all defaults if IE Holdings raised $30 million in equity capital by June 1, 2016 to pay down a portion of the notes. In consideration for EIG’s forbearance, the LLCA was amended to admit EIG as a member with a single common unit (commonly called a “golden share”) and to require in IE Holdings to obtain the approval of each holder of common units prior to filing for bankruptcy protection.
In its motion to dismiss, EIG asserted that the parties had expressly negotiated for EIG’s admittance as a member with consent rights over any voluntary bankruptcy filing in exchange for a nine-month forbearance, at the conclusion of which IE Holdings breached its agreements and filed for bankruptcy without seeking EIG’s consent. EIG further alleged that the filing served no legitimate reorganization objective because an out-of-court process had already been under discussion for months prior to the filing, which contemplated that general unsecured creditors of the operating business would be unimpaired and IE Holdings would be deleveraged. In fact, the petition listed EIG as IE Holdings’ only creditor, and EIG argued that IE Holdings therefore could not hope to obtain the approval of an impaired class of creditors to confirm a plan of reorganization unless it satisfied EIG.
EIG stressed that Delaware law provides limited liability companies with “the broadest possible discretion” to enter freely into agreements to deal with issues relating to corporate governance. EIG explained that, in exchange for express language in the LLCA limiting the fiduciary duties of IE Holdings’ managers to the fullest extent permitted by law, EIG had negotiated for consent rights over any voluntary bankruptcy filing by IE Holdings. EIG noted that at the time the provisions at issue were negotiated, IE Holdings was already insolvent. Under Delaware law, directors of an insolvent company owe fiduciary duties not only to the company’s shareholders, but also the company’s creditors who are the economic owners of the company’s assets and the residual beneficiaries of any increases in the value of those assets. In that circumstance, EIG argued that IE Holdings was free to contract away its rights to file for bankruptcy, because in the absence of fiduciary duties, IE Holdings was not required to preserve enterprise value for its creditors by filing for bankruptcy protection. In fact, EIG argued that its bankruptcy consent rights were consistent with the Supreme Court of Delaware’s prior cases, which contemplated that dissatisfied creditors of limited liability companies could negotiate terms giving them more control in an insolvency situation. Noting that the common members’ control over bankruptcy filing under the LLCA was the result of customary arms’-length negotiation, EIG claimed that IE Holdings’ decision to ignore its contract rights “threaten[ed] an entire industry premised on the ability to contract for protections that limit credit risk, thereby increasing the cost of capital for borrowers.”
In his decision, Judge Carey acknowledged that the parties had raised interesting arguments regarding freedom to contract under Delaware law, but was reluctant to “accept the parties’ invitation to decide what may well be questions of first impression of state law.” With little discussion, Judge Carey instead held that the provisions of the LLCA requiring member consent to a bankruptcy filing were void as contrary to federal public policy. Judge Carey reasoned that these provisions acted as a waiver of the company’s ability to file for bankruptcy, and likened the waiver to those that courts have routinely struck down for public policy reasons. Judge Carey further noted that his decision protected “access to the right of a person, including a business entity, to seek federal bankruptcy relief.” As a result, creditors may no longer rely on “golden shares” as a tool to prevent borrowers to seek bankruptcy protection.