Bankruptcy remote structures have become common in recent years to attempt to prevent a borrower from filing for Chapter 11. One such structure is commonly referred to as a “golden share.” The “golden share” typically refers to a noneconomic membership interest provided to a lender whose vote would be necessary for the borrower to file Chapter 11.
The Fifth Circuit in In re FranchiseServs. of N. Am., Inc., 891 F.3d 198, 209
(5th Cir. 2018), as revised (June 14, 2018), recently considered the enforceability of blocking “golden share” provisions and whether a creditor or shareholder could use such a provision to prevent a company from filing for bankruptcy.
In re Franchise Services
Prior to the petition date, the debtor obtained a $15 million investment from an investor, Boketo, LLC (“Boketo”), to finance an acquisition. Id. at 203. Boketo was a fully-owned subsidiary of Macquarie Capital Inc. (“Macquarie”), which created Boketo to finance the transaction. Id. The debtor agreed to pay Macquarie a $3 million fee for arranging the financing. Id. Boketo was given 100% of preferred stock in the form of a convertible preferred equity instrument. Id. Boketo was the largest single investor in the debtor and its stake in the debtor amounted to a 49.76% equity interest if converted. Id. As a condition of the investment, the debtor reincorporated in Delaware and adopted a new certificate of incorporation that provided, in part, the majority of all equity classes, voting separately, must approve a bankruptcy filing. Id.
The debtor filed a chapter 11 petition without requesting or securing the consent of Boketo and the common shareholders. Id. at 204. Boketo and Macquarie moved to dismiss the bankruptcy case claiming the debtor failed to seek shareholder authorization. Id. In response, the debtor argued that the consent provision was an invalid restriction on its right to file a bankruptcy petition. Id.
Following an evidentiary hearing, the bankruptcy court granted the motion to dismiss finding that, because Boketo was an owner, rather than a creditor, conditioning the debtor’s right to file a voluntary petition on the investor’s consent was not contrary to federal bankruptcy policy. Id.
Thereafter, the bankruptcy court certified three questions for direct appeal to the Fifth Circuit:
(i) Is a provision, typically called a blocking provision or a golden share, which gives a party (whether a creditor or an equity holder) the ability to prevent a corporation from filing bankruptcy valid and enforceable or is the provision contrary to federal public policy?
(ii) If a party is both a creditor and an equity holder of the debtor and holds a blocking provision or a golden share, is the blocking provision or golden share valid and enforceable or is the provision contrary to federal public policy?
(iii) Under Delaware law, may a certificate of incorporation contain a blocking provision/golden share? If the answer to that question is yes, does Delaware law impose on the holder of the provision a fiduciary duty to exercise such provision in the best interests of the corporation? Id.
The Fifth Circuit observed as an initial matter that a “blocking provision” and “golden share” are not synonymous. Id. The term “‘blocking provision’ is a catch-all to refer to various contractual provisions through which a creditor reserves a right to provide debtor from filing for bankruptcy.” Id. A “golden share” is a “share that controls more than half of the corporation voting rights and given the shareholder veto power over changes to the company’s charter.” Id. The facts at issue did not fit into either definition and would narrow the certified questions. Specifically, the bankruptcy court requested the Fifth Circuit opine on the legality of “blocking provisions” and “golden shares”, but to do so would result in an advisory opinion. Id. Instead, the Fifth Circuit confined its analysis to whether federal and Delaware law permit parties to “amend a corporate charter to allow a non-fiduciary shareholder fully controlled by an unsecured creditor to prevent a voluntary bankruptcy petition.” Id. at 206.
On appeal, the debtor argued that federal law precluded enforcement of the corporate charter because it violated a “federal public policy against waiving the protections of the Bankruptcy Code.” Id. at 207. The debtor also asserted that the case involved “a creditor masquerading as a bona fide equity owner.” Id. at 207. The Fifth Circuit, however, found no evidence that the arrangement was merely a ruse to ensure that the investor would pay the affiliate’s bill. Id. at 207. Based on the facts presented, the Fifth Circuit held that “federal bankruptcy law does not prevent a bona fide equity holder from exercising its voting right to prevent the corporation from filing a voluntary bankruptcy petition just because it also holds a debt owed by the corporation and owes no fiduciary duty to the corporation or its fellow shareholders.” Id. at 209.
The Fifth Circuit next addressed, in two parts, whether Delaware law allows the investor to exercise the block right: (i) “whether Delaware law allows parties to provide in the certificate of incorporation that the consent of both classes of shareholders is required to file a voluntary petition” and (ii) “whether Delaware law would impose a fiduciary duty on a minority shareholder with the ability to prevent a voluntary bankruptcy petition.” Id.
As to the first inquiry, the Fifth Circuit noted the debtor had waived such argument on appeal, and, having found no Delaware cases on point, the Fifth Circuit assumed that Delaware law would tolerate a provision in a certification of incorporation conditioning a corporation’s right to file a petition on shareholder consent. Id. at 210-211. As to the second question involving consent, the Fifth Circuit noted that an investor could only owe a fiduciary duty if it qualifies as a controlling minority shareholder. Id. The Fifth Circuit stated the standard for minority control is high and “potential control is not enough.” Id. at 212. Rather, the debtor must prove “Boketo actually dominated the [debtor’s] corporate conduct. Id. 213 (emphasis included). The board’s willingness to act without Boketo’s consent undercut the case for control according to the Fifth Circuit. Id. Accordingly, the Fifth Circuit found that the record before it did not establish that Boketo was a controlling shareholder. The Court also observed a fundamental defect in the debtor’s argument. Id. at 214. Assuming Boketo was a controlling shareholder and breached its fiduciary duty, the proper remedy was not to “deny an otherwise meritorious motion to dismiss the bankruptcy petition.” Id. The debtor must seek “its remedy under state law.” Id.
The Franchise Services decision touches on difficult questions regarding whether a creditor or shareholder can block a bankruptcy filing pursuant to a corporate charter’s “golden share” or other blocking provisions. The decision may be viewed as somewhat favorable to creditor’s ability to block a bankruptcy; however, the Fifth Circuit’s decision is limited to the unique set of facts involved in the case.