In a highly anticipated decision, the U.S. Court of Appeals for the Fifth Circuit affirmed a U.S. bankruptcy court order dismissing a chapter 11 case filed by a corporation (once one of the largest car-rental companies in North America) 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 three-judge panel of the Fifth Circuit ruled that:
- U.S. state law determines who has the authority to file a voluntary bankruptcy petition on behalf of a corporation;
- U.S. federal law does not strip a bona fide equity holder of its preemptive voting rights merely because it is also a creditor; and
- The preferred shareholder-creditor in the case considered was not a controlling shareholder under applicable state law (Delaware 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. Blocking provisions and other means of managing or limiting access to bankruptcy protection, such as ‘bankruptcy remote’ corporate structures involving special purpose entities (SPEs) and pre-bankruptcy waivers of the U.S. Bankruptcy Code’s ‘automatic stay,’ have been increasingly relied upon by creditors, including private equity sponsors and other investors who take both equity and debt positions in a portfolio company, as a means of managing or limiting access to bankruptcy protection. However, such bankruptcy management measures have met with mixed results in the courts. The Fifth Circuit’s decision in Franchise Services does little to remedy the unsettled state of U.S. bankruptcy jurisprudence regarding the enforceability of blocking provisions and golden shares. Moreover, because the case 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: see, e.g., 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).
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.
The ruling in Franchise Services also reinforces the importance of knowing what approach the courts have endorsed in any likely U.S. bankruptcy venue.
The full version of this article is available here.
Mark A. Cody is a Chicago-based partner in the Business Restructuring & Reorganization practice of Jones Day.
Mark G. Douglas is Jones Day’s Restructuring Practice Communications Coordinator.
The views stated in this article are solely those of the authors and should not be attributed to Jones Day or its clients.