By: Frank Pecorelli
St. John’s University School of Law Student
American Bankruptcy Institute Law Review Staff
The United States Court of Appeals for the Fifth Circuit in In re Franchise Services of North America[1] held that a shareholder that is also a creditor of the corporation may exercise its shareholder right to vote against a bankruptcy filing by the corporation.[2] In this instance, the debtor’s certificate of incorporation specifically required the consent of a majority of each class of the corporation’s stockholders before the corporation could file a bankruptcy petition.[3] Here, the sole preferred shareholder, which was also a creditor, did not vote in favor of the bankruptcy filing.[4]
Following the debtor’s bankruptcy filing,[5] the preferred shareholder/creditor filed a motion to dismiss the bankruptcy case.[6] The United States Bankruptcy Court of the Southern District of Mississippi granted the motion because the consent requirement in the debtor’s certificate of incorporation was not met.[7] Thereafter, the bankruptcy court certified an appeal directly to the Fifth Circuit.[8] On appeal, the Fifth Circuit did not find that the corporate structure in place — a parent company, creditor, owning a subsidiary, shareholder — constituted a “blocking provision” or “golden share.”[9] Once it was determined that in this situation no blocking provision existed, the Fifth Circuit turned its focus to whether the law permits corporate charter amendments that allow a non-fiduciary shareholder, fully controlled by an unsecured creditor, to prevent a voluntary bankruptcy petition through voting mechanisms.[10] The Fifth Circuit declined to decide whether the shareholder consent provision in the charter itself violated Delaware law.[11] Ultimately, the court concluded, that federal bankruptcy law does not prevent a shareholder, who is also an unsecured creditor, from exercising its voting rights in order to prevent a corporation from filing a voluntary bankruptcy petition.[12]
It is well established that a person, including a corporation, may voluntarily file a bankruptcy petition.[13] However, a corporation may not file a petition for bankruptcy without the requisite authority.[14] As articulated by the court in the Matter of Quarter Moon Livestock Co. Inc., “the authority to file a bankruptcy petition must be found in the instruments of the corporation and applicable state law.”[15] In Quarter Moon, the court ruled against the shareholders’ complainants, finding nothing in the company bylaws to suggest that lack of a quorum at a stockholder meeting could prevent the filing of a bankruptcy provision.[16] Despite a corporation’s freedom to place the requisite authority governing their ability to file bankruptcy in their instruments of incorporation, it is generally accepted that a corporation may not waive their rights to the benefits of bankruptcy in a pre-petition waiver.[17] The court in Bank of China v. Huang articulated this principle stating that “it is against public policy for a debtor to waive the prepetition protection of the Bankruptcy Code."[18] There, the Court of Appeals for the Ninth Circuit explained, “this prohibition of preemption waiver has to be the law; otherwise, astute creditors would routinely require their debtors to waive.”[19] Here, the debtor’s certificate of incorporation required the consent of the majority of each class of the debtor’s shareholders as a prerequisite to filing a bankruptcy petition.[20] Traditionally when assessing a conflict created by restrictive filing provisions, courts have been hesitant to apply the law in a manner that would take away corporations’ ability to enter into Bankruptcy.[21]
In re Franchise Services of North America reinforces the principle that a shareholder of a debtor may exercise its rights notwithstanding that it also a creditor of the debtor. The court implies that this principle could be rebutted if the creditor were merely a “wolf in sheep’s clothing,” masquerading as a bonafide equity holder. Yet, absent a showing that the arrangement was merely a ruse to ensure future payment, such a rebuttal is unlikely to be successful.
[1] Franchise Services of North America, Inc. v. United States Trustee (In re Franchise Services of North America), 891 F.3d 198 (5th Cir. 2018).
[2] See id. at 202–203.
[3] See id.
[4] See id. at 207 (“[subsidiary] is fully controlled by [parent company] meaning the veto right in fact belongs to [parent company] — an unsecured creditor by virtue of its unpaid fees.”); see also id. at 203–204.
[5] See id. at 204.
[6] See id.
[7] See id. at 205
[8] See id.
[9] See id. at 206 A “blocking provision” or “golden share” is a provision which gives a creditor or equity holder the ability to prevent a corporation from filing bankruptcy.
[10] See id.
[11] See id. at 211.
[12] See id. at 209.
[13] 11 U.S.C. § 301 (2012).
[14] See Price v. Gurney, 324 U.S. 100, 106 (1945); see also In re N2N Commerce, Inc., 405 B.R. 34, 41 (Bankr. D.Mass. 2009) (“It is well-settled that a bankruptcy filing is a specific act requiring specific authorization.”).
[15] In re Quarter Moon, 116 B.R. 775, 778 (Bankr. D. Idaho 1990).
[16] Id.
[17] See Wank v. Gordon, 505 B.R. 878, 887 (9th Cir. BAP 2014).
[18] See Bank of China v. Huang, 275 F.3d 1173, 1177 (9th Cir. 2002).
[19] See id.
[20] See Franchise Services, 891 F.3d at 202-203.
[21] See Bank of China, 275 F.3d at 1177.