In the recent case of In re Franchise Servs. of N. Am., Inc. 891 F.3d 198 (5th Cir. 2018), as revised (June 14, 2018), the U.S. Court of Appeals for the Fifth Circuit upheld decisions of the lower courts that dismissed a Chapter 11 bankruptcy case because it was not authorized by a preferred shareholder. Under the facts, a Delaware corporation’s charter required the consent of a shareholder holding 100% of the preferred shares (49.5% of common shares if converted) to a bankruptcy filing. The shareholder received this blocking right in exchange for a $15 million investment. An affiliate of the shareholder held a $3 million claim against the company for unpaid fees. The company filed a Chapter 11 case without the shareholder’s consent. The shareholder moved to dismiss the case. In defense, the company relied upon recent bankruptcy court decisions in Delaware and other courts (reported by the September 2016 Edition of Relating to Real Estate) which held that the issuance of a “golden share” to a creditor, combined with an amendment to an operating agreement requiring the creditor’s consent to a bankruptcy filing, violated federal public policy and was unenforceable.
The Fifth Circuit held that under federal and Delaware law a stockholder cannot be deprived of its voting rights simply because the stockholder is also a creditor. It considered the “golden share” decisions and ruled that they were inapplicable. The court noted that unlike the case before it, which involved a stockholder that made a material investment in the company, the “golden share” decisions involved creditors that were issued an immaterial amount of equity under a loan workout for the purpose of giving the creditor the right to block a bankruptcy filing. Although the question of whether the “golden share” decisions were correctly decided was raised by the appeal, the court refused to address it, stating that it would not issue an advisory opinion.
The issue of whether a creditor that is given the right to block a bankruptcy filing through the issuance of a “golden share” violates public policy has not been decided by any appellate court to date. The Fifth Circuit’s decision holds that no policy is violated when a legitimate shareholder, which is also a creditor, is granted the right to block a bankruptcy filing.
For questions, contact Larry Coppel (410) 576-4238.