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Corporate Governance: Bankruptcy Petition Filing Authorization

Articles & Publications

September 13, 2018
Brenna A. Dolphin
American Bankruptcy Institute: Young and New Members Committee


Corporate Governance: Bankruptcy Petition Filing Authorization

Corporate governance battles spill into bankruptcy courts and at times serve as the genesis for bankruptcy petition filings. For example, recently the Fifth Circuit in In re Franchise Services of North America Inc. addressed a motion to dismiss a bankruptcy petition on the basis that under the state law governing the would-be corporate debtor, the petition filing was unauthorized and invalid.[1] This article discusses the Bankruptcy Code, federalism, corporate law and public policy. These routinely surface during disputes over whether a corporate debtor’s bankruptcy petition constitutes a valid authorized corporate action that should be allowed to proceed or, in the alternative, whether the bankruptcy petition is unauthorized and invalid and should be dismissed.

Who May Be a Debtor?

Bankruptcy cases begin when either an eligible debtor files a voluntary petition or creditors file an involuntary petition against the debtor.[2] A voluntary case begins when an “entity that may be a debtor” files a bankruptcy petition.[3] Corporations are entities that may be debtors and may file voluntary petitions for relief under chapters 7 or 11 of the Bankruptcy Code.[4]Although a corporation may be an eligible debtor under the Bankruptcy Code, the corporation cannot act on its own and can act only if authorized by appropriate agents.[5] The Bankruptcy Code does not provide instruction on who may authorize a corporate entity’s petition filing; it merely tell us that only an entity that may be a debtor may initiate a voluntary bankruptcy case.[6]

Federalism: State Law Determines Whether a Bankruptcy Petition Is Authorized

In the absence of federal incorporation, state law determines who has the authority to file a voluntary petition on behalf of a corporation.[7] A bankruptcy court must dismiss a corporate entity’s petition if the corporation acted without proper authorization under state law.[8] The Supreme Court underscores that “[i]t is not enough that those who seek to speak for the corporation may have the right to obtain that authority,” but rather, those seeking to act for the corporation in filing a bankruptcy petition must have the actual authority at the time of filing.[9] In the absence of a duly filed petition, the bankruptcy court must dismiss the petition because it lacks power “to shift the management of a corporation from one group to another, to settle intracorporate disputes, and to adjust intracorporate claims.”[10] To determine whether a bankruptcy petition is a valid corporate action, a bankruptcy court will examine the state law that governs the corporate entity.

Corporate Law: Basic Overview

Frequently, bankruptcy courts resort to an examination of the Delaware General Corporation Law (DGCL) when determining whether a challenged petition is a valid and authorized corporate action. The DGCL “is widely regarded as the most flexible in the nation” and allows stakeholders — even creditors on occasion — a great deal of autonomy when deciding on provisions to include in articles of incorporation.[11] When deciding whether a would-be debtor possesses the requisite corporate authority to file a bankruptcy petition, the terms “golden share” and “blocking provision” enter the equation.

A golden share is a share that controls more than half of a corporation’s voting rights and gives the shareholder veto power over changes to the corporate charter.[12] Generally, in the bankruptcy context, a golden share describes an entity’s issuance of a finite number of shares to a creditor, along with the right to prevent a voluntary bankruptcy petition filing.[13] A blocking provision, a contractual provision, grants a creditor or equityholder the ability to prevent a corporation from filing a bankruptcy petition. For example, a creditor may become the sole shareholder of a preferred class of stock, and the articles of incorporation may require the consent of a majority of the shareholders in each class of stock to authorize a bankruptcy petition filing.[14]

In reviewing corporate governance concepts, questions surrounding fiduciary duties arise that compel bankruptcy courts to consider whether they are owed. Generally, a shareholder is “free to act in its self-interest, unencumbered by any fiduciary obligation.”[15] There are two exceptions: majority shareholders and minority controlling shareholders.[16] A would-be debtor may argue that a shareholder must comply with its fiduciary duties when voting on a bankruptcy petition filing and may not withhold its consent to filing without breaching its fiduciary duties.

Public Policy Pointers

Generally, federal public policy forbids waiving the protections of the Bankruptcy Code.[17] Bankruptcy courts often decline to enforce contractual provisions that purport to require an entity to refrain from seeking the protections afforded under the Bankruptcy Code as being against federal public policy.[18] For example, it is “axiomatic that a debtor may not contract away the right to a discharge in bankruptcy.”[19]

Conclusion

In an argument over whether a debtor’s petition filing constitutes a valid authorized corporate action, begin with the Bankruptcy Code, then review and analyze the state law that governs the corporate debtor’s ability to act through its agents. When advocating for dismissal, focus on the disenfranchisement of the shareholders, the lack of proper authorization under the articles of incorporation, the flexibility of corporate governance, and the sophistication of the parties. If arguing for the bankruptcy petition filing’s survival, highlight that the provision the opponent relies upon comprises an impermissible restraint on or waiver of federal bankruptcy rights and that the opponent owes and must comply with its fiduciary duties. Remember also to articulate the public policy considerations that support your position on whether the petition is valid and authorized.



[1] 891 F.3d 198, 209 (5th Cir. 2018) (granting motion to dismiss and holding that federal bankruptcy law does not prevent bona fide shareholder from exercising its voting rights against a bankruptcy petition filing just because it is also an unsecured creditor when it owes no fiduciary duty to the corporation or any fellow shareholder).

[2] In re Franchise Servs. of N. Am. Inc., 891 F.3d at 206.

[3] 11 U.S.C. § 303(a).

[4] 11 U.S.C. § 109(a)-(b), (d).

[5] In re Franchise Servs. of N. Am., Inc., 891 F.3d at 206 (referencing W.G. Yates & Sons Const. Co. Inc. v. Occupational Safety & Health Review Comm’n, 459 F.3d 604, 607 (5th Cir. 2006)).

[6] 11 U.S.C. § 301(a).

[7] Price v. Gurney, 324 U.S. 100, 106-07 (1945).

[8] Id. at 206-07 (citing Price, 324 U.S. at 106).

[9] Price, 324 U.S. at 106-07.

[10] Id.

[11] Jones Apparel Grp. Inc. v. Maxwell Shoe Co., 883 A.2d 837, 845 (Del. Ch. 2004). Note that when faced with a provision that allows creditors of a would-be corporate debtor to weigh in on a bankruptcy petition filing, some courts allow bankruptcy cases to proceed notwithstanding that creditors withheld their consent. See In re Franchise Servs. of N. Am. Inc., 891 F.3d at 202.

[12] In re Franchise Servs. of N. Am. Inc., 891. F.3d at 202, 204.

[13] In re Intervention Energy Holdings LLC, 553 B.R. 258, 261-62 (Bankr. D. Del. 2016). Note that this case involved a limited liability company and not a corporation.

[14] In re Franchise Servs. of N. Am. Inc., 891. F.3d at 202, 204.

[15] Id. at 211 (referencing Ivanhoe Partners v. Newmont Min. Corp., 535 A.2d 1334, 1344 (Del. 1987).

[16] Id. (referencing Kahn v. Lynch Commc’n Sys. Inc., 638 A.2d 1110, 1113-14 (Del. 1994); Ivanhoe, 535 A.2d at 1344).

[17] Id. at 207.

[18] MBNA Am. Bank N.A. v. Trans World Airlines Inc. (In re Trans World Airlines Inc.), 275 B.R. 712, 723 (Bankr. D. Del. 2002).

[19] In re Intervention Energy Holdings LLC, 553 B.R. at 263 n.11 (quoting Klingman v. Levinson, 831 F.2d 1292, 1296 n.3 (7th Cir. 1987)).

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