High Hurdle for Lender to Prevent LLC From Filing Bankruptcy

Roberson Cartridge Co., LLC (“Cartridge”) borrowed $4.4 million from Matador Brass Partners, LLC (“Matador”). To secure the loan, Cartridge’s owner Jeff Roberson (“Roberson”) pledged his 100 percent membership interests to Matador and changed Cartridge’s operating agreement to require Matador’s permission to file bankruptcy.

After Cartridge filed bankruptcy, Matador claimed that the filing was unauthorized. Matador first argued that Roberson was divested of his membership interests in Cartridge when Cartridge defaulted on the loan. As a result, Matador claimed that Roberson was without authority to cause Cartridge to file bankruptcy.

The bankruptcy court disagreed. Relying on the Texas Business Organizations Code (“Texas Code”) (which is substantially similar to California’s Corporations Code– ML), the court stated that Matador, as an assignee, only controlled the economic portion of the company’s membership interests. As Matador could not control whether Cartridge could file bankruptcy, because it did not control Cartridge’s voting interests.

Matador further argued that because Roberson had been divested of his membership interests in the company, there were no members to vote for the bankruptcy filing. Again the court disagreed, finding that Roberson, in his capacity as manager, had the right under the circumstances to authorize the bankruptcy filing. The court reasoned that Roberson retained such authority because, under the Texas Code, “if the limited liability company has no members, a majority of all of the managers of the company is required to approve . . . a voluntary winding up of the company[.]”

The court then tackled Matador’s second argument, that Cartridge’s Amended and Restated Company Agreement (the equivalent of an “operating agreement” in California- ML] required Matador’s written consent before it took any action that resulted in a liquidation or dissolution of the company. This is called a “blocking provision.” The court wrote that, in general, “the enforceability of blocking provisions depends on who has them. If it is creditors, they are generally unenforceable. If it is equity interest holders, they are generally enforceable.”

More specifically, the court stated that blocking provisions are void on public policy grounds when a creditor, without an ownership interest, retains the ability to block the filing a bankruptcy petition. The court cited another case in which a different court had held that a blocking provision, in that case, was void because the creditor held only a nominal equity interest in the borrower.

In re Intervention Energy Holdings, LLC, 553 B.R. 258 (Bankr. D. Del. 2016). After noting that “it is a well settled principal [sic] that an advance agreement to waive the benefits conferred by the bankruptcy laws is wholly void as against public policy” [citation omitted], the Cartridge court denied Matador’s motion to dismiss, holding that “[r]equiring a borrower to waive its right to file a bankruptcy petition, as Matador Brass required of Roberson Cartridge, is void as against public policy.”

Conclusion

If your client is a borrower caused his company’s operating agreement to require lender consent to file a bankruptcy petition or whose owner has pledged his equity interest in the company, the company might still have the right to file a Chapter 7 or Chapter 11 bankruptcy petition, especially if the lender holds no equity interest or only de minimus equity interest in the borrower. If your client is considering requiring a blocking provision from a borrower, it should understand that the provision may be unenforceable unless it also holds a meaningful equity interest in the borrower.

If you are located in Los Angeles and are considering filing for bankruptcy, it is essential to seek the advice of a qualified bankruptcy attorney. Understanding the nuances of the law is crucial, which is why consulting with an experienced business bankruptcy attorney in Los Angeles is highly recommended.