By Mark A. Cody and Mark G. Douglas (Jones Day).
In a highly anticipated decision, the U.S. Court of Appeals for the Fifth Circuit affirmed a bankruptcy court order dismissing a chapter 11 case filed by a corporation 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 Fifth Circuit panel ruled that: (i) state law determines who has the authority to file a voluntary bankruptcy petition on behalf of a corporation; (ii) federal law does not strip a bona fide equity holder of its preemptive voting rights merely because it is also a creditor; and (iii) the preferred shareholder-creditor was not a controlling shareholder under applicable state 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. Such provisions 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, but with mixed results in the courts. Franchise Services does little to remedy the unsettled state of bankruptcy jurisprudence regarding this important issue. 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.
The article is available here.