“Golden Shares” May be Fool’s Gold for Lenders

By Peter Cal and Eric Johnson

February 16, 2018 – One of the biggest risks that any lender faces is a potential bankruptcy filing by its borrower.  To counter that risk, lenders have developed creative strategies—with varying degrees of success—to gain greater protection for themselves.  One popular tactic is to require non-individual borrowers (including corporations, LLCs, LLPs, and limited partnerships) to include in their organizational documents the issuance of a “golden share” to the lender, which usually takes the form of a 1% equity interest in the borrower.  The borrower’s organizational documents will then provide that the borrower is prohibited from filing for bankruptcy without the unanimous approval of all equity holders.  By holding the “golden share,” the lender could theoretically block the borrower from filing for bankruptcy and protect the lender’s interests.  And by “theoretically,” we mean only if a bankruptcy court enforces the unanimous approval provision that the lender devised.

“Golden shares” highlight a tension in the law. On the one hand, a contractual waiver of the right of any person or entity to file for bankruptcy will be invalidated by courts across America as a violation of federal public policy.  But on the other hand, a bankruptcy petition that is filed without proper authorization under an entity’s organizational documents must be dismissed as unauthorized.  Where does a court draw the line?  The United States Fifth Circuit Court of Appeals is about to become the highest court in the land to decide that question.  On February 8, 2018, that Court accepted an extraordinary appeal from a bankruptcy court of the question whether a “golden share” provision in articles of incorporation in favor of both a lender and equity investor is valid to prevent a bankruptcy filing, or is void under federal public policy. [1]

In Franchise Services, the debtor’s articles of incorporation prevented a bankruptcy filing without unanimous shareholder approval.  That provision inspired two motions to dismiss the debtor’s bankruptcy case, filed by (1) an entity that was both a creditor and a shareholder and (2) a shareholder.  The bankruptcy court surveyed all seven cases that it found from around the country that had analyzed the validity of a “golden share” or a bankruptcy-blocking provision and found that the provision will be valid if it is held by an equity investor, but is invalid if asserted by a creditor.  The court therefore denied the motion by the creditor-shareholder, but granted the equity investor’s motion and dismissed the case.  Recognizing the importance of the issue, the bankruptcy court certified the decision for direct appeal to the Fifth Circuit.

The “golden share” question has two unique Colorado aspects. First, in In re DB Capital Holdings, LLC [2] both the Colorado Bankruptcy Court and the Bankruptcy Appellate Panel held that a bankruptcy case should be dismissed where the members of an LLC included in the LLC’s operating agreement a provision prohibiting the LLC from filing for bankruptcy. DB Capital is important because the court specifically stated there was no evidence of coercion by the LLC’s lender regarding the authorization restriction and expressly declined to comment whether the outcome would have changed if such coercion existed.

Second, in contrast to the Franchise Services court’s statement that no court had upheld a creditor’s use of a “golden share” to block a bankruptcy filing, the Colorado Bankruptcy Court did exactly that in a case where one of the authors of this Alert represented the lender.  In In re Aspen Legacy Holdings LLC, [3] the author’s lender client, who was also a 1% equity holder in the debtor, negotiated an amendment to the debtor’s operating agreement that precluded the LLC from filing for bankruptcy without unanimous member consent.  In an unpublished decision, the bankruptcy court dismissed the debtor’s bankruptcy case due to the lender’s equity position and the validity of the “golden share” blocking provision.  To the author’s knowledge, no other case has cited Aspen Legacy Holdings.

Lenders and borrowers across the country will await the Fifth Circuit’s decision in Franchise Services as the latest and most important guidance on the question of the validity of “golden shares.”  For the equity holder in that case, the provision indeed proved to be golden, while the lender found only fool’s gold.

The lawyers in Sherman & Howard’s Banking and Finance Practice Group have significant experience helping their lender and borrower clients navigate the complex issues in today’s dynamic climate for finance and bankruptcy matters. The Group’s members would welcome the opportunity to work with participants in financial transactions to achieve their financial goals while minimizing legal risks. For further information on the matters discussed in this Alert or other legal issues pertaining to lending or bankruptcy matters, please contact any of the members of Sherman & Howard’s Banking and Finance Practice Group.

[1] Franchise Services of North Am., Inc. v. U.S. Trustee et al., Case No. 18-90006 (5th Cir. Feb. 8, 2018) (granting direct appeal from bankruptcy court); In re Franchise Services of North Am., Case No. 1702316EE, 2018 WL 485959 at ** 6-7 (Bankr. S.D. Miss. Jan. 17, 2018) (granting motion for direct appeal to circuit court and certifying questions for appeal).

[2] 463 B.R. 142, 2010 WL 4925811 at *3 (10th Cir. B.A.P. Dec. 6, 2010).

[3] Case No. 10-25617-ABC [Dkt. #33] (Bankr. D. Colo. July 26, 2010).