When agreements cannot be reached between businesses and lenders or certain other creditors to stretch the repayment of debts, legal and financial advisors may recommend that the company file a Chapter 11 bankruptcy case. Such action can also apply to profitable companies looking to restructure debt that has grown due to temporary reductions in cash flow which the company covered in part by drawing on its line of credit with its lender. As business owners consider whether or not to file a Chapter 11 case, they may find themselves asking (1) can my company file a Chapter 11 case, (2) can anyone stop my company from filing, and (3) where can my company file?
Can my company file a Chapter 11 case?
The company is eligible to file a Chapter 11 case. Most companies are eligible. Only a few companies, such as banks, insurance companies, and similar highly-regulated businesses, are not eligible.
However, some companies, especially those involved in real estate, have lending arrangements that are structured to restrict their authority to file bankruptcy. Lenders usually don’t like bankruptcy unless the bankruptcy is filed with their consent for the purpose of protecting or selling their collateral. Because loan provisions that prohibit a company from filing bankruptcy are not enforceable, lenders use more “creative” ways to try to block a bankruptcy filing. For example, the lender might require the company to amend its organizational documents to give the lender a small ownership interest in the company and to provide that the company cannot file bankruptcy without the consent of all of its owners. This arrangement gives the lender what is known as a “golden share” which can block a bankruptcy filing.
Can anyone stop my company from filing?
There are many variations of the “golden share” concept. For example, the lender might require the appointment of an outside director (presumably independent but often with ties to the lender) and the unanimous consent of the directors for a bankruptcy filing. These arrangements have had mixed results with the courts. Some courts have enforced them, dismissing the bankruptcy case if the company does not comply with them. Other courts have refused to enforce them and have permitted the bankruptcy case to proceed even though the company has not complied.
The courts’ decisions depend very much on the specific restrictions and applicable state and federal laws. These laws can be relatively complicated but, generally, courts may be reluctant to enforce these arrangements where it is clear the “blocking” shareholder or director is acting primarily for the benefit of the lender and not in the best interests of the company and all of its constituents, including other creditors, other owners, and employees.
It is important for the company to determine whether its loan documents contain these arrangements and, if they do, to comply with them or analyze whether the court where the company would file bankruptcy is likely to enforce them if the company cannot or does not comply with them.
Where can my company file a Chapter 11 case?
The company can file a Chapter 11 case where it is domiciled (usually its state of organization) or where its principal place of business or principal assets are located. For many companies, these will be the same place. For larger companies, however, there may be several places where the Chapter 11 case can be filed, depending on how the company is structured and where its headquarters and assets are located. When the company consists of several entities, “affiliate” venue provisions permit all of the companies to file where one affiliate files. If there is a choice, the company should identify the issues likely to arise in its Chapter 11 case, such as the “golden share” issue discussed above, and choose the venue where the court is likely to be most favorable to the company’s positions.
For further information, please contact any member of Taft’s Distressed Companies Task Force.
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