I was bitten by this concept once. At the time I was stunned to learn that the courts seem to say that bankruptcy remote vehicles were appropriate and enforceable. Finally Bankruptcy Judge Timothy Barnes, Northern District of Illinois, has ruled that public policy overrides the veto given to the lender that was appointed in a workout to be a “special member” of the debtor, a Michigan LLC. The article can be accessed here. The case is In re Lake Michigan Beach Pottawattamie Resort LLC, 2016 WL 1359697 (Bankr. N.D.Ill. April 5, 2016). The court also denied the lender’s motion to dismiss the bankruptcy as a bad faith filing under section 1112 (b) of the Bankruptcy Code because the lender failed to meet its burden of showing bad faith.
So what’s this all about? The lender agrees to lend to an LLC but only if the Operating Agreement provides that the lender or some third party be entitled to vote on whether the LLC may file a bankruptcy case. In fact, the lender or the third party is given a complete veto on the issue. This means that the members that owe fiduciary duties to the entity are prevented from voting for bankruptcy protection by a person whose sole interest is the lender. Assuming the lender’s appointee has fiduciary duty of care to the LLC, Delaware law permits “exculpation from all fiduciary duties except the duty of loyalty.”
So the foreclosure sale of the LLC’s sole asset is next week. The managing members are trying to figure out the best course for the LLC. The third person is not involved in this. It is only when the members decide to vote on a bankruptcy filing that they must give notice to the new person, appointed by the bank, who then gives a thumbs up or thumbs down. This is simply a waiver in advance of the right to file bankruptcy! That violates public policy but is largely, hopefully until now at least, permitted by the courts.