US Bankruptcy Court grants motion to dismiss LLC chapter 11 case for failure to obtain requisite corporate filing authority

Introduction

The US Bankruptcy Court for the Northern District of Illinois (Bankruptcy Court) recently issued an opinion in In re 301 W North Avenue, LLC, Case No. 24 B 2741 (DDC) [Docket No. 253] (January 6, 2025) granting a secured lender’s motion to dismiss an LLC debtor’s chapter 11 case because the debtor failed to obtain the requisite corporate authority to file that chapter 11 case (eg, consent of a duly appointed “independent manager”). In so doing, the Bankruptcy Court rejected the debtor’s arguments that the independent manager consent rights in the debtor’s LLC agreement impermissibly restricted the debtor’s right to file a bankruptcy case because the LLC agreement imposed broad fiduciary duties on the independent manager’s exercise of those consent rights.

Background

301 W North Avenue, LLC (Debtor) is a Delaware limited liability company. The Debtor operates a mixed-use real estate development in Chicago. In September 2020, the Debtor entered into a $26 million secured loan agreement with BDS III Mortgage Capital G, LLC (Secured Lender).

Prior to making the loan, the Secured Lender’s predecessor in interest tendered a term sheet to the Debtor, which required that the Debtor be a “bankruptcy remote entity” and to have one acceptable independent director serve on its board. Accordingly, the Debtor entered into a staffing agreement with CT Corporation Staffing, Inc., whereby, among other things, CT Corporation would provide a qualified independent director to serve on the Debtor’s governing body (Independent Manager). The staffing agreement required that the Debtor provide the Independent Manager with reasonable time to investigate and perform due diligence with respect to matters before the board, as well as standard indemnification rights and a release from causes of action other than for willful misconduct.

The Debtor’s secured loan agreement also included certain key provisions regarding the Independent Manager, including:

• The Debtor cannot file a bankruptcy petition without unanimous consent from all members of the LLC and the Independent Manager


• The Debtor’s LLC Agreement shall provide that at all times at least one independent director shall serve on the Debtor’s board, and


• The board cannot take any action which requires the unanimous consent of the board unless at the time of such action an independent director is serving on the board.

As part of the loan transaction, the Debtor, its manager, and its two existing members entered into an LLC Agreement governed by Delaware law. The LLC Agreement contained several provisions requiring Independent Manager consent that mirrored the terms of the secured loan agreement set forth above. The LLC Agreement also required that, in acting or otherwise voting on matters provided in the LLC Agreement, the Independent Manager (a) must consider the interests of the LLC members and the company (including the company’s creditors), and (b) shall have the fiduciary duties of loyalty and care consistent with those of directors under Delaware law.

The chapter 11 case and the motion to dismiss

On December 15, 2023, after the Debtor defaulted under its secured loan, the Secured Lender initiated foreclosure proceedings against the Debtor. Immediately prior to a hearing on the foreclosure action, the Debtor filed a petition for relief under chapter 11. The president of the Debtor’s manager signed the bankruptcy petition, declaring under penalty of perjury that he was authorized to file the petition on the Debtor’s behalf. Thereafter, the Secured Lender filed a motion to dismiss the chapter 11 case for failure to obtain requisite filing authority.

The motion to dismiss raised two issues for the Bankruptcy Court: (i) whether the Debtor was authorized to file the bankruptcy case and, if not, (ii) whether the LLC Agreement impermissibly restricted the Debtor’s right to file for relief under the Bankruptcy Code.

The Bankruptcy Court’s ruling

The Debtor was not authorized to file the bankruptcy case

Under section 1112(b) of the Bankruptcy Code, bankruptcy courts shall dismiss or convert a bankruptcy case “for cause,” which includes a lack of corporate authority to file the case. In particular, when a court “finds that those who purport to act on behalf of the corporation have not been granted authority by local law to institute the proceedings, it has no alternative but to dismiss the petition.” Price v. Gurney, 324 U.S. 100, 106 (1945) (emphasis added).

Upon review of the evidence in the record and the parties’ arguments on the motion to dismiss, the Bankruptcy Court determined that “cause” existed to dismiss the Debtor’s bankruptcy case under section 1112(b) of the Bankruptcy Code. In so ruling, the Bankruptcy Court found that under Delaware law, an LLC can only act if authorized by its operating agreement. Here, the LLC Agreement dictated that the decision to file for bankruptcy required unanimous consent of the Debtor’s members and the Independent Manager. The evidence demonstrated that the Debtor categorically failed to obtain (or even seek) the Independent Manager’s consent before filing the chapter 11 petition. Accordingly, the bankruptcy filing was unauthorized under Delaware law.

In its analysis, the Bankruptcy Court first rejected the Debtor’s contentions that the Independent Manager’s resignation prior to the bankruptcy filing rendered moot the need to obtain the Independent Manager’s consent to the bankruptcy filing. However, the evidence laid bare that the Independent Manager resigned approximately two months after the Debtor filed for bankruptcy relief and only after learning about the Debtor’s bankruptcy filing. Further, the Bankruptcy Court did not find credible the president’s apparent ignorance as to the existence of the Independent Manager.

Second, the Bankruptcy Court rejected the Debtor’s argument that the Independent Manager ratified the bankruptcy filing. In contrast, according to the Bankruptcy Court, the Independent Manager repudiated the bankruptcy filing by resigning immediately after she learned about the bankruptcy, which suggests the Independent Manager did not acquiesce to the bankruptcy filing. Finally, because the Independent Manager took immediate steps to disassociate herself with the Debtor, the Bankruptcy Court rejected the Debtor’s assertion that the Independent Manager ratified the filing.

The LLC agreement’s conditions for filing bankruptcy did not impermissibly restrict the Debtor’s right to file for relief under the Bankruptcy Code

The Bankruptcy Court additionally held that the Debtor’s LLC agreement did not impermissibly restrict the Debtor’s right to file for bankruptcy. In so doing, the Bankruptcy Court reviewed each of the provisions that installed and defined the scope of the Independent Manager’s duties to conclude that they were not void as against public policy. Specifically, the Bankruptcy Court found the requirement that the Independent Manager consider the interests of the Debtor, its members, and its creditors to be critical and distinguishable from the cases cited by the Debtor:

• In re Lake Michigan Beach Pottawattamie Resort LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016). In that case, the court found unenforceable a provision requiring the consent of a special member installed by a lender as a precondition to the debtor commencing a bankruptcy case. However, the provision also expressly “exclude[d] the Debtor’s interests from consideration” by the special member.


• In re Intervention Energy Holdings, LLC, 553 B.R. 258 (Bankr. D. Del. 2016). In that case, the court denied a motion to dismiss by a creditor with a “golden share” (an economically insignificant interest with a veto right over a potential bankruptcy filing) who did not consent to the commencement of the debtor’s bankruptcy case. Specifically, the court noted that the movant’s primary relationship with the debtor was “that of creditor—not equity holder—and which owes no duty to anyone but itself ….” The court ultimately held that the “golden share” was tantamount to an absolute waiver of a debtor’s right to file bankruptcy and thus was void by reason of public policy.

In contrast, the Bankruptcy Court found that the plain terms of the LLC Agreement imposed express fiduciary duties of loyalty and care on the Independent Manager, which duties extended to the Debtor’s members and the Debtor (including the Debtor’s creditors). The Bankruptcy Court also rejected the Debtor’s argument that the Independent Manager’s bankruptcy filing consent right should be deemed violative of public policy because she served exclusively for the benefit of the Secured Lender. Instead, the Bankruptcy Court validated the Independent Manager’s initial appointment and found that “it makes sense, therefore, that the position would remain in place so long as the [Secured Loan] exists.” Accordingly, the Bankruptcy Court held, “The fact that the position co-exists with the Loan is just logical. It does not lead inexorably to the conclusion that the Independent Manager is not subject to direct fiduciary duties affecting the ability to file a bankruptcy petition.”

Finally, the Bankruptcy Court disagreed with the remainder of the Debtor’s contentions, including that the indemnification provisions and covenant not to sue tainted the Independent Manager’s consent rights. Accordingly, the Bankruptcy Court found the provisions installing the Independent Manager to be enforceable. Consequently, because the Independent Manager did not consent to the bankruptcy filing, the Debtor did not have authorization to file the petition, the Bankruptcy Court dismissed the chapter 11 case.

Key takeaways

The Bankruptcy Court’s ruling adds to the growing body of case law analyzing the validity of “blocking rights” in corporate organizational documents. While grounded in the enforceability of the specific provisions in the Debtor’s LLC Agreement, the Bankruptcy Court’s ruling may serve as a roadmap for lenders seeking influence over a debtor’s ability to seek bankruptcy relief.

For example, courts in Delaware have generally been loath to allow creditor influence to creep into the bankruptcy decision-making process even when the creditor has a bona fide equity interest in the debtor. See, eg, In re Pace Industries, LLC, Case No. 20-10927 (MFW) (Bankr. D. Del. May 5, 2020) (finding, under the facts and circumstances of the case, the exercise of a blocking right by either an equity holder or a creditor with an equity interest to restrict a debtor’s constitutionally protected right to file bankruptcy is void as against public policy) (emphasis added); In re PWM Property Management, LLC, Case No. 21-11445 (MFW) (Bankr. D. Del. Dec. 13, 2021) (denying a motion to dismiss the bankruptcy case despite lack of consent from the LLC member that held a veto right on the grounds that filing for chapter 11 relief was in the best interest of the debtors and their stakeholders and the only viable option under the circumstances, as determined in the independent CRO’s exercise of his fiduciary duties).

The holding of In re 301 W. North Avenue, LLC counsels a different approach. Namely, coupling a lender-installed director or manager with the fiduciary duties of a member or director under Delaware law may overcome even Delaware’s liberal standard for denying motions to dismiss for lack of corporate authority when the bankruptcy filing is in the best interests of the debtor. It remains to be seen, however, whether this approach will gain traction in other courts or if members or directors will agree to take on such duties. Lenders considering installing an independent member or director with bankruptcy filing consent rights as part of a loan agreement or in exchange for forbearing on defaulted debt should also consider subjecting such member or director to broad fiduciary duties.

For more information

DLA Piper remains at the forefront of issues regarding corporate blocking rights and their impact on entity formation and restructurings. If you have any questions about this ruling or any restructuring-related matter, please reach out to the authors, Robert Klyman and Matthew Sarna, or your usual DLA Piper contact.