Special purpose entities or vehicles (commonly referred to as SPEs or SPVs) are frequently created as part of various types of financing transactions from real estate loans to more complex securitization structures. The benefits of utilizing such entities are widely understood, such as asset isolation and the attendant lower borrowing costs. However, as corporate entities (or LLCs), such entities are eligible to file for relief under U.S. bankruptcy laws. Lenders continue to try to mitigate or eliminate this risk by having borrowers structure the entities in ways that make it difficult or impossible for the entity to file for bankruptcy. One method that has been the subject of recent case law involve the utilization of an arrangement whereby the lender is given significant rights to, among other things, block a bankruptcy proceeding. This right is sometimes referred to as the grant of a "golden share". The holder of such share is given the right to consent to a bankruptcy filing.

However in two recent cases out of Delaware and Illinois, two companies were allowed to file for bankruptcy relief despite the fact that the debtors failed to obtain the necessary consent of their members, which held the "golden-shares". In re Lake Michigan Beach Pottawattamie Resort, LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016); In re Intervention Energy Holdings, LLC, No. 16-11247, 2016 WL 3185576 (Bankr. D. Del. June 3, 2016).

The courts concluded that these "golden share" or "blocking share" provisions were not enforceable as violations of public policy. The Delaware court explained that "[a] provision in a ... governance document ..., the sole purpose of which is to place into the hands of a single minority equity holder the ultimate authority to eviscerate the right of that entity to seek federal bankruptcy relief ... is tantamount to an absolute waiver of that right, and ... is void as contrary to federal public policy." In re Intervention Energy Holdings, LLC, No. 16-11247, 2016 WL 3185576 at 5 (Bankr. D. Del. June 3, 2016).

Two critically important public policies were implicated in these cases – the fiduciary obligations of corporate leaders and the constitutionally authorized ability to seek federal bankruptcy relief. The ability of one member or shareholder to block the exercise of these duties as well as the right to seek bankruptcy code protection is what the courts found the most troubling in each situation. However, where a creditor has an equity interest separate from the loan, a court might view the parties' interests as being more aligned and enforce a golden share. Finally, where the agreement is entered into prior to the borrower facing financial distress, a court may view the transaction more favorably as the parties will have more equal bargaining power. The crucial takeaway from these cases is that the courts are going to look at the purpose and effect of the transactions and not simply the form or language of the agreements.

In addition, borrowers may now have persuasive authority to challenge agreements that altogether eliminate the fiduciary obligations of the directors or members, which exist under state law. However, it is plausible that where a debtor is insolvent and the duties of its members or directors under applicable state law include considerations of creditor interests, a court may view the enforcement of the "golden share" provision as being consistent with the reason for the establishment of the special entity – isolation of an asset for credit and enforcement purposes. It should be noted that if the corporate separateness of the entities was not properly established or was not observed, a court could still find a basis to prevent enforcement of the golden share.

While these cases may be viewed as another step down the road in a series of cases frustrating the efforts to make entities bankruptcy-proof, the benefits of utilizing special purpose entities in finance still outweigh this additional risk, which can, and likely will, be priced into the deals. The decisions also raise the bar for lenders and their counsel to generate more creative techniques to provide lenders with assurances that their borrowers will not file bankruptcy.

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