On May 5, 2020, Judge Mary Walrath of the United States Bankruptcy Court for the District of Delaware delivered a bench ruling that denied a minority shareholder’s motion to dismiss the Chapter 11 cases of Pace Industries and certain of its affiliates on the grounds that the shareholder’s contractual right to block a bankruptcy filing under the debtor’s certificate of incorporation was contrary to public policy.1 In so deciding, Judge Walrath ruled that the exercise of “a blocking right by a shareholder who is not a creditor is void as contrary to federal public policy that favors the constitutional right to file bankruptcy.”2 Judge Walrath’s decision, if validated by other courts, would represent a potentially significant shift in the ability of a minority shareholder to exercise a contractual right to block a putative debtor’s bankruptcy filing.
Enforceability of “Golden Shares”
Although the Pace Industries decision addressed an issue of first impression for the United States Bankruptcy Court for the District of Delaware, it exists within the context of a series of decisions in recent years that address the enforceability of a creditor’s or shareholder’s use of a “golden share” or similar right that provides such holder the ability to prevent a company’s bankruptcy filing. On the one hand are cases that generally uphold such rights in the hands of equity holders, so long as they do not operate as a de facto bar on the debtor’s ability to file for bankruptcy.3 On the other hand are cases where courts have refused to enforce such blocking rights, particularly where the non-consenting equity holder was also a creditor of the debtor.4
Prior to Pace Industries, the most recent major case addressing these issues was the Fifth Circuit Court of Appeals’ decision in In re Franchise Services of North America, in which the court held that a preferred shareholder could exercise its bargained-for rights that allowed it to block a bankruptcy filing even though that preferred shareholder (which had made a $15 million investment in the debtor) was wholly owned by one of the debtor’s creditors, which was owed $3 million for advisory services.5 The Franchise Services decision concluded that the equity holder was not a controlling shareholder and observed that federal bankruptcy law does not prevent a “bona fide” shareholder from exercising its voting rights to prevent a company from filing bankruptcy.6
The Pace Industries decision arose out of a set of circumstances that has become increasingly common in recent months. Pace Industries is an Arkansas-based supplier of aluminum, zinc and die-cast to the automotive industry.7 Prior to filing bankruptcy, Pace was experiencing severe liquidity issues; in fact, Pace had only approximately $146,000 of cash on hand when it filed for bankruptcy.8 Pace proposed a pre-packaged bankruptcy plan centered around the restructuring of approximately $324 million of debt in a debt-for-equity swap.9 The plan had the support of the majority of Pace’s stakeholders, with the exception of one of its preferred shareholders.10
In January 2018, the shareholder purchased 400 Series A preferred shares in Pace’s parent entity, KPI Intermediate Holdings, Inc. (KPI), for $37.15 million.11 In connection with the purchase of the Series A preferred shares, the shareholder negotiated for and obtained certain protective rights that required KPI to obtain the shareholder’s consent in order to file for bankruptcy.12 Notwithstanding the minority shareholder’s consent rights, KPI’s board of directors authorized bankruptcy filings by KPI, Pace and their direct and indirect subsidiaries without obtaining the minority shareholder’s consent.13
Shortly after the bankruptcy filing, the shareholder filed a motion to dismiss the Chapter 11 cases. The shareholder alleged that the debtors’ bankruptcy filings were unauthorized because the debtors did not obtain the shareholder’s required consent prior to filing.14 The minority shareholder further argued that although federal public policy supports a liberal right of debtors to file for bankruptcy, it does not invalidate an equity holder’s ability to exercise its right to consent to (or not to consent to) a bankruptcy filing.15 The shareholder relied on cases generally supportive of an equity holder’s ability to exercise such bargained-for consent rights over a bankruptcy filing, notwithstanding the general public policy favoring a liberal right of debtors to seek bankruptcy relief.16 The shareholder further sought to distinguish the current case, in which it sought to exercise consent rights solely in its capacity as an equity holder, from related cases in which consent rights were not enforced because the equity holders seeking to exercise such rights were significant creditors of the debtor and held only a nominal equity interest.17
In opposition, the debtors emphasized that federal public policy supports the liberal rights of debtors to seek bankruptcy relief, arguing that “a right to consent to a voluntary bankruptcy filing may be disregarded if, under the circumstances, enforcing the right would conflict with the important public policy of assuring companies can seek federal bankruptcy relief when needed or where it would be inequitable.”18
The debtors identified a variety of factors supporting their need for bankruptcy protection and the benefits that bankruptcy would confer on the majority of the debtors’ stakeholders, including that nearly all of the debtors’ debt was in default on the petition date, that they had only minimal cash on hand and that the debtors were forced to terminate over 1,000 employees as a result of the COVID-19 pandemic.19 The debtors further argued that because the Chapter 11 cases were overwhelmingly beneficial to all stakeholders, the debtors’ secured lenders would commence an involuntary bankruptcy case in the event that the minority shareholder’s motion to dismiss was granted, and, therefore, the practical effect of dismissing the debtors’ cases would only be to delay the debtors’ access to necessary bankruptcy relief.20
The Court’s Decision
In denying the minority shareholder’s motion to dismiss, Judge Walrath determined that there was no controlling case law and focused her analysis on the debtors’ substantial need for bankruptcy protection and on the benefits to most stakeholders that a bankruptcy proceeding could provide.21 In recognizing that the debtors would benefit from being permitted to continue their Chapter 11 cases, Judge Walrath stated, “The provision in the charter of one of the debtors that bars the filing by that debtor and all its subsidiaries I believe violates public policy and is void as it is exercised by a minority shareholder.”22
Judge Walrath also rejected the minority shareholder’s contention that its seeking to block a bankruptcy filing solely in its capacity as a minority shareholder was distinguishable from cases in which creditors with nominal equity interests in a debtor were barred from exercising blocking rights. On that point, Judge Walrath declined to follow the Franchise Services decision and in so doing noted that “[f]ederal public policy allows any entity to file for bankruptcy, and it is the same regardless of who is seeking to block that filing.”23
Judge Walrath further concluded that, under the circumstances, the minority shareholder’s blocking rights imposed fiduciary duties upon it, which required the shareholder to consider the debtors’ best interest in deciding to exercise its blocking rights.24 Given the court’s finding that a bankruptcy proceeding was necessary and in the best interests of most stakeholders and the minority shareholder’s failure to propose an equally beneficial alternative to bankruptcy, the court found that “federal public policy does require that the Court consider what is in the best interest of all, and does consider whether the party seeking to block [a bankruptcy filing] has a fiduciary duty that it appears it is not fulfilling . . . [and the minority shareholder] has said clearly it is not considering the rights of others in its decision to file the motion to dismiss.”25
By invalidating the minority shareholder’s bargained-for consent rights based on federal public policy in favor of liberal access to bankruptcy, and concluding that minority shareholders who possess such rights owe fiduciary duties to debtors under Delaware law, Judge Walrath’s decision may be the most noteworthy bankruptcy court decision to date in terms of calling into question the enforceability of “golden shares” held by equity holders. In a time when many companies are facing severe COVID-19-related stress similar to Pace Industries’, it remains to be seen whether Judge Walrath’s decision will influence other courts to grant debtors access to bankruptcy relief over the objection of holders of their “golden shares.”26
1 Transcript of Telephonic Hearing on Motion for an Order Dismissing the Chapter 11 Cases of KPI Immediate Holdings, Inc., and its Direct and Indirect Subsidiaries, In re Pace Industries, LLC, No. 20-10927 (Bankr. D. Del. May 5, 2020).
7 Debtors’ Opposition to Motion for an Order Dismissing the Chapter 11 Cases of KPI Intermediate Holdings, Inc. and its Direct and Indirect Subsidiaries at 3, In re Pace Industries, LLC, No. 20-10927 (Bankr. D. Del. Apr. 28, 2020), ECF No. 115.
11 Motion for an Order Dismissing the Chapter 11 Cases of KPI Immediate Holdings, Inc., and its Direct and Indirect Subsidiaries at 2, In re Pace Industries, LLC, No. 20-10927 (Bankr. D. Del. Apr. 17, 2020), ECF No. 88.