Several months ago the U.S. Court of Appeals for the Fifth Circuit agreed to hear a direct appeal from a bankruptcy court decision dismissing a Chapter 11 case as being unauthorized due to a failure to comply with its articles of incorporation. See Corinne Ball, A Case to Watch: The Fifth Circuit Accepts Direct Appeal Respecting Enforcement of Corporate Restraints Preventing Bankruptcy, NYLJ (Feb. 21, 2018). The questions certified posed the issue of whether a blocking provision or a golden share, which gives a party the ability to prevent a corporation from filing bankruptcy is valid and enforceable or contrary to federal public policy. Further, the certified question asked whether, under Delaware law, such a blocking provision imposes upon the holder of the provision a fiduciary duty to exercise such provision in the best interests of the corporation. Rather than address these broad questions, the Fifth Circuit narrowed the questions to whether U.S. and Delaware law permits what happened here, notably, amending the corporate charter to allow a non-fiduciary shareholder fully controlled by an unsecured creditor to prevent a voluntary bankruptcy filing. The appellate court ruled in the affirmative. Franchise Servs. of N. Am. v. United States Trs. (In re Franchise Servs. of N. Am.), No. 18-60093, 2018 U.S. App. LEXIS 13332 (5th Cir. May 22, 2018).

Background

This case arose from the failed acquisition of Advantage Rent-A-Car by Franchise Services of North America, Inc. (FSNA). An investment bank assisted FSNA in the acquisition acting as an advisor and providing, through a wholly owned affiliate, an investment of $15 million in convertible preferred equity issued by FSNA. The preferred stock was convertible to 49.76 percent in common equity. Concurrently with the investment, FSNA, which was originally incorporated in Canada, was required to reincorporate in Delaware and include in its certificate of incorporation that FSNA could not “effect any liquidation event,” including “preparatory steps towards or filing a petition for bankruptcy,” without the consent of the holders of a majority of the preferred stock, voting separately as a class, and the holders of majority of the shares of common stock, voting as class. Advantage filed for bankruptcy within a year of the acquisition. FSNA did not pay the investment bank its advisory fees. Litigation ensued. FSNA sought bankruptcy relief without requesting or obtaining the consent of its preferred shareholder. The investment bank, acting through its shareholder affiliate, moved to dismiss the Chapter 11 case as unauthorized. The bankruptcy court granted the preferred shareholder’s motion and dismissed the Chapter 11 case. FSNA successfully sought certification and direct appeal to the Fifth Circuit.

Public Policy