Supreme Court decision, CML V, LLC
v. Bax, 28 A.3d 1037 (Del. Sup. 2011),
highlights the unique nature of LLCs
and the greater ability of creditors
of those entities to negotiate for
considerable control over their fate.
bankruptcy (which may be enforceable,
depending on the jurisdiction and the
facts and circumstances of the case).
Bax held that creditors lack standing
under the LLC Act to bring derivative
suits (and that this provision of the LLC
Act is constitutional) because their rights
are governed by the act and by contract.
The court emphasized that the structure
of the LLC affords creditors significant
contractual flexibility to protect their
unique, distinct interests. The court
provided examples of remedies creditors
of an LLC could negotiate by contract,
including a provision that would give
a creditor control of the governing
body in the event of insolvency.
State of the Art Tools
Beyond these general terms, a
forbearance agreement with an LLC
borrower can deal substantively with the
possibility of the borrower’s bankruptcy.
The borrower could stipulate that it
will not file bankruptcy; however,
the general rule is that provisions
in loan agreements that restrict a
bankruptcy filing are against public
policy and are not enforceable. 1
As part of the forbearance agreement,
the parties may agree that the
borrower must amend its operative
documents to restrict authority and
prevent a bankruptcy filing. This
may be approached by amending
documents entirely to remove the
ability to file bankruptcy in any case or
by amending the documents to require
lender consent to a bankruptcy.
In general, a forbearance is an agreement
between a lender and its borrower
to delay enforcement of the lender’s
rights based on negotiated terms and
conditions. The forbearance can span
the breadth from a simple agreement
by the lender not to enforce its rights
with no conditions attached to a heavily
negotiated and documented agreement
setting forth a very specific set of
conditions for the agreement to forbear.
Nevertheless, lenders can propose
as part of a forbearance a number of
mechanisms that would require the
borrower to modify its organizational
character to avoid or delay a bankruptcy
filing or at least to provide that the
lender has some say in the timing of a
filing. The structure of such agreements
is critical. The formative documents
should reflect the true intent of the
parties—they should state precisely the
rights, remedies, and limitations of the
borrower, its members, and the secured
creditor. The lender must be wary of
potential liability in negotiating any
of these actions in connection with
a forbearance agreement and should
be careful not to become susceptible
to allegations that it gained excessive
control of a borrower through coercion.
However, depending on the rules
for amendments in the operating
agreement, a borrower could simply
amend the agreements again right
before a filing to allow for a filing.
Thus, the lender may also request
that the documents be amended
to provide that the lender must
consent to any further amendments
made to the LLC agreement.
This approach was recently tested. At the
lender’s behest, a provision was placed
in the operating agreement prohibiting
a bankruptcy filing by the borrower.
Despite the presence of the provision,
the manager of the borrower filed
the borrower for bankruptcy anyway.
The other member moved to dismiss
the filing as unauthorized, and the
court dismissed the petition. In re DB
Capital Holdings, LLC, 2010 WL 4925811
(B.A.P. 10th Cir. (Colo.) Dec. 6, 2010).
When entering into a forbearance, there
are a number of standard business-driven provisions lenders may want to
include. These may include having the
borrower pay down a certain portion of
the loan or pay a fee. The parties may
agree to amend certain terms or to
restructure the loan, including requiring
new or amended loan documentation.
The lender may increase interest
rates, add default triggers, or tighten
financial covenants. Sometimes a
borrower posts additional collateral
or provides additional guaranties.
However, Bax suggests that the following
types of broader contractual rights
may be appropriately contractually
negotiated with an LLC.
The court reasoned that LLC agreements
should be treated as contracts and that
members are free to contract to prohibit
a bankruptcy filing; however, the court
stated that the result might have been
different if it had been shown that
the lender coerced the borrower into
amending the documents to include
the provision. The entity managed to
remain in bankruptcy as a result of
an involuntary filing by its creditors,
a potential threat to the utility of the
approaches discussed in this article and
of which lenders should be aware.
A lender may also push for a
restructuring of an entire project and
require the borrower to seek new
financing, hire turnaround professionals,
and/or reach specific performance
milestones. Alternatively, the parties
can stipulate to a judgment with terms
of forbearance spelled out or agree
to a judgment to be held in escrow
during the forbearance period and
tripped upon certain explicit defaults.
They also may stipulate for relief from
the automatic stay in the event of a
Amending the Borrower’s
Organizational Documents. As part
of forbearance, a lender may request
that a borrower amend its formative
documents to make filing for bankruptcy
more difficult. A corporate entity or
partnership may only file for bankruptcy
relief if it has been duly authorized to do
so under applicable state law and its own
organizational documents. See Price v.
Gurney, 324 U.S. 100, 102 (1945). If the
documents are silent, under general
applicable state law, the determination to
file most likely rests with the governing
body or person vested with control
over the company’s major decisions.
As discussed, agreements between
third parties should not impact the
borrower’s ability to file for bankruptcy.
Becoming a Minority Equity Holder
in the Borrower. Rather than simply
amending the operating documents,
the parties may agree to make the
lender a minority equity holder of the
borrower. This may address some
of the issues inherent in relying
solely on the amendments to the
borrower’s operating agreements.