PCG Credit Partners, LLC (“Lender”) loaned $6,150,000 to Lexington Hospitality Group, LLC (“Borrower”). Lender conditioned the loan on the amendment of Borrower’s operating agreement, to give an LLC owned and controlled by Lender a 30% membership interest in Borrower, and to add provisions limiting Borrower’s ability to file bankruptcy. The new provisions were: (1) Borrower could declare bankruptcy only with the consent of an independent manager, and then only upon a 75% vote of the members, and (2) Borrower could not file bankruptcy without the advance written consent of Lender and all members of Borrower (contradicting the 75% requirement).
Later, Borrower filed for chapter 11 bankruptcy and neither obtained the independent manager’s authority nor a 75% vote. Lender filed a motion to dismiss, arguing that the filing violated the bankruptcy restrictions in the operating agreement.
The Court denied Lender’s motion, holding the bankruptcy restrictions were void. There is a strong federal public policy in favor of a debtor’s right to a fresh start in bankruptcy, and accordingly, prepetition agreements that prohibit a debtor’s ability to file bankruptcy without a lender’s consent are void. Members can agree among themselves not to file bankruptcy, but the decision cannot be controlled by a single minority equity holder with no duties to the debtor. Here, the bankruptcy restrictions enabled the LLC controlled by Lender to carry the deciding vote. Moreover, even if that member voted in favor, Lender still had a veto. The Court found these restrictions amounted to an absolute waiver of Borrower’s right to file bankruptcy, and were therefore void.
In dicta, the Court noted the requirement for the consent of an independent manager does not necessarily offend federal public policy and avoids the risk of members and managers filing bankruptcy out of self-interest. But in this case, the independent manager was a pretense because of the requirements of a 75% vote and Lender’s consent, which allowed Lender to block a bankruptcy filing, even if the independent manager was in favor of one.
