Court Blocks Investor’s Use of ‘Golden Shares’ to Prevent BANKRUPTCY FILING

BY CANDICE M. CARSON & CHRISTOPHER R. MADDUX, ATTORNEYS, BUTLER SNOW LLP

n football, proper blocking helps a debtors a new page for their offensive filing for bankruptcy. Because a bona team control the line of scrimmage. playbook when hers became the first fide equity holder’s ability to exercise its IBecause a bankruptcy filing can shift court to hold that a shareholder’s golden share to prevent a bankruptcy the power away from an investor to the attempt to exercise its voting right filing was not previously in question financially distressed company, investors in the company’s certificate of (see In re Franchise Servs. of N. Am., often have sought to “control the line incorporation to prevent the filing Inc., 891 F.3d 198, 203 (5th Cir. 2018)), of scrimmage” and block companies of a voluntary bankruptcy petition is this decision may have far-reaching in which they have invested from contrary to federal public policy. repercussions in the wake of the filing for bankruptcy. This has become COVID-19 pandemic and the resulting more difficult following a recent bench Although the court was careful to limit economic downturn as shareholders ruling by Bankruptcy Judge Mary F. its decision to the circumstances of attempt to protect their investments. Walrath in In re Pace Indus., LLC, No. July/Aug the case, the ruling touches upon the 2020 20-10927 (Bankr. D. Del. May 5, 2020). enforceability of provisions referred to as The Players “blocking provisions” or “golden shares,” Founded in 1970, Pace Industries LLC Journal of Corporate Walrath of the U.S. Bankruptcy Court which give shareholders authority to and its affiliated debtors comprise one of Renewal for the District of Delaware gave consent to or block a company from the largest suppliers of aluminum, zinc, 28 and magnesium die-cast and finished restated certificate of incorporation, engaged restructuring professionals products in North America, operating which included a negative control to help it address its liquidity needs nine die-casting manufacturing plants blocking provision requiring the and negotiate a transaction with its (seven in the United States and two in consent of a majority of the holders lenders that would provide it with Mexico), two tool and die shops, and of Series A preferred stock prior to a necessary liquidity infusion and two painting and finishing shops. the filing of a voluntary bankruptcy deleverage its balance sheet. petition by KPI Intermediate or its In 2018, Macquarie Septa (US) I LLC and subsidiaries. Though Macquarie Sierra During the negotiations, the United its affiliate, Macquarie Sierra Investment had sold its shares, as of the petition States, along with the rest of the world, Holdings Inc., purchased 250 shares date, Macquarie Septa held 62.5% of KPI was hit by the COVID-19 pandemic, and 150 shares, respectively, of Series A Intermediate’s Series A preferred stock. resulting in a global economic preferred stock issued by debtor KPI shutdown due to stay-at-home orders July/Aug Intermediate Holdings Inc., the direct In January 2020, after failing to raise that vastly exacerbated Pace’s already 2020 parent of Pace Industries LLC. As part new equity in conjunction with a tenuous liquidity position. As a result Journal of of the investment transaction, KPI launch of new automotive products Corporate Intermediate adopted an amended and and a stymied sale process, Pace Renewal continued on page 30 29 In denying the motion to dismiss, Walrath held that the blocking provision in KPI Intermediate’s certificate that would bar the filing of the debtors effectively acted as a waiver of rights granted under the Bankruptcy Code, violating federal public policy, and thus was void as exercised by Macquarie under the circumstances of the case.

continued from page 29 A Page Out of an Earlier Playbook Delaware state law, (2) the court lacked In In re Franchise Servs. of N. Am., Inc., subject matter jurisdiction over the of the pandemic, Pace was forced the 5th U.S. Circuit Court of Appeals unauthorized petitions, and (3) a bona to shut down five of its seven U.S.- held that federal bankruptcy law did not fide shareholder’s exercise of its consent based die-casting facilities and lay off prevent a bona fide shareholder from right over the bankruptcy filing of a approximately 70% of the employees exercising its consent right to prevent corporation is not void as against federal who worked in those plants. Pace was a corporation from filing a voluntary public policy favoring bankruptcy. ultimately able to reach a deal with bankruptcy petition just because it its prepetition secured creditors and was also an unsecured creditor. In re In denying the motion to dismiss, filed a voluntary bankruptcy petition Franchise Servs. of N. Am., Inc., 891 F. Walrath held that the blocking provision on April 12, 2020, to implement its 3d. at 203. Declining to rule on whether in KPI Intermediate’s certificate that prepackaged plan without seeking such shareholder consent provisions would bar the filing of the debtors authorization from Macquarie. On the violate Delaware state law, the 5th Circuit effectively acted as a waiver of rights petition date, Pace had approximately rejected the debtor’s argument that granted under the Bankruptcy Code, $146,000 in available liquidity. Boketo LLC, the complaining minority violating federal public policy, and thus shareholder, was acting as a controlling was void as exercised by Macquarie Under the proposed restructuring minority shareholder and thus owed under the circumstances of the case. transaction, the debtors’ prepetition a fiduciary duty to the corporation The court declined to follow the senior secured noteholders were in exercising its blocking right. distinction drawn by the 5th Circuit, to receive 100% of the equity of which found that blocking provisions reorganized Pace Industries LLC, The 5th Circuit found that there was no that would be void when exercised by subject to dilution by new warrants evidence of actual control on the part self-interested creditors were valid when to be issued to certain postpetition of Boketo, despite its 49.75% stake in exercised by bona fide shareholders. lenders and new equity that may be the company. The 5th Circuit further issued under a management incentive found that even if there was a breach Noting the distinction without a plan. The debtors’ general unsecured of fiduciary duty by Boketo, the proper difference, the court found that the claims were expected to be unimpaired, remedy for such a breach would be a federal public policy which allowed while old equity would be wiped out. state law claim and not for the court any entity to seek the protection of to allow the company to disregard its the Bankruptcy Courts was the same, On April 13, 2020, immediately after charter to declare bankruptcy absent regardless of who sought to block a the petition date, Macquarie filed shareholder consent. Id. at 214. filing. Highlighting Pace’s undisputed a notice filing citing the blocking need for bankruptcy and lack of provision in the certificate and Citing In re Franchise Servs. of N. Am., alternative options, the court further asserting that because it had not Inc., in its motion to dismiss, Macquarie found that blocking rights under given permission for the voluntary argued that dismissal was warranted Delaware law would create a fiduciary July/Aug petition, as the majority holder of KPI because (1) the debtors did not have duty on the part of the minority 2020 Intermediate’s Series A preferred stock, authority to file the voluntary petitions shareholder, which duty must be the bankruptcy petitions were invalid. exercised in the best interest of both the Journal of from Macquarie and, as a result, the Corporate Shortly thereafter, on April 17, 2020, debtors’ voluntary petitions were not company and the creditors when the Renewal Macquarie filed its motion to dismiss. authorized as a matter of applicable company is in the zone of insolvency. 30 A New Game Plan? What is interesting about Walrath’s Christopher R. Maddux serves as chair of Butler decision is that the court not only found Snow LLP. He is an experienced business attorney that the entire concept of blocking whose practice focuses on bankruptcies, business provisions may be void as against reorganizations, and distressed transactions. public policy but also imposed a new Maddux regularly serves as debtor’s counsel in a fiduciary duty on minority shareholders wide range of Chapter 11 bankruptcy cases and seeking to exercise such rights. restructurings, and represents asset purchasers in distressed commercial transactions. He currently Prior to this decision, Delaware law held is president of the Mississippi Bankruptcy that to impose a fiduciary duty on a Conference. Maddux holds an undergraduate minority shareholder, such shareholder degree and a law degree from Vanderbilt University. must exercise actual control over the corporation. See In re Franchise Servs. of N. Am., Inc., 891 F. 3d. at 211 (collecting cases and noting that “[t]he standard Candice M. Carson is a member of Butler Snow’s for minority control is a steep one. business department and practices within the Potential control is not enough. Instead, finance, real estate, and restructuring group the shareholder must ‘dominat[e]’ the in the firm’s Dallas office. She has experience corporation ‘through actual control counseling clients in restructuring and contingency of corporation conduct.’’’) (internal planning, both in and out of court, across a citations omitted); see also In Basho variety of industries, including automotive, Techs. Holdco B, LLC v. Georgetown airline, oil and gas, and retail. Carson holds Basho Investors, LLC, No. CV 11802- a law degree from Harvard University and a VCL, 2018 WL 3326693, at *26 n.315 bachelor’s degree from the University of Florida. (Del. Ch. July 6, 2018), aff'd 221 A.3d 100 (Del. 2019) (citing cases and noting that “[a]s with other indicators of control, a blocking right standing alone is highly unlikely to support either a finding or a reasonable inference of control.”). JCR-Island_v1.qxp_Layout 1 4/6/20 5:52 PM Page 2 In making this decision, Walrath appeared to be driven by Pace’s undisputed need for bankruptcy, the lack of alternative options presented by Macquarie in the face of a prepackaged BUYING, SELLING & LENDING ON plan that proposed to pay general unsecured creditors in full, and the current state of economic emergency ALL TYPES OF USED MFG EQUIPMENT precipitated by the COVID-19 pandemic. Though entirely dependent on the This Includes...COMPLETE AUCTION SERVICES! context of the case, Walrath’s decision presents a new data point to investors relying on similar blocking provisions to protect their equity investments during the current downturn.

Shareholders who previously may have been free to use their leverage in the form of a golden share to negotiate a tip in the face of an inevitable filing or to garner a seat at the table with the fulcrum creditors during prepetition plan negotiations may find their leverage undercut in the wake of this decision. It will be interesting for practitioners to trace the potential fallout in the wake of Pace Industries and the expected uptick in bankruptcy filings and out-of-court restructurings. J July/Aug Contact Tim Serritella for More Information 2020

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