Newsflash: US Bankruptcy Filing Limitations - How Far Can You Go?

October 04, 2017

In order to file for bankruptcy, a corporate entity must be legally authorized to do so. Whether the bankruptcy petition has been duly authorized is governed by state law and often depends on the entity’s governance documents. If a petition has not been properly authorized, creditors may seek its dismissal.

Lenders, either in structured finance transactions or otherwise, routinely seek to limit their bankruptcy exposure by requiring that the borrower’s corporate governance documents include “bankruptcy remote” provisions which, inter alia, make filing for bankruptcy more difficult. This can be done as a precondition to lending or subsequently in a default situation such as a forbearance. The question, however, is whether such restrictions are enforceable in light of the public policy in favor of allowing a fresh start through bankruptcy. In In re Lexington Hospitality Group, LLC, Case No. 17-51568-grs (Bankr. E.D. Ky. Sept. 15, 2007), the bankruptcy court held that creditor-imposed restrictions in a limited liability company’s operating agreement that prohibited the company from filing bankruptcy without the creditor’s consent were unenforceable as a matter of federal public policy. The court also criticized the appointment of an independent manager who was given sole responsibility to pre-authorize any bankruptcy filing because the manager was not truly independent and the operating agreement purported to abrogate the manager’s fiduciary duties.

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