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Oregon Bankruptcy Court Throws Out Pre-Bankruptcy Waiver

Posted on: May 12, 2014

The inclusion of pre-bankruptcy waivers in “standard issue” credit documents has generated a host of litigation in bankruptcy cases about the enforceability of such provisions. While certain waivers among creditor classes have been called “safe” (e.g., a junior creditor waiving the right to object to actions by a more senior creditor), bankruptcy courts have generally balked at upholding waivers by a debtor of fundamental bankruptcy rights, such as the right to commence a chapter 11 case. The usual rationale cited for striking down such provisions is that they violate public policy and prevent the orderly reorganization that Chapter 11 is designed to foster. 

Recently, the United States Bankruptcy Court for the District of Oregon (the “Bankruptcy Court”) in In re Bay Club Partners-472, LLC, (In re Bay Club), Case No. 14-30394 (Bankr. D. Oregon) [Dkt. No. 141], found itself calling balls and strikes on a novel pre-bankruptcy waiver. In Bay Club Partners, the debtor, a manager-managed Oregon LLC, did not have a pre-bankruptcy waiver in its credit documents as is typical. Instead, Bay Club’s secured lender, Legg Mason Real Estate CDO I, Ltd. (“Legg Mason”), insisted on a restrictive covenant in Bay Club’s LLC Operating Agreement that precluded the company from filing for bankruptcy until Legg Mason’s secured debt was repaid. When Bay Club commenced a chapter 11 case in the Bankruptcy Court after defaulting under its secured debt, Legg Mason tried a “pick-off” move by filing a motion to dismiss the case for cause. In its motion to dismiss, Legg Mason argued that the restrictive covenant contained in Bay Club’s LLC Operating Agreement was consistent with Oregon state law and, therefore, enforceable against Bay Club in its bankruptcy proceeding. Trail Ranch Partners, a minority member of Bay Club, supported Legg Mason’s motion to dismiss. It had not consented to the bankruptcy filing prepetition.

After holding an evidentiary hearing, the Bankruptcy Court denied the motion to dismiss, finding the issue of enforceability of a prepetition waiver governed by federal law and not state law. Under federal law, applicable Ninth Circuit precedent was clear that a debtor’s prepetition waiver of the right to file a bankruptcy case was unenforceable on public policy grounds. Therefore, the Bankruptcy Court held that the restrictive covenant in Bay Club’s LLC Operating Agreement was also unenforceable. That the members of Bay Club signed the Operating Agreement among themselves rather than acquiescing to the bankruptcy waiver in a loan agreement was held by the Bankruptcy Court as a “distinction without a meaningful difference.”

Legg Mason and Trail Ranch Partners also challenged Bay Club’s bankruptcy filing on the ground that Bay Club’s managing member did not have authority to commence the chapter 11 case without the affirmative consent of 100% of Bay Club’s members. Here too, however, the Bankruptcy Court disagreed.  Although Bay Club’s manager undertook to get affirmative written consent from the LLC members to the filing in the hope of avoiding unnecessary litigation later, the Bankruptcy Court found that the Operating Agreement granted the manager expansive powers to conduct and further the interests of the LLC, both in and outside of the ordinary course, which powers included commencement of the chapter 11 case. Therefore, despite Trail Ranch Partners failure to sign the member consent to the bankruptcy filing, the bankruptcy was properly authorized by the manager who required no additional corporate authority to act. And that, as they say, was the ballgame….