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In re Lake Michigan Beach Pottawattamie Resort LLC

United States Bankruptcy Court, N.D. Illinois
547 B.R. 899 (2016)
ELI5:

Rule of Law:

A provision in a corporate operating agreement that grants a creditor the status of a 'special member' with the power to block a bankruptcy filing is void as against public policy if it also contractually eliminates that member's fiduciary duties to the company. Such a provision removes the essential element—the fiduciary obligation to the company—that makes 'blocking director' structures permissible under corporate and bankruptcy law.


Facts:

  • Lake Michigan Beach Pottawattamie Resort LLC (the 'Debtor') granted a mortgage to BCL-Bridge Funding LLC ('BCL') to secure a loan.
  • The Debtor defaulted on its loan obligations to BCL in July 2015.
  • In exchange for BCL's temporary forbearance from foreclosure, the Debtor executed a 'Third Amendment' to its operating agreement on August 21, 2015.
  • This amendment established BCL as a 'Special Member' of the Debtor, with the power to approve or disapprove certain 'Material Actions,' including filing for bankruptcy.
  • The Third Amendment explicitly stated that BCL, as Special Member, had 'no duty or obligation to give any consideration to any interest of or factors affecting the Company or the Members' and could consider only its own interests.
  • After the Debtor defaulted again, BCL initiated foreclosure proceedings and scheduled a foreclosure sale for December 17, 2015.
  • On December 16, 2015, the Debtor filed for Chapter 11 bankruptcy with the consent of its four original members, but without the consent of BCL.

Procedural Posture:

  • Lake Michigan Beach Pottawattamie Resort LLC ('Debtor') filed a voluntary petition for Chapter 11 bankruptcy in the U.S. Bankruptcy Court for the Northern District of Illinois.
  • BCL-Bridge Funding LLC ('BCL'), a creditor, filed a Motion to Dismiss the bankruptcy case.
  • BCL argued for dismissal on two grounds: that the filing was made in bad faith and that it was unauthorized because BCL, as a 'Special Member,' did not consent to the filing.
  • The Bankruptcy Court held a hearing on the motion.

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Issue:

Does a provision in a limited liability company's operating agreement, which grants a creditor a 'special member' vote to block a bankruptcy filing while also explicitly eliminating any fiduciary duty for that member to consider the company's interests, violate public policy and is therefore unenforceable?


Opinions:

Majority - Judge Timothy A. Barnes

Yes, such a provision is unenforceable as it violates public policy. While corporate control documents can create structures like 'blocking directors' to protect a creditor's interest, the validity of such structures hinges on the director or member retaining their fiduciary duties to the corporation. By explicitly eliminating BCL's fiduciary duty to consider the Debtor's interests, the Third Amendment created an absolute prohibition against bankruptcy filing, which is void. The provision allowing BCL to consider only its own interests 'expressly eliminates the only redeeming factor that permits the blocking director/member construct.' Because the blocking provision is void, the consent of the other members, constituting a majority of sharing ratios under the original operating agreement and Michigan law, was sufficient to authorize the bankruptcy filing.



Analysis:

This decision reinforces the fundamental public policy that entities cannot contract away their right to seek bankruptcy protection. It provides a crucial clarification on the use of 'bankruptcy remote' structures and 'blocking directors,' a common tool in sophisticated financing. The court distinguishes between a permissible structure, where a creditor's appointee must still adhere to fiduciary duties to the debtor entity, and an impermissible one, where those duties are eliminated. This holding establishes a clear boundary for lenders, signaling that stripping a blocking member of all fiduciary obligations transforms a permissible corporate governance mechanism into an unenforceable waiver of bankruptcy rights.

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