Court Invalidates the Use of Blocking Directors as Against Public Policy
By: Samantha Guido
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
The use of a blocking director is a common practice by creditors looking to mitigate the risk of a debtor’s bankruptcy filing. In In re Lake Michigan Beach Pottawattamie Resort LLC, the United States Bankruptcy Court for the Northern District of Illinois held that a blocking director provision was invalid because it impermissibly eliminated the fiduciary duty owed by the creditor to the debtor. In interpreting Michigan corporate governance law, the court reasoned that the use of blocking directors is generally permissible. The provision in this case, however, contracted away the fiduciary duty on the part of the blocking director, and that is impermissible. The debtor granted a mortgage and assignment of rents to BCL – Bridge Funding (“BCL”) to secure a loan and a line of credit given by BCL to the debtor. The debtor defaulted on his payment and created a Third Amendment establishing BCL as a “Special Member” with the right to approve or disapprove any material action by the debtor. The provision requires the debtor to obtain BCL’s consent, which can be withheld for any reason, before filing for bankruptcy. The agreement also contained a waiver of the fiduciary duty owed by the special member to the debtor by stating that BCL was not obligated to consider any interests but their own and has no obligation to give any consideration to the debtor’s interests. When the debtor filed for bankruptcy, four out of five creditors voted in favor of the filing, with BCL withholding its vote. BCL, in its motion to dismiss the debtor’s chapter 11 case, argued that the debtor was not authorized to file for Chapter 11 bankruptcy because the debtor did not have the consent of the blocking director.
The court determined that the use of a blocking director and the requirement of a unanimous vote by the creditors in order for a debtor to file for bankruptcy was permissible under Michigan law. The court then analyzed whether the blocking director described in the Third Amendment was against public policy. Relying on case law, the court noted that a corporate entity, similar to that of an individual, may not contract away its right to file for bankruptcy. Typically, the blocking director’s purpose is to exercise his vote in favor of the creditor. A director, including a blocking director, however, also has a fiduciary duty to the corporate entity. The provision prohibiting the debtor from filing for bankruptcy without consent from the blocking director, as noted in the Third Amendment, is impermissible as against public policy because it allows BCL to block the debtor’s attempt to avail itself of bankruptcy relief without owing a fiduciary duty to the debtor.
Courts are reluctant to find debtors ineligible for bankruptcy. While blocking director provisions may be permissible by law, courts have held that the blocking director still owes a fiduciary duty to the creditor and provisions contracting away that duty invalidate the blocking director as against public policy. The United States Bankruptcy Court for the District of Delaware in In re Intervention Energy Holdings, LLC held that requiring the consent of a blocking director with no fiduciary duty for a debtor to file for bankruptcy is “tantamount to an absolute waiver” of the right to file for bankruptcy and “is void as contrary to federal public policy.” Already in 2016, courts have been putting limitations on the powers of blocking directors; indeed, finding them not contrary to federal or state law but instead impermissible contrary to public policy. The court’s holding in In re Lake Michigan Beach Pottawattamie Resort LLC emphasizes the importance of a debtor retaining its right and discourages the use of blocking directors to inhibit this right.
 Darren Azman & Michael Galen, Blocking a Bankruptcy Filing Still a Remote Possibility, Law 360 (May 6, 2016), http://www.law360.com/articles/792943/blocking-a-bankruptcy-filing-still....
 547 B.R. 899 (Bankr. N.D.Ill. 2016).
 Azman & Galen, supra note 1.
 Matthew J. Gold, Courts Cast Doubt on Common Bankruptcy – Blocking Tactic, Law 360 (June 23, 2016), http://www.law360.com/articles/809898/courts-cast-doubt-on-common-bankru....
 In re Lake Mich. Beach Pottawattamie Resort LLC, 547 B.R. at 903.
 Id. at 903-04.
 Id. at 904.
 Id. at 909.
 Id. at 910.
 Id. at 911.
 Id. at 912.
 Id. at 913–14.
 See In re Lake Mich. Beach Pottawattamie Resort LLC, 547 B.R. 899; see also In re Intervention Energy Holdings, LLC, No. 16-11247, 2016 Bankr. LEXIS 2241 at *15 (Bankr. D. Del. 2016).
 2016 Bankr. LEXIS 2241 at *17.
 Gold, supra note 4.