Bankruptcy Judge Upholds Lender-Imposed Independent Manager Consent Requirement for Borrower’s Bankruptcy Filing
It is commonplace for real estate lenders to require their borrowers to adopt corporate governance controls, such as the appointment of an independent director and restrictions on the borrower’s ability to make major decisions, including the filing of a bankruptcy petition. The desire to prospectively interfere with a sponsor’s ability to place the borrower in bankruptcy must account for the risk that such restrictions may later be deemed void on public policy grounds. In a number of cases, courts have invalidated pre-bankruptcy agreements curtailing a borrower’s right to file for bankruptcy. However, a recent decision[1] from the Bankruptcy Court for the Northern District of Illinois in Chicago enforced provisions in an LLC operating agreement prohibiting a bankruptcy filing without the unanimous consent of all members and managers of the LLC, including the independent manager.
In re 301 W N. Ave.
a. Facts
The debtor’s primary asset was a mixed-used real estate development in Chicago. In September 2020, the lender’s predecessor-in-interest made a $26 million loan to the debtor secured by the property. The loan agreement required the debtor’s organizational documents to include various provisions, including that:
- “[A]t all times there shall be at least one (1) duly appointed member of its board of directors or managers, as applicable (an ‘Independent Director’) reasonably satisfactory to Lender[.]”
- Without the unanimous written consent of all members, as well as the consent of the Independent Director, the debtor will not file or consent to the filing of any petition in any domestic or foreign jurisdiction relating to bankruptcy.
- The debtor’s board “shall not take any action which, under the terms of any organizational documents” requires the unanimous vote of the board of directors or managers “unless at the time of such action there shall be at least one (1) Independent Director[.]”
As part of the loan transaction, the debtor, its manager, and its two members entered into a limited liability operating agreement (the “LLC Agreement”) incorporating the provisions required by the loan agreement, among others. Importantly, the LLC Agreement provided that in exercising their rights and performing their duties under the LLC Agreement, the independent manager “shall . . . have a fiduciary duty of loyalty and care similar to that of a director of a business corporation organized under the General Corporation Law of the State of Delaware.” In addition, the LLC Agreement directed the independent manager to consider only the interest of members of the debtor and the debtor itself (including its creditors), to the extent of their economic interest in the company and to the exclusion of the economic interests of third-parties, including affiliates of members and managers, in acting or otherwise voting on the matters provided for in the LLC Agreement.
The debtor contracted with a staffing company to assist the debtor’s search for an independent manager. The staffing agreement provided that in the event any matter came before the debtor’s governing body for consideration, the debtor would provide the independent manager with reasonable time and assistance to investigate the matter and perform due diligence, including allowing the independent manager in its sole discretion to engage counsel or other advisors.
The loan matured in October 2023 and consequently the debtor defaulted under the loan. The debtor filed its Chapter 11 petition in February 2024, several months after the lender commenced a foreclosure action against the debtor. The president of the debtor’s manager signed the Chapter 11 petition on behalf of the debtor. The independent manager did not consent to the bankruptcy filing nor was she ever consulted about the bankruptcy filing. The lender filed a motion to dismiss on the grounds that the debtor lacked the authority to file the petition.
b. Ruling
The court found that the debtor failed to obtain the consent of the independent manager for the bankruptcy filing, as required by the LLC Agreement. It then addressed, and ultimately rejected, the debtor’s contention that the bankruptcy was nonetheless properly filed because the LLC Agreement’s restrictions on filing for bankruptcy are unenforceable. To start its analysis, the court observed that “if an operating agreement creates a structure in which a director's fiduciary duties are respected and that complies with non-bankruptcy statutes or law, it is enforceable. Provisions restricting the exercise of fiduciary duties that effectively nullify or eliminate the right to file bankruptcy violate public policy and are not enforceable.”[2]
Based on the foregoing principles, the court had little trouble concluding that the independent manager’s consent rights in the LLC Agreement for a bankruptcy filing is enforceable and not against public policy. The court chiefly relied on the provision in the LLC Agreement imposing on the independent manager a fiduciary duty of loyalty and care and the staffing agreement’s requirement on the debtor to allow the independent manager to properly conduct due diligence of matters before the board. The court distinguished two decisions invalidating limitations on bankruptcy relief – a case in which a lender was appointed as a “special member” pursuant to a forbearance agreement[3] and another involving a “golden share” endowing a creditor and minority equity holder with “with ultimate authority to eviscerate the right of the [company] to seek federal bankruptcy relief….”[4]
Takeaway
The appointment of an independent director with bankruptcy consent rights offers a powerful tool for lenders. As illustrated in 301 W N. Ave., the level of independence of the director may determine whether the bankruptcy consent right is unenforceable if the issue is ever litigated. The 301 W N. Ave. decision provides timely guidance on drafting consent rights and related provisions in loan documents and governance documents that may withstand attacks by distressed borrowers and their sponsors.
Contact
Should you have any questions regarding this topic, please do not hesitate to contact Robert J. Malatak, Wayne S. Cook, Jr., or Eloy A. Peral, or your Windels Marx relationship lawyer.
Disclaimer
In some jurisdictions, this material may be deemed as attorney advertising. Past results do not guarantee future outcomes. Possession of this material does not constitute an attorney/client relationship.This material should not be relied upon as a primary research source, and should issues arise pertaining to matters discussed herein, those issues should be independently researched.
[1] In re 301 W N. Ave., LLC, 666 B.R. 583 (Bankr. N.D. Ill. 2025).
[2] Id. at 598 (footnote omitted).
[3] Id. at 599 (citing In re Lake Michigan Beach Pottawattamie Resort LLC, 547 B.R. 899, 913 (Bankr. N.D. Ill. 2016)).
[4] Id. (quoting In re Intervention Energy Holdings, LLC, 553 B.R. 258, 265 (Bankr. D. Del. 2016)).
