Advisories May 8, 2020

Financial Restructuring & Reorganization Advisory: Delaware Courts Leery of Shareholder Obstruction

Executive Summary
Minute Read

Our Financial Restructuring & Reorganization Group examines the implications of a bankruptcy case where the majority shareholder seeks to enforce its blocking rights.

  • In re Pace Industries; Bankruptcy Court for the District of Delaware
  • The public policy implications of provisions conferring upon one party the exclusive right to authorize/block a bankruptcy filing
  • Is it wise to exercise blocking rights, preventing a bankruptcy filing, in the current economy?
“Blocking rights”—corporate governance provisions designed to prevent management from putting a company in a Chapter 11 case without certain stockholders’ consent—have increasingly been the focus of bankruptcy courts across the country. On May 5, 2020, Judge Mary Walrath of the U.S. Bankruptcy Court for the District of Delaware refused to dismiss a corporate debtor’s pending bankruptcy case on account of the debtor’s failure to seek the consent of a stockholder with blocking rights.

Pace Industries, an Arkansas-based manufacturer of aluminum, zinc, and die cast and major supplier to the auto industry, sought Chapter 11 protection on April 12 in the District of Delaware, along with 10 affiliated entities (In re Pace Industries, No. 1:20-bk-10927). Leading up to the bankruptcy filing, Pace was experiencing severe liquidity issues to the extent that it had a mere $150,000 in cash at the time of filing. Still, Pace and its affiliates entered bankruptcy already proposing a prepackaged plan that would restructure approximately $324 million in debt, primarily through a debt-for-equity swap.

Five days after the bankruptcy petition was filed, the majority shareholder sought to dismiss the bankruptcy case because Pace did not obtain the shareholder’s consent before seeking Chapter 11 protection. In its motion to dismiss, the shareholder alleged that its stock purchase agreement gave it the right to approve or veto any bankruptcy or liquidation filings in exchange for its equity infusion.

In its objection to the motion to dismiss, the company argued that circumstances such as Pace’s allowed a company to seek bankruptcy protection without the shareholder’s consent because enforcing the right would conflict with the important public policy of assuring companies can seek federal bankruptcy relief when needed or when it would be inequitable. Pace further alleged that the shareholder’s attempt to block the bankruptcy filing was actually aimed at achieving leverage in its negotiations with the debtor’s lenders.

At the hearing, the debtor’s position was supported by the agent for its $232.1 million in secured notes. The agent emphasized at the hearing that, were the court to rule for the shareholder, the agent and other creditors were prepared to immediately launch an involuntary Chapter 11 proceeding, which would ultimately place the debtor back in the same position.

At the hearing, the shareholder pointed the court to the recent Fifth Circuit ruling on a similar issue where it concluded that an investor was not prevented from exercising its blocking rights to stop the corporation from seeking bankruptcy protection. Judge Walrath indicated that she “respectfully would decline to follow that case.” She stated further, “I do believe, under Delaware state law, contrary to the Fifth Circuit, my interpretation of the law would and does find that blocking rights, such as exercised in the circumstances of this case, would create a fiduciary duty on the part of the shareholder.” 

Judge Walrath ultimately sided with the debtor and the agent to its secured lenders, holding that the shareholder’s blocking rights provision “violates public policy and is void.” 

Due to COVID-19 and the state of the global economy, many companies are considering or are currently engaging in the process of a bankruptcy filing. Companies with blocking rights governance provisions (and the stockholders that enjoy those rights) should carefully examine the outcome of this ruling to determine whether their provision is enforceable. Similarly, any lender that has obtained or intends to require the issuance of an authority to file an opinion, analyzing the interplay of state-based corporate law and federal bankruptcy law with the authority needed to commence a bankruptcy case, should carefully consider whether bankruptcy courts will follow Judge Walrath’s ruling. 

Alston & Bird has formed a multidisciplinary task force to advise clients on the business and legal implications of the coronavirus (COVID-19). You can view all our work on the coronavirus across industries and subscribe to our future webinars and advisories.
Media Contact
Alex Wolfe
Communications Director

This website uses cookies to improve functionality and performance. For more information, see our Privacy Statement. Additional details for California consumers can be found here.