Bankruptcy Remote Special Purpose Entities Are Not Necessarily Bankruptcy Proof

In In re Lake Michigan Beach Pottawattamie Resort LLC.,[1] Judge Timothy A. Barnes of the Northern District of Illinois addressed an issue that is crucial to many business transactions—to what extent are entities protected against a bankruptcy filing by restrictive provisions placed in the entities' organizational documents? The restrictions often include the creation of a special purpose entity ("SPE") which holds collateral, the appointment of an independent director of the SPE by the lender, and the requirement that all directors unanimously consent before the SPE can file a voluntary petition under the United States Bankruptcy Code.[2] This organizational structure is designed to ring fence the assets of the SPE from the claims of creditors other than the lender and is often a condition to the lender's willingness to make the loan. Although Lake Michigan Beach dealt with restrictions arising in connection with a loan workout rather than a structure created in connection with the origination of the loan, the principles discussed therein are applicable to all SPEs.

THE FACTS

In January 2015, BCL-Bridge Funding LLC ("BCL") extended a $1.3 million term loan and a $500,000 line of credit secured by a mortgage on Lake Michigan Beach's vacation resort in Coloma, Michigan. The debtor defaulted in July 2015 and, in connection with a forbearance agreement, BCL required an amendment to the debtor's Operating Agreement which provided for the appointment of a Special Member who had the right to approve or disapprove any "Material Actions" taken by the debtor. Material Actions were defined to include the filing of a petition in bankruptcy. The Special Member had no interest in profits or losses of the debtor, no right to distributions and was not required to make capital contributions. Significantly, the amendment provided that, in exercising its rights, BCL was not obligated to consider any interests other than its own, and had "no duty or obligation to give any consideration to any interest of or factors affecting the Company or the Members."[3]

When the debtor failed to pay the obligations owed to BCL by the October 21, 2015 deadline specified in the forbearance agreement, BCL commenced a foreclosure action. The day before BCL was scheduled to conduct a non-judicial foreclosure sale under Michigan law, the debtor filed a petition for relief under Chapter 11 of the Code based upon the consent of only the non-BCL Members. BCL moved to dismiss the...