May 26, 2020

Distressed Deals: Bankruptcy Court Ruling Tarnishes “Golden Shares”

The term “golden share” is used to refer to an equity security that provides its holder with a number of consent rights, including the right to block a bankruptcy filing. Courts have differed on the enforceability of golden share provisions under Delaware law.  A 2016 Bankruptcy Court decision held that the ability to prevent a bankruptcy filing was against public policy, while a 2018 5th Circuit case applying Delaware law upheld such a provision.  This Proskauer memo discusses those decisions, as well as a recent Bankruptcy Court decision striking down a golden share provision. This excerpt reviews that decision:

Recently, the efficacy of the “golden share” was tested again in a bankruptcy filing by Pace Industries (In re: Pace Industries, LLC, Case No. 20-10927-MFW (Bankr. D. Del.)). In connection with its $37.15 million preferred equity investment, the preferred shareholder obtained various rights and protections, including an amendment and restatement of the company’s corporate charter to include a “golden share” provision.

In the wake of the COVID-19 pandemic, Pace Industries found itself in dire financial straits, unable to pay hundreds of millions of dollars of debt, closing many of its manufacturing facilities, and laying off the majority of its employees. However, the company successfully negotiated a restructuring and filed a Chapter 11 petition to implement the restructuring, which was supported by the company’s secured creditors and which proposed to pay unsecured creditors in full. The preferred shareholder did not consent to the petition and moved to dismiss the case.

In denying the motion to dismiss, Judge Walrath was keenly focused on the harsh reality facing Pace Industries. The court was persuaded by the fact that the COVID-19 outbreak had forced the company to shut down most of its operations and that the proposed debtor-in-possession financing was the company’s only source of liquidity in the midst of the global pandemic. Furthermore, Judge Walrath observed that the preferred shareholder had not offered any viable alternatives.

As a result, the court concluded that permitting the bankruptcy filing would likely benefit the greatest number of stakeholders, while dismissing the bankruptcy case would violate federal public policy by taking away a debtor’s constitutional right to bankruptcy relief. In declining to follow the Fifth Circuit’s interpretation of Delaware state law, Judge Walrath went so far as to conclude that a blocking right might create a fiduciary duty on the part of a minority shareholder.

If that last sentence about minority blocking rights potentially creating fiduciary duties sounds familiar, it’s probably because it echoes the Chancery Court’s recent decision in Skye Mineral Investors, LLC v. DXS Capital (U.S.) (Del. Ch.; 2/20), which reached a similar conclusion in a non-bankruptcy setting.

John Jenkins