If You Sue Me, I Will File Bankruptcy and You Can't Stop Me! Maybe Not!

by Sidney Goldstein

Excerpt:  

There is a commonly held view that individuals and business entities have a "God Given Right" or at least a Constitutional Right to declare bankruptcy to protect themselves from creditor claims. Not being a theologian, we will only discuss the legal aspect of this point of view. In this EIA we will examine several different scenarios in which either the owners of a business or their lenders have devised schemes which limit the ability of the business entity to voluntarily have access to the bankruptcy courts to delay the enforcement of creditors' claims. As we shall see, not all of these ploys have withstood legal scrutiny.

The Constitution

The right to file bankruptcy is a fundamental right, provided in Article I, Section 8, of the Constitution, pursuant to which Congress has enacted today's "Bankruptcy Code," codified as Title 11 of the United States Code. The Bankruptcy Code governs all bankruptcy cases and established a US Bankruptcy Court in each judicial district, which total 90 in number, presided over by a Bankruptcy Judge. A person or entity subject to a bankruptcy proceeding is called a Debtor.

Given that the Debtor's or a creditor's right to file a bankruptcy petition is a protected Constitutional right, are there any permissible limitations on the exercise of such right? Limitations on this right have arisen in several contexts such as included in the: (a) formation or organizational documents of a business entity, (b) the loan or credit documentation between the Debtor and its creditors, or (c) in an action to block the filing of a creditor's bankruptcy petition. Significant judicial rulings interpreting the scope of this Constitutional right and permissible limitations thereof have been argued and decided in 2009/2010, which will be analyzed below.

Can a Debtor's Owners Prohibit a Bankruptcy Filing?

Before exploring this issue, it must be understood that a business entity such as a limited liability company (LLC) is a separate entity that acts in accordance with its Operating Agreement adopted by each owner or member. Any duly appointed manager can only act in accordance with the authority granted to the manager in the LLC's Operating Agreement. [footnote omitted] [footnote omitted]

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Sidney S. Goldstein is a partner at McCarter & English, LLP, New York office. He is the author of Business Law Monograph, Loan Agreements (Volume G4) (Lexis Nexis Matthew Bender); "How to Help Clients Finance Businesses," 33 Practical Lawyer 25 (Sept. 1987); Co-Author, "Unsecured Creditors' Actions and Remedies in Bankruptcy and Insolvency Cases," Corporate Counseling (N.Y.S.B.A. 1988); Author, "Drafting a Security Agreement for an Offshore Borrower or Offshore Collateral" (2008); Contributing Editor, "Advising Small Businesses"; Lecturer, Credit Law, New York Institute of Credit; Vice Chairman, Banking Law Committee, General Practice Section, American Bar Association; Chair, Business, Corporate and Commercial Law Committee, General Practice Section, American Bar Association; Member, Business Law Section of the American Bar Association; Member, Banking Law Committees of the New York State Bar Association and New York County Lawyers' Association; New York State Bar Association Representative on the Tri-Bar Legal Opinion Committee; Advisor to Revised Article 5 (Letters of Credit) of the Uniform Commercial Code; Member of ABA Task Force on Revised Article 7 (Documents of Title) of the Uniform Commercial Code; Member of ABA Task Force on Deposit Account Control Agreements; Director of the Education Fund of the Commercial Finance Association; Member, Association of Commercial Finance Attorneys; and Member of the New York Bar.