The recent decision by an Oregon Bankruptcy Court rejecting an anti-bankruptcy provision in an LLC operating agreement as an invalid bankruptcy waiver highlights the courts’ confusing approach to bankruptcy proofing strategies.  See In re Bay Club Partners-472, LLC, 2014 WL 1796688 (Bankr. D. Ore. May 6, 2014).  A variety of bankruptcy proofing strategies are now popular and they have received mixed reactions from the courts.  One explanation for the inconsistent treatment is the usual tension we see in bankruptcy between policy and rules.

Bankruptcy waivers present a special dilemma because the anti-waiver principle, although accepted as bedrock bankruptcy doctrine, is not found in the statutory language but based on a vaguely-articulated public policy. A broad view of this policy would invalidate terms that have the practical effect of preventing a bankruptcy filing, although the courts have not gone that far.  On the other hand, adherence to too narrow a view would deprive the anti-waiver principle of any real force.

While the Bay Club opinion tries to stake out the middle ground, there is no firm footing available on those shifting sands.  Although not cited by Bay Club, the other important opinion on the enforceability of LLC operating agreement bankruptcy waivers is In re DB Capital Holdings, LLC, 463 B.R. 142 (10th Cir. B.A.P. Dec. 6, 2010) (unpublished). There the court focused on the Bankruptcy Code’s section 301 requirement for filing a voluntary petition and the well-established rule that state law determines the validity of corporate actions.  Since the LLC operating agreement deprived the entity of the power to file a bankruptcy petition, the court concluded that the petition had to be dismissed.  The cases appear to be in conflict, especially since the operative language of the waiver in Bay Clubis identical to that in DB Capital, except for one added comma and one minor grammatical correction.

While the two opinions clearly adopt different approaches, the facts may provide a harmonizing principle.  DB Capital involved a dispute between the primary member of an LLC and its manager (which was owned by the junior member) over whether to file bankruptcy.  While the debtor/manager asserted that the anti-bankruptcy clause was inserted at the secured lender’s request, it produced no evidence of lender coercion.  Thus, the opinion treated the provision as a term governing the members’ relationship and expressly reserved judgment “whether, under the right set of facts, an LLC’s operating agreement containing terms coerced by a creditor would be enforceable.”  Bay Club may be the right set of facts because the debtor established that the anti-bankruptcy provision was inserted into its operating agreement “at the request” of the secured lender.  In contrast to DB Capital, Bay Club avoids the state corporate law issues by asserting that federal law (as embodied in the anti-waiver principle) controls.  As a policy-driven principle, the court applies it both to pre-petition bankruptcy waivers in loan documents and “more cleverly insidious” provisions in operating agreements.

This leaves us in a factual morass with no clear lines.  Indeed, the two opinions appear to diverge on the question of whether a lender request triggers the anti-waiver principle or whether some higher level of coercion is needed.  Either way, it takes little imagination to conceive of even “more cleverly insidious” ways to insert anti-bankruptcy provisions into operating agreements without leaving any lender fingerprints at the scene.