Corporate Governance In Chapter 11 – Business As Usual, With Possible Exceptions

Under the Bankruptcy Code, a debtor in possession operates its business “as usual” during the pendency of a case. Likewise, in most cases, prepetition corporate governance practices and procedures should continue post-petition. In fact, as Judge Sontchi recently held in In re SS Body Armor I, Inc., Case No. 10-1125(CSS) (Bankr. D. Del. April 1, 2015), the right of a shareholder to compel a shareholders’ meeting for the purpose of electing a new board of directors continues during bankruptcy.  Absent “clear abuse,” the automatic stay of 11 U.S.C. §  362 is inapplicable.`

Not surprisingly, Judge Sontchi’s decision arose in a contentious case. Prepetition, a class of shareholders had commenced a class action against the debtors, David H. Brooks (SS Body Armor’s former CEO) and Jeffrey Brooks (David H. Brooks’ brother). These parties had competing claims to escrowed funds in the amount of $37 million. David Brooks was criminally convicted for, among other things, securities fraud. The district court found that he was liable to SS Body Armor and the class plaintiffs for restitution, which those parties asserted in the respective amounts of $53.9 million and $37.6 million.

During the pendency of the chapter 11, the parties agreed to a settlement which would resolve competing claims to the escrowed funds, fund a chapter 11 plan and resolve claims asserted in the class action and related litigation. The parties executed a settlement agreement and the debtor filed a motion for approval of the settlement under Fed. R. Bankr. P. 9019. Approval of the motion was delayed.

SS Body Armor was required under its by-laws to h old an annual meeting of shareholders, but had held such a meeting in several years. Pursuant to 8 Del C. §  211, Jeffrey Brooks issued a demand for a shareholder meeting. Prior to any hearing on the Rule 9019 motion, Jeffrey Brooks filed a motion with the bankruptcy court for an order finding that an action in the Chancery Court to compel an annual meeting would not violate the automatic stay. In the alternative, he sought relief from the automatic stay.

The debtors opposed the motion, arguing that Jeffrey Brooks controlled a 25% interest in the company and that his goal was to elect a new board which might abandon the settlement. For his part, Jeffrey Brooks relied on the uncontested fact that SS Body Armor had not held an annual meeting in years.

Judge Sontchi easily rejected the argument that a Chancery Court action to compel a shareholders’ meeting (with the ultimate goal of replacing the board) violates the automatic stay, following the decisions in Manville Corp. v. Equity Security Holders Committee (In re Johns-Manville Corp.), 801 F.2d 60, 63 (2d Cir. 1986) and Official Bondholder Committee v. Chase Manhattan Bank (In re Marvel Entm’t Grp., Inc.), 209 B.R. 832 (D. Del 1997). Shareholders are not disenfranchised during the pendency of a chapter 11 case. Judge Sontchi noted, however, that an exception arises where the shareholder’s actions constitute “clear abuse,” combining “delay” with “real jeopardy to the reorganization process.”

While Jeffrey Brooks’ actions might support a finding of “clear abuse,” Judge Sontchi declined to inquire into this issue on procedural grounds.   To the extent that the debtors intended to resist calling an annual meeting, they should file an adversary proceeding under Fed. R. Bankr. P. 7001(7) and seek injunctive relief. Opposition to a motion for relief from the automatic stay cannot provide the basis for an injunction .

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The opinions expressed on this blog are those of the author and are not to be construed as legal advice.

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