Debtor May Avoid Bankruptcy Remote Provisions by Orchestrating Filing of Involuntary Bankruptcy

DEBTOR MAY AVOID BANKRUPTCY REMOTE PROVISIONS BY ORCHESTRATING FILING OF INVOLUNTARY BANKRUPTCY

In order to increase certainty and to decrease the cost of borrowing, lenders have increasingly sought to prevent borrowers from filing bankruptcy petitions by including "bankruptcy remote provisions" in their borrowers' bylaws. Bankruptcy remote provisions are designed to make bankruptcy unavailable to a borrower without the affirmative consent of the lender’s designee on the borrower’s board of directors.

In In re Kingston Square Associates (Bankr. S.D.N.Y. Sept. 24, 1997) (Brozman, J.), the United States Bankruptcy Court for the Southern District of New York addressed whether borrowers could avoid bankruptcy remote provisions by orchestrating the filing of involuntary bankruptcy petitions against themselves. The bankruptcy court's opinion is notable for its (i) holding that, where a debtor may have equity in the collateral, a debtor may avoid a bankruptcy remote provision by orchestrating the filing of an involuntary bankruptcy petition against itself, (ii) statements concerning the fiduciary duties of a lender's designee on a borrower's board of directors, (iii) statements concerning a lender's duty to creditors and equity holders after the lender has foreclosed upon the interests of the debtor's equity holders.

The borrower-debtors consisted of eleven corporations and real estate partnerships. The debtors owned apartment complexes in Florida and New York. Each of the debtors had granted a mortgage on its real property as part of a mortgage-backed securitization.