Coauthored by Stephen B. Brauerman
The Delaware Court of Chancery recently emphasized that issues of corporate governance remain the purview of the state of incorporation, notwithstanding the filing of a bankruptcy petition and the accompanying automatic stay, which ordinarily acts to halt proceedings against the debtor. Most significant about the court’s opinion in Fogel v. U.S. Energy Systems, 2008 WL 151857 (Del. Ch.) is not that it retained jurisdiction over corporate governance issues following a bankruptcy petition, but rather, the ease with which the court reached its decision. Notably, the court took just one day to issue its opinion and did so without allowing the Bankruptcy Court the opportunity first to consider whether a shareholder could continue to seek relief from the Court of Chancery in an action to compel the company to hold an annual meeting. Given this period of economic uncertainty and the recent increase in bankruptcy filings, this decision should make clear that companies cannot hide behind the Bankruptcy Code’s automatic stay to avoid corporate governance obligations.
THE FOGEL CASE
On Dec. 13, 2007, Chancellor Chandler issued a post-trial memorandum opinion directing U.S. Energy Systems, Inc. (“U.S. Energy”) to hold a shareholder meeting. In its opinion, the court determined that Asher Fogel had not been terminated as U.S. Energy’s Chief Executive Officer when Mr. Fogel exercised the right conferred on the Chief Executive Officer in the company’s bylaws to call a special meeting and, therefore, the exercise of this power by Mr. Fogel was valid and effective. Concerned that the company would take steps to evade the court’s ruling, Mr. Fogel filed a motion requesting that the court order the company to hold the shareholder meeting on Jan. 7, 2008. After the parties briefed the motion, but before the court could rule on it, the company filed for bankruptcy protection in the United States Bankruptcy Court for the Southern District of New York on Jan. 9, 2008.
Relying on § 362 of the Bankruptcy Code, the company argued that the Court of Chancery could not schedule the shareholder meeting it had previously ordered because the automatic stay acts to prohibit all proceedings against the debtor outside the bankruptcy. In response, Mr. Fogel attempted, albeit unsuccessfully, to fit the scheduling of the shareholders meeting into the ministerial act exception to the automatic stay and argued that corporate governance obligations survive the filing of a bankruptcy petition. The company argued that should the court agree with Mr. Fogel that corporate governance obligations survive notwithstanding the bankruptcy, the Bankruptcy Court, and not the Court of Chancery, should properly determine the propriety of scheduling the shareholders meeting after the filing of a bankruptcy petition.
Although Chancellor Chandler noted that setting a date for the shareholder meeting requires the exercise of judicial discretion beyond a mere clerical act rendering the ministerial act exception to the automatic stay inapplicable, nevertheless he found that the automatic stay does not prevent the court from scheduling a shareholder meeting under the facts and circumstances of this case. More notably, Chancellor Chandler refused to defer to the Bankruptcy Court before issuing his decision. As the court explained, “This Court, the Delaware Supreme Court, and federal bankruptcy courts have held that corporate governance does not cease when a company files a petition under Chapter 11 and that issues of corporate governance are best left to the courts of the state of incorporation.” In supporting his decision, Chancellor Chandler noted that the Second Circuit Court of Appeals has already “implicitly approved” the “well-settled rule that the right to [apply to a Delaware court] to compel a shareholders’ meeting for the purpose of electing a new board subsists during reorganization proceedings.”
Hardly ground-breaking, in that state and federal courts within and outside of Delaware previously had held that corporate governance obligations survive the filing of a bankruptcy petition, Fogel is noteworthy because of the ease with which the opinion was issued. Taking less than one day to decide the issue, the Court of Chancery demonstrated its comfort with the impact of the Bankruptcy Code’s automatic stay on corporate governance. Rather than wait for the Bankruptcy Court to decide whether the propriety of scheduling a shareholder meeting ordered prior to the petition date, when faced with an explicit request by the Company to do so, the Court of Chancery clearly and emphatically stated that bankruptcy will not provide a basis for Delaware corporations to avoid their corporate governance obligations.
A close reading of Fogel leaves open the possibility of limited impact because the Court of Chancery simply scheduled a shareholder meeting it had already ordered the company to hold. As a result, one could argue, the court may not have so easily overcome the protections of the automatic stay if it had not previously ordered the company to hold the shareholder meeting. Indeed, the opinion itself seems to welcome such an argument, as the court explained that its ruling merely sets the time when the shareholders will have the meeting to which they are entitled. Such a narrow reading, however, ignores the court’s unmistakable holding that “the right to compel a shareholders’ meeting for the purpose of electing a new board subsists during reorganization proceedings.” While a company may reasonably argue for a limited reading of Fogel to avoid corporate governance obligations, it should do so at its peril because the court’s opinion makes clear that “the passage into bankruptcy does not sound the death knell for the shareholders’ role in corporate governance.” Even in the face of pressure from creditors, troubled companies should not ignore the fundamental corporate governance structure set forth in their charters and bylaws.
With recession looming on the horizon and the accompanying economic uncertainty making life more difficult for Delaware corporations, their management, and advisors, bankruptcy often provides a haven, at least temporarily, to rethink corporate strategy and right the proverbial sinking ship. Ironically, the same principles that justify the automatic stay similarly justify the exclusion of corporate governance from its grasp. As the Court of Chancery observed in Fogel, “[i]f the primary purpose of Chapter 11 is the rehabilitation of debtor corporations, there is no reason to disenfranchise equity holders so long as their exercise of voting rights does not impair such rehabilitation.” As a result, absent specific statutory authority set forth in the Bankruptcy Code, Delaware companies will not be able to avoid corporate governance problems and responsibilities, simply by filing for bankruptcy protection. To avoid such obligations entirely, they will need to show how continued corporate governance burdens the reorganization process.
The Court of Chancery’s recent decision in Fogel v. U.S. Energy Systems makes clear that Delaware companies will not be able to avoid their corporate governance obligations simply by filing a bankruptcy petition because, at least in the absence of evidence that such obligations impair the reorganization process, the automatic stay will not divest shareholders of Delaware corporations of the powers of corporate democracy. Quickly issuing its opinion without allowing the bankruptcy court the opportunity to address the issue, the Court of Chancery’s decision provides clear guidance to Delaware corporations. Although recent economic uncertainty makes the corporate environment more challenging, and the protections of the automatic stay more appealing, companies will not be able to avoid their obligations to shareholders simply by filing for bankruptcy.
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