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.
In one such securitization, Chase Manhattan Bank, N.A. (“Chase”) lent in excess of
$132 million to certain of the debtors. Chase held a mortgage on several of the debtors’ properties
to secure the obligations. Chase was the trustee for the benefit of the holders of the pass-through
certificates. REFG Investor One Inc. (“REFG”) was the beneficial holder of those securities.
In the other securitization, REFG lent approximately $145.25 mil