Waivers Of Bankruptcy Protections Contained In Workout Agreements
By: JAMES L. BAILLIE
It is well established that debtors cannot waive their right to file a bankruptcy case. Such waivers are unenforceable whether they are contained in the original loan documents or in workout agreements entered into after default. What is less clear is whether specific rights within a bankruptcy case, particularly the protection of an automatic stay, can be waived. Following divided court decisions, some creditors are starting to ask for these waivers in workout agreements.
Typically, negotiations over bankruptcy waiver provisions occur between a debtor in default and a secured creditor who is entitled to exercise its right to foreclose on collateral. Almost all of the cases that have addressed waivers of the automatic stay involved loans on single parcels of real estate. After default, the debtor hopes that with additional time, and perhaps other concessions, the debtor will be able to resolve its problems without filing a bankruptcy case, perhaps by sale of the property or by finding new equity. The secured creditor may be willing to delay exercising its rights and to grant concessions believing that this approach is preferable to a bankruptcy filing. The secured creditor may also believe that it too would benefit from the forbearance. In other situations, the secured creditor believes that the debtor will not succeed and that a later foreclosure or bankruptcy is inevitable.
Thus, the essence of the workout agreement between the debtor and the secured creditor is often that there will not be a later bankruptcy. If the debtor does not succeed in solving the problem in the negotiated time period, he or she will cooperate with the secured creditor by allowing a foreclosure on the collateral or perhaps by delivering a deed in lieu of foreclosure. In negotiating a workout agreement, sometimes called a forbearance agreement, attorneys for the secured creditor are now sometimes insisting that if there is a later bankruptcy, the debtor will waive its right to the protection of an automatic stay so that the creditor receives the benefit of its bargain and may proceed with foreclosure notwithstanding the bankruptcy.
The Courts' Response
Courts have been divided on whether these waivers are enforceable. It is not the purpose of this short article to review the case law in detail. However, it is apparent that the underlying facts are very important and provide the real explanation for most of the rulings.
As a preliminary matter, it should be noted that while these waivers are sometimes drafted as if they are self-executing, a secured creditor should not attempt to foreclose without an order of the bankruptcy court granting relief from the automatic stay. An attempt to foreclose without that relief might very well draw sanctions under Section 362(8)(h) of the Bankruptcy Code.
Attention to this subject has followed a series of decisions starting in the bankruptcy court in the Middle District of Florida. In the leading case, the secured creditor had agreed to a forbearance in a real estate foreclosure in exchange for an agreement that it would be entitled to immediate relief from the stay should the debtor file a bankruptcy case. When the debtor filed bankruptcy, the bankruptcy court enforced the waiver and immediately granted relief from the stay, although it is apparent from that case (others like it) that the court thought the debtor's prospects for reorganization so hopeless that it was either explicitly or implicitly deciding that there was "cause" for relief from the stay based on the underlying facts. In other words, the court might well have granted relief from the stay without the waiver.
Soon after, a bankruptcy court in the Eastern District of Pennsylvania specifically refused to enforce a pre-petition waiver, relying on the legislative history and public policy behind the relevant sections in the Bankruptcy Code. It noted that the purpose of the automatic stay was to protect not only the debtor but also any other creditors. Since then, there have been a number of other decisions, some in which the courts have been willing to enforce the waiver and others where the courts have not. Most later courts have reached a middle position concluding that the fact of the waiver is something that the court should take into consideration but that it is not necessarily decisive.
Considerations For Lawyers And Clients
There are no decisions in Minnesota or any bankruptcy court in the upper Midwest. The general opinion of bankruptcy lawyers in Minnesota is that such waivers would not be directly enforced. However, the fact that such a waiver was given in connection with a workout might influence a judge in determining whether there was "cause" for relief from the stay. There is a basic element of fairness. If an agreement not to file bankruptcy was really part of the original workout negotiations, then it does not seem altogether fair to give the debtor the benefits of the agreement without the detriments. On the other hand, circumstances do change, sometimes significantly, and there may be other parties at interest. For this reason, some lawyers have taken to carving a middle course in which the workout agreement may provide that the debtor waives the protection of the automatic stay and stipulates as to the existence of various facts that could make it relatively easy for the creditor to obtain relief from the stay.
Is it a good idea for a secured creditor to insist on or even ask for a waiver or a stipulation to the facts? The opinion among lawyers is mixed on this, but all would agree that it will depend somewhat on the circumstances. On the one hand, it would generally be an advantage to have such a provision in a workout agreement. On the other hand, if the waiver is not going to be enforced anyway, why should the debtor receive any credit for this provision as a bargaining chip in the overall negotiations? Moreover, if the bankruptcy judge is going to take a dim view of such waiver provisions, the inclusion of such a waiver at the creditor's insistence could actually lead to, or help reinforce, a conclusion by the judge that the creditor was overreaching. Another complication that may not be immediately apparent has to do with fiduciary duties. The pressure the secured creditor is putting on the debtor to give such a waiver may be pressure on a general partner of the debtor or an officer who has personal liability as a partner or guarantor. It may later be argued that in return for some personal benefit, the partner or guarantor was pressured to breach his fiduciary duties to the corporation, the partnership, or to other creditors of the debtor.
On balance, there are some benefits to these provisions. When it is clear that the essential deal is additional time or other concessions to the debtor in exchange for an agreement not to file bankruptcy (in other words the debtor gets one bankruptcy and it is contained in the workout agreement), it may be useful to make that situation clear in the workout agreement and also to provide carefully considered stipulations concerning the facts (i.e., the property value, the amount of time which the debtor has been looking for a new buyer, etc.). In those circumstances, waiver provisions may have some real value to the secured creditor in later attempts to enforce the bargain struck in the workout agreement.