Contributed by Maurice Horwitz
As a general rule, bankruptcy courts do not enforce provisions in organizational documents, loan agreements, or other prepetition contracts that purport to alter or waive the protections of the Bankruptcy Code. As with most rules, however, there are exceptions. We have previously discussed, for example, provisions that waive the borrower’s right to seek bankruptcy protection altogether (almost always unenforceable, but when it comes to LLCs, there are certain exceptions, and exceptions to the exceptions); a junior creditor’s right to assign its right to vote on a plan (some courts have enforced them, but the majority will not); and waivers of the automatic stay, which the Bankruptcy Code’s legislative history describes as “one of the fundamental debtor protections provided by the bankruptcy laws.”
It may surprise our readers that, even as to this last fundamental bankruptcy right, courts across the country continue to disagree. It is well settled in the Second and Third Circuits, where many large corporate bankruptcies are filed, that only the bankruptcy court may modify the stay. As the Second Circuit stated in Ostano Commerzanstalt, “Since the purpose of the stay is to protect creditors as well as the debtor, the debtor may not waive the automatic stay.” Courts in other circuits, however, range in their views about whether, and to what extent, a debtor can waive the protections of the automatic stay.
One court to recently consider the enforceability of automatic stay waivers is the United States Bankruptcy Court for the District of Puerto Rico. The decision in In re Triple A & R Capital Investment, Inc. is interesting, in part, because of its survey of the caselaw on this issue. In this single asset real estate case, the debtor had entered into a forbearance agreement prepetition with its one secured creditor. The agreement provided, in pertinent part, as follows:
Automatic Stay. Each Loan Party hereby stipulates that, at Bank’s option, Bank will be entitled to an immediate and absolute lifting of any automatic stay of the enforcement of Bank’s remedies under this Agreement, the Forbearance Documents and the Loan Documents, at law or in equity (including, without implied limitation, the provisions of 11 U.S.C. § 362, as amended) which might be accorded to a Loan Party [in] any Debt Relief Proceeding. Each Loan Party agrees that it will not contest any application by Bank to lift or vacate any such stay.
The forbearance agreement was subsequently supplemented by an additional forbearance agreement which contained the following provision:
Consent to Relief from Automatic Stay. As a material inducement for the Creditor to enter into this Agreement, in recognition of the risks associated with the Creditor’s execution and performance of this Agreement, and in consideration of the recitals and mutual covenants contained herein, and for other good and valuable consideration, including the agreement of the Creditor to forbear from the exercise of its rights and remedies, the receipt and sufficiency of which are hereby acknowledged, each of the Debtors hereby agrees and consents that if any Debtor shall…file or be subject of any petition under Title 11 of the U.S. Code, as the same may be amended from time to time … then the Creditor shall thereupon be entitled to relief from any automatic stay imposed by § 362 of the Bankruptcy Code, or from any other stay or suspension of remedies imposed in any other manner with respect to the exercise of the rights and remedies otherwise available to the Creditor under the Financing Agreements and/or the other Loan Documents, and as otherwise provided by law, and each of the Debtors hereby expressly and unconditionally waives the benefit of such automatic stay and consents and agrees to raise no objection to such relief.
Although this is the sort of waiver that almost certainly would be considered unenforceable in the Second or Third Circuit, the court noted that “[t]here is no controlling law on this subject in this District [of Puerto Rico] or [the First] Circuit.” Noting that “stay waivers were long thought to be unenforceable as against public policy,” the court also recognized that “an increasing number of courts are now enforcing them,” reflecting “the tension between the public policies favoring out of court workouts, on the one hand, and protecting the collective interest of the debtor’s creditors, on the other.”
The court observed three prevailing trends that have developed among bankruptcy courts:
- uphold the stay waiver on the basis of freedom of contract;
- reject the stay as unenforceable per se as against public policy; and
- treat the waiver as a factor in deciding whether “cause” exists to lift the stay.
After reviewing the cases and observing that “this last approach has gained ground in recent years,” the court added two significant caveats. First, “courts are in agreement that a prepetition waiver of the automatic stay, even if enforceable, does not enable the secured creditor to enforce its lien without first obtaining stay relief from the bankruptcy.” This caveat is significant because it reinforces the rule that “relief from a stay must be authorized by the Bankruptcy Court.” In the case before it, that requirement had been satisfied: the debtor’s secured creditor had filed a motion seeking relief from the automatic stay.
The court was also persuaded by the debtor’s argument that in a single asset real estate case, a prepetition waiver of the automatic stay can be especially damaging to the debtor and should be “unenforceable as too closely approximating, for a single asset debtor, waiver of the right to file for bankruptcy relief.” With this last endorsement, it appears that the debtor in In re Triple A & R Capital Investment, Inc. may have prevailed, but for one unfortunate oversight by the debtor. At the start of the case, as is typical in cases where a secured creditor has a lien over the debtor’s cash, the debtor entered into a stipulation with its secured creditor to permit the debtor to use its cash collateral. In at least three separate places, the stipulation stated that the debtor’s obligations under the loan documents – which included the forbearance agreements – were ratified by the debtor, remained in full force and effect, and would not be subject to further challenge.
The stipulation was duly filed and noticed, no objections were filed, and the court entered an order approving it. At the time that it was approved, neither the debtor nor the court considered it a stipulation to modify the automatic stay. Even the secured creditor did not immediately think of relying on these provisions of the cash collateral stipulation when first moving for relief from stay. Nevertheless, after the secured creditor brought this language to the court’s attention, the court found that the obligations ratified by the debtor “specifically include the Forbearance Agreements with the prepetition waivers of the automatic stay” and that as such, the debtor, “as a debtor in possession, ratified and agreed to be bound by clauses…which expressly contained a waiver of the protection afforded by the automatic stay.”
Did the secured creditor get lucky? Perhaps. But by equating a waiver of the automatic stay to a waiver of the right to file a bankruptcy case, the court in Puerto Rico may have signaled that such waivers would not ordinarily be enforced – and perhaps would not have been enforced, if someone had brought this language to the court’s attention before the cash collateral stipulation was approved. The decision suggests that debtors filing single asset real estate cases in Puerto Rico may find a sympathetic ear – at least with one of the four bankruptcy judges who preside there – if they were coerced into waiving their automatic stay rights prepetition.