When a company defaults on its contractual obligations, its counterparty can agree to not exercise its remedies or forbear in exchange for certain concessions from the defaulting party or its equity holder. One common concession is the pledge of the voting rights held by the equity holder of its membership interests in the defaulting company. The timing and extent of forbearance and an understanding of exactly when the voting rights or proxy can be exercised is critical.
Often, the purpose of the pledge is to encourage the defaulting company or its equity holder to pursue a particular course of action. At times, that means pursuing a sale of the defaulting company to enable payment to the creditor holding the pledge. Beyond the precision that should be present in the pledge agreement, actually divesting control of a company may have unintended consequences. The creditor taking steps to effect a change in control must be prepared not only for a challenge to its enforcement action, but also for the impact on the distressed company and its other creditors, including the commencement of an involuntary bankruptcy. Any challenge to the enforcement effort may create procedural issues in the event of a bankruptcy filing.