Supreme Court of Delaware: No “Common Law Insolvency Exception” Allowing Delaware Corporation to Transfer Assets to Creditors Instead of Foreclosure Without Shareholder Consent | Jones Day
In Stream TV Networks, Inc. v SeeCubic, Inc.2022 WL 2149437 (Del. June 15, 2022), the Delaware Supreme Court reversed and reversed a 2020 Delaware Court of Chancery decision that held the assets of Stream TV Networks, Inc. (“Stream”), a insolvent Delaware 3D television technology company, could be transferred to an affiliate of two of Stream’s secured creditors in lieu of foreclosure without seeking Stream’s stockholder approval under Section 271 of the Act General Delaware Corporations (“DGCL”) or Stream’s Certificate of Incorporation. See Stream TV Networks, Inc. v. SeeCubic, Inc.250 A.3d 1016 (Del. Ch. 2020).
In February 2020, Stream defaulted on over $50 million in debt secured by all of its assets. At that time, it also owed $16 million to trade creditors, could not pay bills or operating expenses, including payroll, and was insolvent.
In March 2020, Stream’s majority shareholders and directors, Mathus and Raja Rajan (the “Rajans”), at the request of secured creditors, expanded the board of directors with the aim of creating a committee to negotiate a resolution with secured creditors and Stream’s investors. In May 2020, Stream, its two secured creditors and 52 Stream investors entered into an agreement (the “Omnibus Agreement”) pursuant to which, in lieu of foreclosure by the secured creditors, Stream would transfer all of its assets to SeeCubic, Inc. (“SeeCubic”), a newly formed entity controlled by its secured creditors. The secured creditors have agreed to release their claims against Stream upon completion of the transfer of its assets to SeeCubic.
If Stream’s secured creditors had seized Stream’s assets, Stream and its shareholders would not have received any recovery. However, the omnibus deal granted minority shareholders of Stream the right to exchange their shares of Stream for shares of SeeCubic. The omnibus deal also provided for the issuance of one million shares of SeeCubic to Stream.
Stream and the Rajans then sought an injunction preventing the effectiveness of the Omnibus Agreement. They argued that the agreement was invalid because: (i) the outside directors who approved it were never validly appointed; and (ii) the deal was ineffective because it required shareholder approval under Section 271 of the DGCL and the “class voting provision” in Stream’s certificate of incorporation.
The Delaware Chancery Court ruled that the outside directors were validly appointed and that, even if they were not, they acted as de facto directors with authority to bind Stream under the Omnibus Agreement.
Writing for the court, Vice Chancellor (“VC”) J. Travis Laster explained that Section 271 of the DGCL requires majority shareholder approval to “sell, lease or exchange all or substantially all of totality of [the company’s] property and assets” — a relative scarcity outside of bankruptcy compared to the “current predominance of the merger as a transactional vehicle for the sale of a company”. This requirement is a modification of the general common law rule “that directors [had] not have the power or authority to sell all of a company’s assets and terminate its activities”, but had to obtain unanimous shareholder approval for such a transaction. However, VC Lasker wrote, “A widely recognized exception to the rule applied to insolvent or failing companies.” This “failing firm” exception to the common law rule remains in effect today.
Further, VC Lasker noted, the legislative history of Section 271 and its “position within the larger statutory context” indicate that the transaction contemplated by the omnibus agreement was not considered a “sale, lease or exchange” of all or substantially all of Stream’s assets. Instead, he wrote: “[t]These sources demonstrate that Section 271 does not apply to a transaction such as that contemplated by the omnibus agreement, in which an insolvent and failing company transfers its assets to its secured creditors instead of formal foreclosure proceedings. “
Because the class voting provision in Stream’s charter largely followed the wording of Section 271, VC Lasker concluded that it “justified[ed] the same interpretation. The Chancery Court thus ruled that the Omnibus Agreement did not require the approval of Steam shareholders. It therefore denied Stream’s motion for a preliminary injunction to prevent the effectiveness of the agreement and granted the motion. of SeeCubic in injunction implementing the agreement.
The Chancery Court later: (i) granted SeeCubic’s motion in part for summary judgment and a permanent injunction (Stream TV Networks, Inc. v SeeCubic, Inc., 2021 WL 4352732 (Del. Ch. 2021 Sep 23)); (ii) granted Stream’s motion to have the summary judgment order entered as partial final judgment (Stream TV Networks, Inc. v SeeCubic, Inc., 2021 WL 5240591 (Del. Ch. Nov. 10, 2021)); and (iii) denied Stream’s motion to vary or stay the permanent injunction pending appeal (Stream TV Networks, Inc. v SeeCubic, Inc.2021 WL 5816820 (Del. Ch. 8 Dec. 2021)).
Stream appealed the summary judgment and injunctive relief decisions to the Delaware Supreme Court.
The Delaware Supreme Court decision
The Delaware Supreme Court reversed in part, reversed in part, and remanded the case below.
Write for the bench Supreme Court, Delaware Supreme Court Justice Karen L. Valihura held “that a common law insolvency exception, if it existed in Delaware, did not survive the enactment of Section 271 and its predecessor”. Streaming TV, 2022 WL 2149437, at *11. Therefore, she wrote, “there is no Delaware common law ‘board-only’ insolvency exception under Section 271.” Identifier.
Judge Valihura noted that in finding otherwise on the basis of corporate law in the states of the United States, the Court of Chancery relied on treaties and case law published between 1926 and 1948, “without no case cited after 1948 confirms such an exception”. Moreover, she explained, although 15 states recognized the insolvency exception reserved for counsel “from the late 1800s to the early 1900s…no Delaware case expressly addresses or adopts the insolvency exception reserved for advisers”. Identifier. at **20-21.
According to Judge Valihura, his reasoning was supported by “the plain language of Article 271, which contains no exceptions and is unambiguous”. Further, she noted, this finding is “consistent with our policy to promote stability and predictability in our corporate laws, and to recognize that Delaware is a contract state.” Identifier. to *25.
The Delaware Supreme Court therefore quashed the injunction, reversed the declaratory judgment, and returned the case to the Chancery Court for retrial.
The Delaware Supreme Court decision in Streaming TV clarifies that a “failing” Delaware corporation may not give deed in lieu of foreclosure to a secured creditor of all or substantially all of the corporation’s assets without shareholder approval, nor sell, lease, or trade substantially all of its assets in an assignment for the benefit of creditors without obtaining such approval. As such, under this precedent, a bankruptcy filing and sale of assets under Section 363(b) of the Bankruptcy Code or under a Chapter 11 plan may be required where the majority shareholder approval cannot be obtained.