Delaware Supreme Court: No "Common Law Insolvency Exception" Permitting Delaware Corporation to Transfer Assets to Creditors in Lieu of Foreclosure Without Shareholder Consent
In Stream TV Networks, Inc. v. SeeCubic, Inc., 2022 WL 2149437 (Del. June 15, 2022), the Delaware Supreme Court vacated and reversed a 2020 ruling by the Delaware Court of Chancery that the assets of Stream TV Networks, Inc. ("Stream"), an insolvent Delaware-incorporated 3-D television technology company, could be transferred to an affiliate of two of Stream's secured creditors in lieu of foreclosure without seeking the approval of Stream's shareholders under section 271 of the General Corporation Law of Delaware ("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 more than $50 million in debt secured by all of its assets. At that time, it also owed $16 million to trade creditors, could not pay its bills or operating expenses, including payroll, and was insolvent.
In March 2020, Stream's controlling shareholders and directors, Mathus and Raja Rajan (the "Rajans"), at the behest of the secured creditors, expanded the board of directors for the purpose of creating a committee to negotiate a resolution with the 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") under 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 agreed to release their claims against Stream upon completion of the transfer of its assets to SeeCubic.
If Stream's secured creditors had foreclosed on Stream's assets, Stream and its stockholders would have received no recovery. However, the Omnibus Agreement provided Stream's minority shareholders with the right to exchange their stock in Stream for shares in SeeCubic. The Omnibus Agreement also provided for the issuance of one million shares in SeeCubic to Stream.
Stream and the Rajans later sought an injunction preventing the effectiveness of the Omnibus Agreement. They contended that the agreement was invalid because: (i) the outside directors who approved it were never validly appointed; and (ii) the agreement was ineffective because it required stockholder approval under section 271 of the DGCL and the "class vote 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 the power to bind Stream to the terms of the Omnibus Agreement.
Writing for the court, Vice Chancellor ("VC") J. Travis Laster explained that section 271 of the DGCL requires majority stockholder approval to "sell, lease or exchange all or substantially all of [the company's] property and assets"—a relative rarity outside of bankruptcy compared to the "current dominance of the merger as the transactional vehicle for selling a corporation." This requirement is a modification of the general rule under common law "that the directors [had] no power or authority to sell out the entire property of a corporation and terminate its business" but had to obtain unanimous stockholder approval for such a transaction. However, VC Lasker wrote, "A widely recognized exception to the rule applied to insolvent or failing firms." This "failing business" exception to the common law rule continues in force today.
In addition, VC Lasker noted, the legislative history of section 271 and its "position in the broader context of the statute" indicate that the transaction contemplated by the Omnibus Agreement did not qualify as a "sale, lease or exchange" of all or substantially all of Stream's assets. Instead, he wrote, "[t]hese sources demonstrate that Section 271 does not apply to a transaction like the one contemplated by the Omnibus Agreement, in which an insolvent and failing firm transfers its assets to its secured creditors in lieu of a formal foreclosure proceeding."
Because the class vote provision in Stream's charter substantially tracked the language of section 271, VC Lasker concluded that it "warrant[ed] the same interpretation." The Chancery Court thus ruled that the Omnibus Agreement did not require the approval of Steam's shareholders. It accordingly denied Stream's motion for a preliminary injunction to prevent the agreement's effectiveness and granted SeeCubic's motion for an injunction enforcing the Agreement.
The Chancery Court later: (i) granted in part SeeCubic's motion for summary judgment and for a permanent injunction (Stream TV Networks, Inc. v. SeeCubic, Inc., 2021 WL 4352732 (Del. Ch. Sept. 23, 2021)); (ii) granted Stream's motion to have the summary judgment order entered as a 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 modify or stay the permanent injunction pending appeal (Stream TV Networks, Inc. v. SeeCubic, Inc., 2021 WL 5816820 (Del. Ch. Dec. 8, 2021)).
Stream appealed the summary judgment and injunction rulings to the Delaware Supreme Court.
The Delaware Supreme Court's Ruling
The Delaware Supreme Court vacated in part, reversed in part, and remanded the case below.
Writing for the en banc court, Delaware Supreme Court Justice Karen L. Valihura held "that a common law insolvency exception, if one existed in Delaware, did not survive the enactment of Section 271 and its predecessor." Stream TV, 2022 WL 2149437, at *11. Therefore, she wrote, "there is no Delaware common law 'board only' insolvency exception under Section 271." Id.
Justice Valihura noted that, in concluding otherwise based upon corporate law in states throughout the United States, the Chancery Court relied on treatises and case law issued between 1926 and 1948, "with no case cited after 1948 upholding such an exception." Moreover, she explained, although 15 states recognized the board-only insolvency exception "from the late 1800's to the early 1900's … no Delaware case expressly addresses or adopts the board-only insolvency exception." Id. at **20-21.
According to Justice Valihura, her reasoning was supported by "the plain language of Section 271, which contains no exceptions and is not ambiguous." In addition, she noted, this conclusion is "consistent with our policy of seeking to promote stability and predictability in our corporate laws, and with recognition that Delaware is a contractarian state." Id. at *25.
The Delaware Supreme Court accordingly vacated the injunction, reversed the declaratory judgment, and remanded the case to the Chancery Court for further proceedings.
The Delaware Supreme Court's ruling in Stream TV clarifies that a "failing" Delaware corporation may not give a deed in lieu of foreclosure to a secured creditor involving all or substantially all of the corporation's assets without shareholder approval, nor can it sell, lease, or exchange 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 an asset sale under section 363(b) of the Bankruptcy Code or pursuant to a chapter 11 plan may be necessary where majority shareholder approval cannot be obtained.
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