In Stream TV Networks, Inc. v. SeeCubic, Inc., 2020 WL 7230419 (Del. Ch. Dec. 8, 2020), the Delaware Court of Chancery held 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.
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 (“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 (“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. The Rajans did not vote to approve the Omnibus Agreement and immediately tried to undermine it.
If Stream’s secured creditors had foreclosed on Stream’s assets, Stream’s 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 majority 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 what he characterized as the “current dominance of the merger as the transactional vehicle for selling a corporation”). This 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 Laster 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 Laster 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 transaction to “sell, lease or exchange” all or substantially all of Stream’s assets. Instead, he wrote, “These 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 Laster concluded that that it “warrant[ed] the same interpretation.” The Chancery Court ruled that the Omnibus Agreement did not require the approval of Stream’s shareholders. It accordingly denied Stream’s motion for a preliminary injunction and granted SeeCubic’s motion for an injunction enforcing the Agreement.