On December 8, 2020, the Delaware Court of Chancery in Stream TV Networks, Inc. v SeeCubic, Inc.^[1] upheld a unique structure established by secured lenders to protect their interests and in doing so the Court addressed a number of corporate law issues.

Stream TV Networks, Inc. (“Stream”) was a Delaware family-owned company with outside investors and two secured lenders who held security interests in substantially all of Stream’s assets. Stream was in financial difficulty, having defaulted on secured loans, defaulted on payroll, and failed to pay off commercial debt. Under pressure, the two controlling family members who were the directors increased the size of the board and added four independent outside directors. The outside directors then formed a committee with full authority to resolve any payment default. Following negotiations, the committee cleared and Stream executed a restructuring agreement providing that the secured lenders would not seize the assets of Stream but would instead agree to the voluntary transfer of the assets of Stream to SeeCubic, Inc. (“SeeCubic”) , a new entity controlled by the secured lenders. As part of the deal, the minority shareholders of Stream would receive shares of SeeCubic in exchange for their Stream shares and Stream itself would receive shares, for the benefit of its remaining shareholders, primarily the controlling family. Stream also granted a power of attorney to implement the agreement and complete the transaction. The controlling family members, unhappy with the arrangement, then sought to remove the outside directors, allegedly (but the court did not actually find) before the board committee cleared the restructuring deal and they also sought to challenge the status of outside directors. They then filed a lawsuit to ban enforcement of the restructuring deal, and SeeCubic responded by seeking to enforce the deal.

In resolving the dispute in favor of SeeCubic’s right to enforce the restructuring agreement and exercise the power of attorney to do so, the Court addressed the following issues:

Expand the board of directors and fill vacant positions. The Court concluded that the board of directors was validly enlarged and that the outside directors were validly appointed to fill the vacancies thus created because the two family members were the only members of the two-person board. As authorized by §141 (b) of the Delaware General Corporation Law (the “DGCL”), the articles of association provided that the number of directors was fixed by the board of directors and, in accordance with §141 (f), the directors authorized to act by unanimous written consent. The Court said the matter would have been more complicated if the number of directors had been five, with three vacant posts, because under Article 223 (a), the two directors, since they would not have constituted the quorum, could only have filled the vacant positions and not increase the board of directors to six (citing Applied Energetics, Inc. v. Farley, 239 A.3d 409 (Del. Ch. 2020)). The Court then explored other alternatives that the two directors could have followed in this hypothetical circumstance, but one was not to act as shareholders to increase the size of the board of directors, as this authority was given only to administrators. The Court also gave advice on how to draft resolutions to properly effect the increase in the size of the board of directors and fill vacant posts.

Power of de facto directors. Even if the external directors were not validly appointed and would therefore not be de jure directors, in the circumstances of this case, they would be de facto directors having the authority to take the actions they have taken, including approving the restructuring agreement. The Court cited several Delaware decisions regarding the status of de facto administrators as applied to protect third parties.

Imposing director’s qualifications. Although the resolution designated the outside directors as “interim directors” and required that certain conditions be met for their service to commence, the court ruled that Delaware law does not contemplate such a position and conditions on the ability to become and remain a director would be a qualifying provision which, under Article 141 (b) of the DGCL, can only be imposed by the certificate of incorporation or by-laws. In addition, a qualification of director must be reasonable, and the Court concluded that those relied on were unreasonable.

Need for shareholder approval for the sale of substantially all of the assets. Under Article 271 of the DGCL, shareholder approval is required for the sale of all or substantially all of a company’s assets. However, approval is not required for the mortgage or pledge of the assets of the company, as provided in §272. The Court noted that the exclusion of a mortgage or pledge should, in principle, encompass the obligee’s ability to enforce its security. The question for the Court was whether the transfer of Stream’s assets as part of the restructuring agreement instead of a foreclosure of the lenders’ security interests in those assets was subject to the requirement for shareholder approval of the §271. After reviewing the history of Delaware Merger and Asset Sale Act, the evolution of DGCL provisions and relevant case law, the Court ruled that § 271 does not apply to a transaction such as that provided for in the restructuring agreement in which an insolvent company transfers its assets to its secured creditors instead of a formal foreclosure proceeding. The Court recalled the old common law rule that while a board of directors did not have the power to sell all of the assets of the company, it did have the power to transfer the assets to creditors when the company was insolvent, and that the Legislature added that the power of the board to sell assets with shareholder approval should not be interpreted as limiting the power that existed under the common law. Moreover, the addition of the legal exclusion of mortgages supported this conclusion.

Need a class vote for such a sale. Stream had a share class which required the approval of the holders of this class in order to effect an “asset transfer”, which was defined in the same terms as § 271 of the DGCL. Since a provision of the charter which follows a legislative provision must have the same meaning as the legislative provision, the Court held that the collective voting provision did not apply to the transfer of Stream to the secured creditors of the assets on which they held a security interest.

Application of the business judgment rule. The last allegation was that the restructuring agreement was void because the committee members breached their fiduciary obligations by approving it. The Court described the three levels of judicial review of the actions of directors and held that the business judgment rule, as a default rule, applied in this case. Under this rule, unless rebutted, “the court is simply seeking to determine whether the business decision taken was rational in the sense of being a logical approach to further the goals of the company.” The Court concluded that there was no basis to rebut the protections of the business judgment rule and, therefore, dismissed the claim for breach of fiduciary duty.

Conclusion

the Flux The decision illustrates a creative way for lenders to successfully manage a distressed borrower situation. The court ruling upholding the actions taken by the lenders also provides insight into some basic corporate law rules worth noting.

[1] CA n ° 2020-0310-JTL (Dél. Ch. 8 Dec. 2020) here.