Stream TV Networks, Inc. v. SeeCubic, Inc., C.A. No. 2020-0310-JTL (Del. Ch. Dec. 8. 2020)—The Delaware Court of Chancery granted a secured creditor a preliminary injunction preventing an insolvent corporation from interfering with the implementation of an agreement, which effectively transferred all of the debtor’s assets to the secured creditor. In reaching this result, the court rejected the corporation’s arguments concerning the authority of certain independent directors to bind the firm and the applicability of Section 271 of the Delaware General Corporate Law (DGCL). Having rejected the corporation’s arguments, the court concluded that the independent directors properly exercised their authority to enter into an agreement on behalf of the firm, which allowed for the transfer of assets to the secured creditor.
Stream TV Networks, Inc. developed technology that enabled consumers to view 3D content without 3D glasses. For more than a decade, Stream was essentially controlled and operated by members of the Rajan family. To finance operations, Stream obtained a loan from SLS Holdings VI, LLC (SLS), which was secured by the assets of Stream and its wholly owned subsidiaries. A few years later, Stream obtained a separate loan from Hawk Investment Holdings Limited (HIHL). Stream’s assets served as collateral for the HIHL loan, in which HIHL’s security interest was junior to SLS’s security interest.
In 2019, Stream experienced financial difficulty and initiated discussions with its secured creditors. These discussions broke down, and Stream’s finances continued on a downward spiral. In February 2020, Stream defaulted on the SLS and HIHL loans, respectively. Stream also failed to make payments to suppliers and customers. Restructuring discussions resumed, and the creditors persuaded the two-member board to appoint four outsiders as independent directors. The independent directors were appointed by unanimous consent. After their appointment, the board held meetings, approved minutes, voted on resolutions, and engaged in other corporate formalities, all with the participation of the independent directors. The original two board members, Raja and Mathu Rajan, also referred to the independent directors as members of the board and held them out as such to third parties.
The independent directors concluded that a restructuring was Stream’s only option. In May 2020, the six-member board approved the creation of the Resolution Committee, which consisted entirely of the independent directors. The Resolution Committee was authorized to resolve Stream’s debt defaults without further action from the board. Two days later, the Resolution Committee executed an Omnibus Agreement with SLS and HIHL on behalf of Stream. Under the Omnibus Agreement, SLS and HIHL refrained from foreclosing on Stream’s assets in exchange for a transfer of the assets to SeeCubic, Inc., in satisfaction of Stream’s debts. The agreement also permitted Stream’s shareholders to exchange their shares for an equity interest in SeeCubic. Raja and Mathu Rajan were not happy with the formation of the Resolution Committee, let alone the Omnibus Agreement, and they sought to execute a Shareholder Consent Agreement intended to remove the independent directors. The Rajans executed the consent days after the Resolution Committee entered into the Omnibus Agreement, but backdated the Shareholder Consent Agreement in an effort to strip the Resolution Committee of its authority. Negotiations thereafter between the independent directors and the Rajan family were unsuccessful, and litigation ensued.
The Court of Chancery Ruling
The parties each sought the entry of a preliminary injunction regarding the Omnibus Agreement. Stream sought to enjoin SeeCubic from enforcing the agreement on the basis that the Resolution Committee was not capable of binding the company, because the independent directors comprising the committee failed to satisfy certain criteria following their appointment. Stream also argued that the proposed transaction did not receive shareholder consent and thus violated Section 271 of the DGCL. The court rejected both arguments and granted SeeCubic a preliminary injunction.
First, the court ruled that the Resolution Committee possessed the requisite authority to bind Stream. Prior to the appointment of the independent directors, Stream’s board consisted of Raja and Mathu Rajan. These two directors consented, in writing, to the expansion of the board to six members and the appointment of four independent directors. Although the resolution lacked formality and precision, the document unambiguously evidenced the intent of the directors. Stream then argued that the backdated Shareholder Consent Agreement caused the independent directors to be interim directors, pending the satisfaction of certain prerequisites. The court rejected that contention because the Shareholder Consent Agreement was not executed until after the Omnibus Agreement, and likewise rejected the concept of an interim director altogether. The court explained further that the imposition of conditions or qualifications on a director must appear in the certificate of incorporation or bylaws. However, both the corporate charter and bylaws were silent. Even so, director qualifications must be reasonable, in which the court concluded that the conditions sought to be imposed by the Shareholder Consent Agreement were unreasonable and would have caused the independent directors to violate certain fiduciary duties. Finally, even if Stream had shown that the independent directors were not lawfully appointed, its efforts to hold out the independent directors to third parties as directors of the company caused them to be de facto directors capable of binding Stream.
Second, the court ruled that the transaction with SLS and HIHL did not require shareholder consent pursuant to Section 271 of the DGCL, which conditions the sale of all or substantially all of a corporation’s assets upon the approval of the majority of its shareholders. Section 271 traces its roots back to common law, but the law has long recognized an exception to the general rule of shareholder approval in the context of an insolvent entity. In Stream, the court concluded the enactment of Section 271 did not eliminate the common law exception to the general rule involving insolvent firms. The court also explained that the scope of Section 271 did not include transactions in which the forgiveness of debt served as consideration. Further, a requirement of shareholder consent as a prerequisite to a creditor levying on its security not only raises public policy concerns but would also create conditions that undermine other sections of the DGCL. Finally, the court noted the absence of any case law applying Section 271 to the transfer of assets to a secured creditor despite the legislation’s lengthy history and the widespread practice of granting security interests.
Stream provides valuable insight to directors of struggling firms in their negotiations with secured creditors. Subject to their fiduciary responsibilities, directors may attempt to eliminate or reduce a corporation’s debt through the transfer of collateral to a secured creditor without shareholder approval. While these transactions may present questions concerning a firm’s insolvency, the validity of a creditor’s security interest, and the directors’ decision-making process, Stream reaffirms the common law authority of directors of an insolvent firm to take action in the best interests of the corporation. That said, directors who find themselves in such situations should consult with knowledgeable counsel to minimize the risk of post-transfer litigation.