United States: Delaware Case Finds Stockholders Acquiesced To Breach Of Preferred Stock Designation

Introduction

In Lehman Brothers Holdings Inc., et al. v. Spanish Broadcasting System, Inc. (February 25, 2014), the Delaware Court of Chancery held that the plaintiffs, led by Lehman Brothers Holdings Inc. ("Lehman"), acquiesced to the incurrence of additional debt by the defendant, Spanish Broadcasting System, Inc. ("SBS" or the "Company"), while allegedly failing to pay $29 million in dividends to the preferred stockholders. In finding for the defendant, the Court found that the plaintiffs, who are preferred stockholders of SBS, were aware of the Company's intention to incur additional debt and made no objections to such action, thereby foreclosing their opportunity to seek relief. Based on this finding, the Court granted summary judgment in favor of SBS.

Background

The defendant, SBS, is a Delaware corporation that owns and operates Spanish-language radio and television stations throughout the United States. SBS has two classes of common stock and two classes of preferred stock. It is the treatment of the holders of the Company's Series B Preferred Stock that is at issue in this case. According to the Certificate of Designation filed in connection with the issuance of the Series B Preferred Stock, the Series B stockholders are entitled to receive dividends accruing at an annual rate of 10.75%, payable quarterly, "when, as and if declared by the Board of Directors." If at any time dividends on the Series B preferred stock are in arrears and unpaid for four consecutive quarterly dividend periods, then a "Voting Rights Triggering Event" (a "VRTE") has occurred pursuant to Section 9(b) of the Certificate of Designation. Upon the occurrence of a VRTE, the holders of Series B Preferred Stock, voting together with the holders of the Series A Preferred Stock, have the right to elect two members of the Board of Directors and the Company is prohibited from incurring new debts without first either obtaining a waiver from the holders of the Series B Preferred Stock or paying its arrearages.

Based on the financial success of SBS and the overall positive economic outlook at the time, the Company began to pay regular quarterly dividends to the Series B stockholders shortly after the initial issuance of Series B Preferred Stock in 2004. During the financial crisis in 2008, however, SBS determined that certain cash preservation measures were necessary in order to prevent a liquidity crisis. In May 2009, SBS publicly announced that it would defer payment of dividends, beginning with the Company's scheduled July 15, 2009 dividend. In the subsequent years, the Company has declared one dividend per year, payable on April 15th of each year.

Since first delaying payment of the dividend to the Series B stockholders in 2009, the Company has twice incurred new debt obligations, first in 2011 and then again in 2012. In the first instance, SBS announced on May 6, 2011 its intention to finance a portion of a $16 million purchase of a Houston, Texas-based television station by issuing an $8 million promissory note. SBS completed this transaction on August 1, 2011, three months after the public announcement and without any objection from the preferred stockholders. In the second instance, on January 27, 2012, the Company announced its plan to issue senior security notes in the aggregate amount of $275 million in order to refinance existing debt. This transaction was completed in February 2012, again, without any objections raised by the preferred stockholders.

On February 14, 2013, Lehman filed a complaint in the Delaware Court of Chancery seeking a declaratory judgment that a VRTE was in effect beginning in either April or July 2010 and seeking damages for breach of contract as a result of the Company's incurrence of debt in both 2011 and 2012. On May 20, 2013, the Court heard oral arguments on SBS' motion to dismiss and Lehman's motion for summary judgment. The Court found Section 9(b) of the Certificate of Designation to be ambiguous on its face and reserved judgment on the summary judgment motions. In July 2013, after a complaint was filed against the Company by another Series B stockholder, T. Rowe Price, the Court consolidated the claims.

Legal Analysis

The plaintiffs in this case asked the Court to find that a VRTE had occurred in either April or July 2010 and that, given that the VRTE was in effect, the incurrence of new debt by the Company constituted a breach of contract. The Court found that it was not necessary to address the substance of the claims regarding the interpretation of Section 9(b) of the Certificate of Designation, holding that, even if a VRTE had occurred, the plaintiffs are not entitled to relief because they acquiesced to the breach of Section 9(b) of the Certificate of Designation. The doctrine of acquiescence, as the Court describes, "works as an estoppel: where a plaintiff has remained silent with the knowledge of her rights, and the defendant has knowledge of the plaintiff's silence and relies on that silence to the defendant's detriment, the plaintiff will be estopped from seeking protection of those rights." In this case, the Court found that the plaintiffs had knowledge of their rights and the power to object to the Company's actions if they so desired, and repeatedly chose not to take action despite SBS' repeated public declaration of its intentions. Given those facts, the Court found that the plaintiffs must be considered complicit in the very breaches for which they are seeking damages.

In disputing the plaintiff's contention that they did not have knowledge at the time of the alleged breach of their rights, the Court points to the fact that the Certificate of Designation, which articulated the definition of a VRTE and the resulting rights of the preferred stockholders, is a publicly available document. Further, the Court made particular mention of the incongruence of the claims by the plaintiffs that, on one hand, the meaning of the language in the relevant provision of the Certificate of Designation was clear, and, on the other, that the plaintiffs were not aware of the VRTE and their resulting rights. The Court also notes that the terms of the Certificate of Designation seem to anticipate that the holders of a large amount of stock would pay particular attention to their investment and, accordingly, the Certificate conferred the responsibility for requesting a special meeting in response to the VRTE on those holders of 10% or greater interest in the Class B Preferred Stock. Despite the fact that either Lehman or T. Rowe Price, owners of 38% and 14% interest in the Series B Preferred Stock, respectively, could have independently called for a special meeting in response to the VRTE, neither plaintiff did so. The Court notes that the plaintiffs had yet another opportunity to raise objections to the Company's actions when, in May 2011 and January 2012 the Company announced its intentions to incur new debt. When presented with this information, the plaintiffs neither objected to the incurrence of debt nor called for a special meeting to elect new members of the Board of Directors, as the plaintiffs have claimed was their right with the occurrence of a VRTE.

The Court found the Company's claim that it relied on the silence of the preferred stockholders compelling in large part because, if the Company had any reason to believe that the incurrence of new debt would result in a breach of contract, it would have been financially prudent to explore any number of alternative approaches. Specifically, the Court cited the possibility of obtaining consent from the preferred stockholders, taking on additional debt in order to pay the accrued arrearages, declaring insolvency and restructuring, litigation of the contractual issue, or eschewing the additional debt entirely as possible alternatives for the Company. Instead of entertaining these possibilities, the Court found that the Company went forward with the debt transactions because they were reasonably unaware of the objections of the preferred stockholders.

Conclusion

In finding that the doctrine of acquiescence applied in this case, the Court was careful to note that the particular circumstances led to its conclusions, and that a different set of facts might have produced a different result. In this case, the plaintiffs, holders of a large percentage of preferred stock, had a significant financial stake in the success of the Company and were bestowed with the right to certain procedural protections through which it could protect those interests against a breach by the Company. To have held for the plaintiffs in this instance, the Court stated, "would be to encourage substantial investors to stand by, witness a breach, and permit the accrual of damages that could have been prevented, or at least mitigated, but for their silence."

While the Court in this case did not attempt to address the broad application of the doctrine of acquiescence, this case serves as a reminder to investors and their counsel that, despite the existence of certain contractual rights and protections, silence or inaction may be interpreted as acquiescence to a breach, barring a plaintiff from both equitable and legal relief. In particular, holders of a significant percentage of stock should be mindful that they may not have a limitless window in which to exercise their contractual rights, especially if there is a reasonable expectation that the Company will rely on the silence of the stockholders when taking corporate action.

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