In The Bank of New York Mellon Trust Co., N.A., v. Liberty Media Corp., No. 284, 2011 WL 4376552 (Del. Sept. 21, 2011), the Delaware Supreme Court held that Liberty Media Corp's proposed split-off was not sufficiently connected to previous transactions to warrant aggregation of both the proposed and previous transactions, and thus the proposed split-off did not constitute a sale of "substantially all" of its assets. Bond indentures issued by corporate borrowers typically contain a covenant that the issuer will not sell "all or substantially all" of its assets without the substitution of the purchaser as successor obligor or without otherwise causing a default and acceleration. This landmark ruling should allow corporate issuers accessing the debt capital markets greater flexibility to manage assets and dealmakers' increased clarity in interpreting a standard indenture provision.
Background
The dispute arose out of Liberty Media Corp's proposed split-off of its Capital Group and Starz Group. Bondholders argued that the proposed split-off would violate the "all or substantially all" covenant in the indenture unless the recipient assumed Liberty's obligations. While the parties agreed that the proposed split-off did not, in isolation, violate the covenant, the trustee, acting on behalf of the bondholders, maintained that the proposed split-off should be aggregated with three previous transactions, which, together constituted a sale of "substantially all" of Liberty's assets. Liberty brought an action for declaratory judgment and injunctive relief to resolve the issue of whether aggregation of the transactions was appropriate in interpreting the language of the indenture.
When will a series of asset sales constitute the sale of "substantially all" of a corporate issuer's assets?
The Court of Chancery applied the Second Circuit's reasoning
in Sharon Steel Corp. v. Chase Manhattan Bank, N.A., 691
F.2d 1039 (2d Cir. 1982) to the aggregation issue. In Sharon
Steel, the court held that aggregation was appropriate where
individual transactions were a part of a "plan of piecemeal
liquidation" and an "overall scheme to liquidate."
If, however, each transaction "stands on its own merits
without reference to each other, courts have declined to aggregate
for purposes of a 'substantially all' analysis." Under
this precedent, the court declined to aggregate the proposed
split-off with the previous transactions, finding that each
transaction resulted from an independent business decision made in
the context of unique facts and circumstances.
The court added a second layer of analysis to its inquiry through
application of the step-transaction doctrine, which the court
deemed proper based on the framework laid out in Sharon
Steel. The step-transaction doctrine utilizes three tests to
determine whether the steps in a series of formally separate
transactions are sufficiently related to warrant consideration as
components of an overall plan. First, the end result test examines
whether the transactions were executed as parts of a plan to
achieve a desired end result. Second, the interdependence test
scrutinizes the independence of the transactions by analyzing
whether any one transaction would have been fruitless without a
completion of the series. Finally, the binding-commitment test
measures whether, at the time of the first step, there was a
binding commitment to follow through with the other steps.
The court viewed the contested transactions through each lens
crafted under the step-transaction doctrine and determined that
aggregation was improper in this context. The transactions did not
meet the end result test because there was no evidence to suggest
that the transactions were executed to evade the bondholder's
claims. Moreover, in finding that the interdependence test was not
met, the court found it significant that each transaction stood on
its own merits and was separated by a number of years. Finally, the
court found that because the transactions were not contractually
connected, the binding-commitment test was not met.
On appeal, the Delaware Supreme Court affirmed the use of the
Sharon Steel analysis to determine the proper degree of
interrelationship necessary to warrant aggregation of a series of
transactions. The Delaware Supreme Court explained that each
transaction was "the result of a discrete, context based
decision" and that no "overall plan to deplete
Liberty's asset base over time" existed. Thus, because the
transactions were not a "plan of piecemeal liquidation"
and because no "overall scheme to liquidate" could be
found, the Delaware Supreme Court declined to aggregate the
transactions.
The Court also declined to adopt the step-transaction doctrine for
the purposes of determining whether aggregation was proper in this
context. Rather than respond to the trustee's claim that such
analysis was improper, the Court rested its decision solely by
utilizing the Sharon Steel framework. Thus, the Delaware
Supreme Court found that aggregation was improper and that a sale
of "substantially all" of Liberty's assets would not
occur upon completion of the proposed split-off.
Why is this case significant?
It is important for the efficiency of the capital markets that
language routinely used in bond indentures be accorded a consistent
and uniform construction and meaning. Corporate bond issuers have
traditionally struggled with confronting business environments
which may call for a general business strategy of spinning-out
assets as opportunities arise for fear of triggering the "all
or substantially all" covenants in their indentures.
The opinions of each of the Delaware Court of Chancery and the
Delaware Supreme Court give greater certainty and clarity to bond
issuers that opportunistically execute divestiture strategies. In
order to avoid triggering an "all or substantially all"
covenant through aggregation of divestitures, a corporate board
should make each divestiture decision independently and with
consideration of and reference to the unique facts and
circumstances that drive each individual decision. We recommend
that boards of directors document carefully these analyses.
What if you have questions?
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