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Cedarview Opportunities Master Fund, L.P, et al. v. Spanish Broadcasting Sys., Inc., C.A. No. 2017-0785-AGB (Del. Ch. Aug. 27, 2018) (Bouchard, C.)

August 27, 2018

In this memorandum opinion, the Court of Chancery denied in part and granted in part defendant’s motion to dismiss for failure to state a claim, holding, among other things, the following: (i) certain language in a certificate of designations was ambiguous, which therefore allowed the Court to consider extrinsic evidence to interpret the its terms; (ii) plaintiffs stated a claim that a corporation breached certain provisions in its certificate of incorporation and improperly disenfranchised plaintiffs by suspending the rights of all of the preferred stockholders; and (iii) plaintiffs stated a claim that a provision in the certificate of incorporation was invalid as applied in the instant case in connection with one stockholder’s attempt to exercise the statutory right to inspect books and records pursuant to 8 Del. C. § 220.

Plaintiffs are holders of approximately 94% of the shares of Series B Preferred Stock of defendant Spanish Broadcasting System, Inc. (“SBS” or the “Company”). Certain of the plaintiffs, holders of approximately 69.9% of the Series B Preferred Stock, are foreign entities, which are defined as “aliens” in the Communications Act of 1934.

The certificate of designations for the Series B Preferred Stock provides that the holders of the Series B Preferred Stock (the “Series B Holders”) have no voting rights until the occurrence of a voting rights triggering event (a “Triggering Event”). As a result of the 2008 financial crisis, multiple Triggering Events occurred that remained uncured, including the following: (i) dividends on outstanding shares of Series B Preferred Stock were not paid and were thus in arrears, (ii) the Company failed to redeem all of the shares held by the Series B Holders who had exercised their redemption rights, and (iii) the Company defaulted under an indenture by failing to pay off certain senior notes when such notes became due and payable. With respect to the senior notes, the Company reached a forbearance agreement with the senior note holders. This agreement provided, in relevant part, that SBS would make certain interest payments to the senior note holders.

Following the filing of plaintiffs’ initial complaint, which alleged that the Company breached the certificate of designations by entering into the forbearance agreement, SBS claimed it learned for the first time that 63% of the Series B Holders were foreign entities, which, the Company claims, exceeded the foreign ownership limit set forth in the Communications Act and in the Company’s certificate of incorporation. In response, SBS suspended the rights of all of the Series B Holders, other than the right to transfer shares to US citizens.

In an amended complaint, plaintiffs asserted a number of claims, which included the following: (i) SBS breached the certificate of designations by incurring debt during a Triggering Event as a result of its entry into the forbearance agreement; (ii) SBS breached its certificate of incorporation by suspending the rights of the Series B Holders; and (iii) the provisions in the certificate of incorporation purporting to permit the suspension of all rights of stockholders of a corporation violated Delaware law and thus were invalid.  SBS filed a motion to dismiss each of the claims for failure to state a claim.

First, the Court denied the motion to dismiss the claim with respect to the breach of the certificate of designations after analyzing the meaning of the definition of “Indebtedness” set forth therein.  Plaintiffs argued that any accrual of interest qualified as “Indebtedness”, while defendant argued that interest is “Indebtedness” only when payment of interest is more than thirty days in arrears. The Court found both interpretations to be reasonable and thus concluded that the provision was ambiguous.

In a typical breach of contract case, any ambiguity is resolved in favor of the non-moving party and the Court ultimately resorts to extrinsic evidence to interpret the contract.  The Court noted, however, that extrinsic evidence is not necessarily illuminative in the context of a certificate of designations where the parties in interest – the holders of the shares of preferred stock – may not have been consulted in the drafting process and where there is a reluctance to risk non-uniform interpretations.  In this context, the Courts often resort to two alternative interpretation principles that are in tension with each other – resolving ambiguities in favor of (i) the investor under the doctrine of contra proferentem in which contracts are construed against the drafter and (ii) the corporation pursuant to the interpretation principle that preferred stock rights must be clearly expressed and are not to be presumed or implied.  The Court chose not to employ either of those interpretation principles until the Court first considered extrinsic evidence – to the extent it exists. 

Second, the Court found plaintiffs stated a claim that SBS breached Section 10.4 of the certificate of incorporation (“Section 10.4”) and improperly disenfranchised plaintiffs by suspending all rights of the Series B Holders. Defendant argued that it was forced to suspend all rights of the Series B Holders in accordance with Section 10.4 after learning that a majority of such holders were aliens. Plaintiffs countered by arguing that SBS could have issued, in accordance with Section 10.4, new “Domestic Share Certificates” for the non-alien Series B Holders, and more “Foreign Share Certificates” to the alien Series B Holders up to the alien ownership limitation threshold, in order to be in compliance with Section 10.4 and the Communications Act. Accordingly, SBS would not be required to unilaterally suspend the rights of all the Series B Holders on account of certain foreign holders.  The Court agreed with plaintiffs, finding that given the severity of depriving stockholders of fundamental rights, it is reasonable to expect that SBS would issue replacement certificates under the terms of the certificate of incorporation.

Finally, the Court found plaintiffs also stated a claim that Section 10.4 was invalid as applied here in connection with one stockholder’s attempt to exercise its statutory right to inspect the books and records of the corporation pursuant to 8 Del. C. § 220. The Court stated that a stockholder’s right to inspect a corporation’s books and records cannot be eliminated or limited by a provision in a certificate of incorporation and noted that there was no limitation on such rights in the certificate of designations for the Series B Preferred Stock.

The full opinion is available here