Delaware companies take note: a state court has ruled that companies in apparent good financial health may not use the bankruptcy process to avoid shareholder approval of an asset sale—even in situations in which a shareholder vote may be difficult to obtain.

In Esopus Creek Value LP v. Hauf, 2006 WL 3499526 (Del. Ch. Nov. 29, 2006), the Delaware Court of Chancery was presented with the question of whether a solvent Delaware corporation that is considering an asset sale could avoid compliance with Delaware law and its own certificate of incorporation requiring approval by the common stockholders of the sale, by seeking approval of the sale from a bankruptcy court.

The corporation had not filed the required 10-K annual reports for several years, even though it was not suffering from financial difficulties. Federal regulations prohibit calling a stockholder meeting if the required filings with the Securities and Exchange Commission (SEC) are not complete. The corporation maintained “that the only reason that it was not current in its securities filings is because of its auditor’s mismanagement and continued obstinacy pertaining to small disagreements with the company’s financial statements that do not greatly affect the overall value of a stockholder’s stake in the company.”


The corporation’s certificate of incorporation and the applicable Delaware corporate laws require that a sale of substantially all of the corporation’s assets be approved by a vote of the corporation’s common stockholders. Thus, the company was faced with a dilemma: if the corporation could not file the required filings with the SEC, and hence not solicit the vote of the common stockholders, how could the corporation sell its assets?

In its opinion, the court noted that “[t]o circumvent this apparent dead end, the board of directors adopted a plan to file a bankruptcy petition once the asset sale agreement [was] signed, and thereafter seek approval of the sale from the bankruptcy court, without a meeting and without a vote by the common stockholders.”

To comply with the Bankruptcy Code provisions for confirmation of a plan that would include the sale, the debtor corporation would need to obtain the support of at least two-thirds of the preferred stockholders. See §§ 1126(d) and 1129(a)(7)(A) of the Bankruptcy Code. Therefore, the corporation sought a lock-up agreement whereby the preferred stockholders would support the plan in return for a certain distribution of the sale proceeds.

Solution Rejected

Several common stockholders sought a preliminary injunction to enjoin the board of directors from selling the assets without the prior approval from the common stockholders, and to bar the execution of the lock-up agreement with the preferred shareholders. The court acknowledged that the sale might be in the best interest of the common stockholders, but found that the corporation had not sought relief from the SEC with respect to the filing issues. It also found that that the “proposed structure of the transaction results in two glaring inequities.” “First, the transaction would prevent the common stockholders from voting on a sale of the assets, a right they have under both Del. C. §271(a) and the company’s certificate of incorporation,” the court stated. “Second, the holders of the preferred stock are given a vote on a transaction, that if consummated outside the bankruptcy context, they would not have under the certificate of designation.”

The Chancery Court stated that it would be an “abuse of the bankruptcy process for a robust and healthy company” to seek the relief suggested from a bankruptcy court. While the court agreed that the Supremacy Clause of the United States Constitution and federal preemption jurisprudence prevented it from issuing an order enjoining the board of directors from filing a bankruptcy petition, it nonetheless had the power to prevent the board of directors from binding the company to a sale that did not comply with Delaware law.

Following oral argument, the parties stipulated to an order, issued with the opinion, that prohibited the corporation and its directors from agreeing to sell the company’s assets without approval of the common stockholders.