Delaware Weighs in on the Meaning of
"Substantially All" for a Series of Transactions

May 5, 2011

The Delaware Chancery Court, in an opinion written by Vice Chancellor J. Travis Laster, recently declined to find that a series of four spin-off and split-off transactions by Liberty Media Corporation over a seven-year period constituted, together, the transfer of "substantially all" of Liberty's assets in violation of the successor obligor provision in its bond indenture.  In doing so, the court set out a "step-transaction test" to be used to ascertain whether a series of transactions should be aggregated when conducting an analysis of whether a transfer of "substantially all" assets will occur.

The court's decision and its adoption of the "step-transaction test" in this instance are not surprising.  The court's adoption of the step-transaction test does, however, provide a sign-post for measuring whether a series of transactions meets the "substantially all" assets threshold in the indenture context and, perhaps, beyond.

The Indenture Covenant

At issue was whether Liberty would violate the successor obligor covenant in its indenture, and therefore default under the indenture, by going forward with a proposed split-off of certain businesses, assets and liabilities.  The successor obligor provision in Liberty's indenture, which is a fairly standard provision, prohibits Liberty from transferring substantially all its assets unless, among other things, the entity to which the assets are transferred assumes Liberty's obligations under the indenture.  While it was undisputed that the proposed split-off alone would not violate the covenant, the indenture trustee asserted that the proposed split-off, when aggregated with three previous spin-off or split-off transactions Liberty had executed over the past seven years, amounted to Liberty's transfer of "substantially all" assets in violation of the provision.

The Transactions in Question

The court describes a variety of actions Liberty took subsequent to 2001 to transform itself from a "fruit salad" of noncash generating minority positions into an owner of controlling stakes in cash-generating operating companies.  The case focuses, however, on whether to aggregate the proposed split-off with two spin-offs completed in 2004 and a split-off completed in 2009.  When combined, the four transactions involved assets representing approximately 67% of Liberty Media's book value as of March 31, 2004, the trustee's proposed measurement date. 

The Step-Transaction Doctrine

In light of the lack of, in the court's view, a "clear standard" for determining when transactions should be aggregated to determine whether a "substantially all" threshold has been met, the court adopted the "step-transaction doctrine" previously utilized by the court in other contexts.  The step-transaction doctrine treats the steps in a series of formally separate but related transactions involving the transfer of property as a single transaction if all the steps are substantially linked.  The steps are viewed together as components of an overall plan if they meet one of three tests:

  1. End Result Test.  It appears that a series of separate transactions were prearranged parts of what was a single transaction, cast from the outset to achieve the ultimate result.
  2. Interdependence Test.  The steps are so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series.
  3. Binding Commitment Test.  A series of transactions are combined only if, at the time the first step is entered into, there was a binding commitment to undertake the later steps.

Applying this overall step-transaction test, the court generally found that the Liberty spin-offs and split-offs should not be aggregated because, although the transactions shared the same theme of distributing assets to Liberty's stockholders, they "were not part of a master plan to strip Liberty's assets out of a corporate vehicle subject to bondholder claims."  Rather, each transaction reflected a context-driven application of the overarching business strategy to consolidate ownership of businesses where Liberty could exercise control while exploring alternatives for assets that did not fit this profile.

In analyzing the three tests, the court found that:

  1. The Interdependence Test was not met because each of the transactions was a distinct corporate event which was separated from the others by a matter of years and stood on its own merits.  None of them would have been fruitless in isolation.
  2. The Binding Commitment Test was not met because none of the four transactions was connected contractually to any of the others.
  3. The End Result Test seemed to give the court the most pause given that Liberty had previously referred to a "disaggregation strategy" and the proposed split-off and its predecessors could potentially be construed as a part of a broad strategy to transform from a holding company "fruit salad" to an owner of controlling stakes in cash-generating operating companies.  The court ultimately found, however, that Liberty had "not pursued a unified disaggregation strategy with a sufficiently well-defined starting point or a sufficiently definitive end result to warrant applying the step-transaction doctrine" because:
    • Liberty management had deployed different tactics depending on the facts on the ground;
    • Liberty did not conceive of and pursue certain of the transactions as instrumental components of an overarching disaggregation plan but rather "backed-into" certain structures;
    • the timing of the spin-offs and split-offs over a seven-year span was not proximate enough in time to suggest a conscious plan to achieve a particular endpoint through asset dispositions; and
    • there was no cause to believe Liberty was trying to evade legitimate claims of the bondholders by removing cash generating assets since the majority of the bonds were not maturing soon and the assets distributed were not the type of cash generating assets typically relied upon for bond repayment.

Possible Application to Section 271 of Delaware General Corporation Law (DGCL)

Vice Chancellor Laster suggests, in dicta, that his analysis of the meaning of "substantially all" and his use of the step-transaction doctrine for this purpose are not necessarily limited to indenture cases but should also extend to the requirement for a shareholder vote under Section 271 of the DGCL. It is important to note, however, that although the Vice Chancellor addresses this issue in the context of spin-off transactions, he does not address the issue of whether a spin-off transaction that involves the distribution of a subsidiary's stock to parent stockholders constitutes a "[sale], lease or exchange" of all or substantially all of a company's property and assets as required under Section 271. Such transactions have not traditionally been viewed as requiring stockholder approval since they do not constitute a "[sale], lease or exchange" of assets but rather a dividend of stock for which there is independent authority under Sections 170 and 173 of the DGCL. While nothing in the opinion should be read to contradict this view, the decision provides dicta that a plaintiff seeking to challenge a proposed spin-off as requiring shareholder approval might cite as a basis to call this traditional view into question. 

See Liberty Media Corp. v. The Bank of New York Mellon Trust Co., C.A. No. 5702-VCL, 2011 WL 1632333 (Del. Ch. Apr. 29, 2011).


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