Alerts and Updates
Delaware Court of Chancery Revisits Directors' Duty of Good Faith and Obligation to Maximize Sale Value
August 27, 2008
Ryan v. Lyondell Chemical Company
One of the most important protections available to directors of Delaware corporations is an exculpatory charter provision permitted by §102(b)(7) of the Delaware General Corporation Law (the "DGCL"). Section 102(b)(7) allows Delaware corporations to limit or eliminate the personal liability of their directors for monetary damages for breaches of fiduciary duty. Specifically excepted from the exculpation allowed by §102(b)(7) are breaches of the duty of good faith, for which a director's personal liability may not be limited or eliminated.
Defining what types of acts or omissions by a director will be deemed to be not in good faith has been the subject of extensive discussion and analysis by courts and commentators over the past several years and remains an amorphous issue today. The Court of Chancery's recent decision in Ryan v. Lyondell Chemical Company, 2008 WL 2923427 (Del. Ch. July 29, 2008), focused on a discrete but important component of a director's duty of good faith — the intersection between the duty of good faith and a director's obligation to maximize stockholder value in sale of control transactions under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.
In a summary judgment decision in Ryan, the Court of Chancery allowed to proceed to trial the issue of whether the independent directors should be exposed to personal liability for their role in the merger, despite the fact that Lyondell was sold to the only known bidder at a substantial premium and the merger was overwhelmingly approved by the stockholders. The factual backdrop of the Ryan case and the Court's summary judgment decision underscore the fact-intensive nature of a case involving Revlon claims and the very real concern that a director faced with such claims may not have decided the issue of whether the protections of §102(b)(7) will apply until after a trial on the merits.
The beginnings of the Ryan case date back to the spring of 2006, when Lyondell, the third-largest independent, publicly traded chemical company in North America, was approached by Leonard Blavatnik of Basell, a privately owned company of Access Industries, about a potential transaction. Lyondell's CEO, Dan Smith, informed Blavatnik that Lyondell was not for sale, but that Lyondell's Board was willing to consider proposals to create value for its shareholders. Basell eventually made an offer to buy the company for between $26.50 to $28.50 per share, which Lyondell's Board rejected as inadequate and not in the best interests of the shareholders. After Basell's offer, Lyondell did not receive any other indications of interest, and because it was in an excellent financial position, it did not seek out a strategic partner.
Then, in the spring of 2007, Blavatnik acquired a right to purchase all of the Lyondell shares owned by Lyondell's second-largest shareholder, and he therefore filed a Schedule 13D with the Securities and Exchange Commission disclosing that right and his intent to engage Lyondell in discussions regarding various transactions between Lyondell and other Access affiliates. The Lyondell Board met to discuss Blavatnik's filing and his possible intentions, but decided that no immediate response was required and that they should wait and see if any other suitors would appear in reaction to the signal sent by the 13D that Lyondell was in play.
Three days after the 13D was filed, Apollo Management, L.P. approached Dan Smith to inquire whether Lyondell's management would be interested in a management-led leveraged buyout transaction. Viewing those transactions as inherently fraught with conflicts of interest for both management and the Board, Smith rebuffed Apollo's overtures. Lyondell received no other expressions of interest. Over the next few months, Smith remained in contact with Blavatnik, but did not keep the Board abreast of his interactions with Blavatnik and Basell's CEO, Volker Trautz. Moreover, despite the signals sent to the market with the filing of the 13D, the Board made no effort to value the company or assess its options in the event that a bid was made for the company. In early July 2007, Smith met with Blavatnik and received an offer to purchase Lyondell for $48 per share in cash if the Board would agree to a $400 million termination fee and would sign a merger agreement by July 16 — within seven days.
Smith called a special meeting of the Lyondell Board of Directors on July 10 to announce and discuss Blavatnik's proposal. The meeting lasted only 50 minutes, and at the conclusion of the meeting, the Board directed Smith to seek a written offer from Basell and obtain detailed information about its financing. The Board reconvened the next day for a 45-minute meeting in which it considered the benefit to the Lyondell stockholders of the transaction as compared to remaining independent, the process likely to be involved in the transaction, engaging an investment bank to serve as a financial advisor in connection with the proposal, and the impact of another potential pending Basell transaction on its ability to acquire Lyondell. After these considerations, it authorized Smith to negotiate with Blavatnik.
Due diligence and negotiation of the merger terms continued over the next few days. On July 15, 2007, Smith contacted Blavatnik and relayed the Board's concern that the transaction was moving too quickly and that the Board wanted to ensure it had obtained the best price for the shareholders. Smith requested (1) an increase in the offer price; (2) a go-shop provision; (3) a break-up fee of 1% during the go-shop period; and (4) a reduction in the $400 million break-up fee after the go-shop period ended. Blavatnik flatly refused to increase the price or extend the time for the transaction to be finalized. He did, however, agree to a reduction in the break-up fee to $385 million.
At the next Board meeting on July 16, the Board considered the terms of the merger and heard from its investment banker, who concluded that the Blavatnik proposal was fair and that they believed no other suitor would emerge to top Blavatnik's $48 offer. After deliberating, the Board voted unanimously to approve and recommend the transaction to the Lyondell shareholders.
Ryan, a Lyondell shareholder, then brought suit challenging the transaction. Among other claims, Ryan alleged that the Lyondell Board failed to take adequate steps to ensure that existing stockholders would receive maximum value for their shares in the sale to Basell. Although most of his claims were dismissed on summary judgment, his Revlon claim survived. To obtain money damages on that claim, however, it was Ryan's burden to overcome the protection of Lyondell's §102(b)(7) charter provision by demonstrating that the Board failed to act in good faith in approving the transaction or otherwise acted disloyally. The Court of Chancery found that Ryan had met that burden by pleading facts showing that the Board failed to be proactive in its approach to the sale process, which failure the Court found may constitute a breach of the good faith component of the duty of loyalty.
Chancery Court's Decision
The Court cited several reasons for finding that Ryan's Revlon claims survived summary judgment. First, the entire transaction was negotiated, considered and approved in less than seven days, and the Board met for approximately seven hours over those days, with approximately half that time spent on the last day when the transaction was approved. Second, the Board never performed a market check of any kind or took any steps to prepare in anticipation of an offer by Blavatnik after the 13D was filed. The Board also delegated its negotiating authority to Smith, and there was no evidence that it actively participated in the sale process. Finally, the Board did not put forth sufficient evidence to justify its reliance on an implicit post-signing market check. Unlike the case in In re Pennaco Energy, Inc., 787 A.2d 691 (Del. Ch. 2001), the Lyondell Board did not demonstrate satisfactory knowledge of the market to justify its single-bidder strategy and did not engage in vigorous negotiations and obtain any concessions in price or protection devices.
The Court also looked at the deal protection devices agreed to by the Board: a $385 million termination fee, matching rights, a no-shop provision and a poison pill, which was pulled only as to Basell. Although the Court found that the protection devices were not coercive, it was concerned that the aggregate preclusive effect of the protections raised the question of whether the Board's decision to grant such strong protection to a deal that may not pass the Revlon test was reasonable. Because the decision was made on a summary judgment motion, the Court could not weigh the evidence and was required to draw all inferences in favor of Ryan. The Court therefore could not conclude that the mix of protection devices was reasonable and denied summary judgment to the directors on that count.
The Court lastly addressed whether, consistent with Revlon, the Lyondell Board was still entitled to summary judgment because of the protection of Lyondell's §102(b)(7) provision, which would preclude an award of damages for a breach of the duty of care. Because the Court found that the Board appeared to have never fully engaged in the deal process, in spite of Revlon's teachings, the good faith aspect of the duty of loyalty was implicated and prevented the application of a §102(b)(7) defense. The Court also rejected the Lyondell Board's reliance on a post-signing market check to demonstrate its good faith at the summary judgment stage because it had not "satisfactorily demonstrated an assiduous balancing of its 'single bidder strategy' with an effective and relatively unencumbered post-signing market check."
Because the Board had not demonstrated any effort to create an active sale process or to engage in salesmanship either before or after the merger was announced, the court found that "the Board has not satisfactorily demonstrated an undertaking of the careful process envisioned by cases such as Revlon, Barkan, and QVC for discharging the directors' unremitting duty of care in a sale of control." Citing Stone v. Ritter, 911 A.2d at 370, the Court went on to hold that if proven, Ryan's allegations could support a finding that the directors had breached their duty of loyalty by failing to act in good faith to discharge their Revlon obligations, and that one consequence of acting not in good faith is the forfeiture of the exculpatory provision contained in Lyondell's charter. As the Court described it:
This may not be a case, however, where a board of directors simply botched the sale process in some careless or even grossly negligent manner; instead, this is a board of directors that appears never to have engaged fully in the process to begin with, despite Revlon's mandate.
Ultimately, the court did not decide whether the Board members were or were not entitled to the protection of Lyondell's exculpatory 102(b)(7) provision, ruling instead that the issue presented a question of fact that could not be resolved on summary judgment.
The Court's decision in Ryan should serve as a serious precautionary note for directors of corporations in Delaware and other jurisdictions. The primary lesson from Ryan is the importance of a thorough and informed process in any corporate transaction, and especially in those involving a sale of control. Directors can and should look to financial and legal advisors to understand the scope and nature of their duties in such transactions and should be vigilant in undertaking and documenting an active and effective deal process. If directors fail to do so, not only might they face the time and aggravation associated with defending stockholder challenges to a transaction, but they may also be held personally liable for any resulting award of monetary damages.
For Further Information
For more information, please contact Daniel V. Folt or Matt Neiderman of the firm's Wilmington, Delaware office, any of the attorneys in the firm's Securities Litigation Practice Group or the lawyer in the firm with whom you are regularly in contact.
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