In an important and controversial corporate governance decision, the Delaware Chancery Court in Ryan v. Lyondell Chemical Company raises new concerns facing directors seeking to negotiate the minefield of duties imposed upon them in the sale of business context. The case, which arose from the $13 billion acquisition of Lyondell by Basell AF, involved claims that the board of directors breached its duties of care and loyalty in failing to engage fully and actively in the sale process. The court denied Lyondell’s motion for summary judgment and left open the possibility that the directors will be held personally liable for money damages notwithstanding the exculpatory language in Lyondell’s charter, which is intended to insulate directors from precisely this type of claim.
Revlon v. MacAndrews & Forbes Holdings, Inc.¹ and its progeny establish that a board of directors, in discharging its fiduciary duties in the context of a sale of the company, must be guided by the central theme of obtaining the highest price for the benefit of stockholders.
The Lyondell court acknowledged that the sale price (a 45% premium to market) was fair, that the board was independent, properly motivated and had no conflicts of interest, and that the board was sophisticated, active and generally well informed about the company’s value and the market. However, the court denied Lyondell’s motion for summary judgment based primarily on “the Board’s failure to engage in a more proactive sale process,” which “may constitute a breach of the good faith component of the duty of loyalty.” In addition, the court questioned the reasonableness of the board’s agreement to the “particular mix of deal protections” included in the final merger agreement.
Thus, the court focused not on the ultimate price Lyondell was able to obtain (“a premium to market alone does not satisfy Revlon”), but on the “troubling board process” that emerged when it scratched “the patina of this ‘blowout’ market premium.” Although the Lyondell decision is a denial of summary judgment (and not a decision on the merits), a fact the court stresses time and again in its opinion, the case is likely to be distressing to boards of directors for two reasons in particular:
- It blurs the line between the fiduciary duties of care and loyalty. This distinction is critical because Section 102(b)(7) of the Delaware Code permits a corporation to eliminate personal, monetary liability of directors for breaches of the duty of care, but not for breaches of the duty of loyalty. This seeming conflation of the fiduciary duties of care and loyalty in the sale of business context is at the heart of the Lyondell decision; and
- It places directors in an untenable position when faced with an unsolicited purchase offer at a substantial market premium but with a short timeframe for acceptance. If one follows Lyondell to its logical conclusion, the board must forestall a transaction in order to have adequate time to discharge its Revlon duties. However, in so doing, the board risks losing the premium offer, which could expose the board to liability for failure to act upon the corporate opportunity.
A Troubling Board Process
The court focused on several facts relating to the sale process in reaching its conclusions in Lyondell, including:
- the short period of time (less than seven days) between Basell’s formal offer and execution of the merger agreement;
- the failure by the board to engage in a formal market check prior to signing the merger agreement despite an acknowledgment that the company was “in play;”
- the lack of participation by the board in the negotiations between Lyondell and Basell, which were conducted on Lyondell’s behalf by its CEO;
- the board’s reliance on an implicit post-signing market check; and
- the board’s lack of diligence in determining the reasonableness of the deal protection provisions of the merger agreement (e.g. the break-up fee and the “no shop” provision).
The enumerated deficiencies in the sale process set forth above may initially appear instructive for directors seeking to avoid repeating the mistakes of the Lyondell board. However, the practical benefit is undercut by inconsistent language in the court’s opinion, which is replete with examples of a board that was adequately informed about the value of its company and the prospects of receiving competitive bids, none of which were forthcoming in the four months between the public announcement of the transaction and the shareholder vote. The Court’s opinion also includes numerous references to the fair sale price, which the court admits “may well have been the best that could reasonably have been obtained.”
Notwithstanding the apparent inconsistencies in the opinion regarding the deficiency of the board in governing the sale process, the most difficult aspect of the court’s opinion to reconcile is the transformation of this deficiency of process, which traditionally has implicated only the duty of care, into a duty of loyalty claim via a breach of the duty of good faith. The cornerstone of bad faith claims under Delaware corporate law is an intentional failure by the board to discharge its known fiduciary obligations; the court in Lyondell has expanded that premise to include the failure of an independent and well informed board to take a more proactive role in the sale process.
Lyondell raises a variety of issues that boards of directors and their counsel would be prudent to consider. Among other things, in order to satisfy its Revlon duties in accordance with the Lyondell court’s guidance, a board of directors needs time — time which is often scarce in the context of transactions of this type, but which directors facing the specter of personal liability will increasingly demand. Notwithstanding tight timeframes, directors must do all they can to ensure that the record reflects that the board was proactive in its approach to a potential transaction and maintained an active role throughout the sale process. In particular, boards must be:
- Proactive in engaging management, financial and legal advisors in anticipation of or early in the sale process to determine company value and the probability of receiving competitive or topping bids;
- Active in their oversight of and communication with management during preliminary discussions and negotiations with potential bidders;
- Active in their efforts to ensure maximization of shareholder value (i.e. discharging their Revlon duties) even if the offer price is at a substantial premium to market, either by conducting a formal pre-signing market check or by negotiating a “go shop” instead of relying on an implicit post-signing market check; and
- Active in negotiating deal protection provisions; in the absence of a meaningful attempt by the board to negotiate the provisions out of the agreement, the court in Lyondell was not persuaded by the defendants’ argument that the “no shop” and break-up fee provisions were typical in deals of this nature.
Since the original Lyondell opinion was handed down by Vice Chancellor Noble on July 29, 2008, there have been three decisions by the Chancery Court that may have a significant impact on the reach of Lyondell.
First, on August 29, V.C. Noble denied Lyondell’s motion for interlocutory appeal. In his opinion, however, Noble went to great lengths to emphasize the paucity of the record on which his denial of summary judgment was based and implied that, on the merits and with the benefit of a fully developed record, the case could very well be decided in Lyondell’s favor.
Second, also on August 29, in McPadden v. Sidhu the Chancery Court granted the defendant directors’ motion for summary judgment in a case in which the plaintiffs alleged that the board of directors of i2 Technologies, Inc. acted in bad faith and breached its fiduciary duty of loyalty by agreeing to sell a wholly owned subsidiary at a price the directors knew was well below market value. The court emphasized the high threshold that must be achieved by plaintiffs seeking to prove that directors have acted in bad faith. Although perhaps distinguishable from Lyondell, the facts in McPadden on their face present a more egregious example of a deficient board process. Nonetheless, the court held that though the directors were grossly negligent in carrying out the sale process their conduct did not rise to the level of bad faith. Therefore, the presence in i2’s charter of a 102(b)(7) provision exculpated the directors from liability.
Finally, on September 2, Vice Chancellor Strine decided In re Lear Corp. Shareholder Litigation, a case that arose out of the attempted acquisition of Lear Corporation. Late in the process the Lear board re-negotiated the transaction to increase the purchase price in an attempt to gain shareholder approval. In consideration of the increased sale price, Lear agreed to pay a $25 million termination fee in the event the shareholders voted the transaction down, which they ultimately did. Lear shareholders brought the action alleging that the board had acted in bad faith in agreeing to the $25 million termination fee. V.C. Strine granted the defendants’ motion for summary judgment and, in so doing, indirectly commented on the Lyondell decision, stating that “[c]ourts should be extremely chary about labeling what they perceive as deficiencies in the deliberations of an independent board majority over a discrete transaction as not merely negligence or even gross negligence, but as involving bad faith.”
Although McPadden and In re Lear seem likely to limit the practical impact of Lyondell, until the Delaware Supreme Court or the General Assembly explicitly overrules Lyondell, it remains a case that could impact boards of directors and the processes they employ in change of control transactions.
To view the full text of the Lyondell opinion click here.
¹Revlon v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986).