Major Decision by Chancery Court on Corporate Law Aspects of Mergers and Acquisitions
In Ryan v. Lyondell Chemical Company, (Del. Ch., July 29, 2008), read opinion here, the Delaware Chancery Court rendered a decision that is "must reading" for anyone who needs to know the latest developments in Delaware corporate law involving mergers and acquisitions.
One reason why this case will attract a great amount of attention in board rooms and law firms all over the world is due, at least in part, to the following particular aspect of the court’s decision–which I describe in my own words:
The court found that at the procedural stage of a summary judgment motion, it would allow to proceed to trial the issue of whether the independent directors should be exposed to personal liability for their role in the sale of the company–despite selling the company to the only known buyer for a substantial premium.
This 73-page decision cannot be fully explained in this short blog post on a busy day, but I will hit the highlights and encourage you to read the whole opinion at the above link (and look forward to future links by the corporate law professors that I predict will soon provide their scholarly analyses of what I expect to be an oft-cited Chancery Court case.)
The court’s introductory overview of the case, excerpted from the opinion, is as follows:
In this shareholder class action, Plaintiff Walter E. Ryan, Jr. (“Ryan”) challenges the $13 billion cash for shares merger transaction (the “Merger”) among Defendant Basell AF (“Basell”), its acquisition subsidiary, Defendant BIL Acquisition Holdings Limited, 1 and Defendant Lyondell Chemical Company (“Lyondell” or the “Company”). Before the Court are Defendants’ motions for summary judgment. 2 On its face, the Merger offering the Lyondell stockholders $48 per share in cash, a substantial premium to market, 3 was very attractive;
indeed, the Lyondell stockholders voted overwhelmingly in its favor, and the Merger was consummated on December 20, 2007. 4 Once one scratches the patina of this “blowout” market premium, however, a troubling board process emerges.
When this transaction materialized in the late spring and early summer of 2007, Lyondell was a financially strong and viable company. It was not in financial distress; it was not looking to raise capital; it was not looking to spin-off one of its divisions; and it was not otherwise “for sale” or “on the auction block.” Lyondell’s board of directors (the “Board”) had neither sought the advice of investment bankers to value the Company, nor was it actively seeking strategic business partners.5
In response to Basell’s unsolicited offer for the Company, the Board avoided an active role in negotiating the Merger, instead delegating much of that task to Lyondell’s Chairman and Chief Executive Officer, Dan F. Smith (“Smith”). The Board never conducted a formal pre-signing market check to determine whether a better price could be obtained; in addition, it was not able to negotiate successfully for a post-signing go-shop period and, thus, did nothing post-signing to confirm that a better price could not have been obtained. The final merger agreement also employed several deal protection devices, including a no-shop provision, matching rights, and a $385 million break-up fee.6 Moreover, the whole deal was considered, negotiated, and approved by the Board in less than seven days.
It is against that factual backdrop that Ryan brought this action and the Court considers the present motions. Notwithstanding the premium price and enthusiastic shareholder approval, Ryan alleges that the directors were looking out only for their own self-interest and that the process by which the Merger was approved and recommended to the Lyondell stockholders was fatally flawed for three reasons. First, the Board began and concluded its review of the transaction over the course of a mere seven day period. Given the frenetic pace at which this deal evolved, Ryan contends that the Board could not possibly have informed itself as to the value of the Company and the wisdom of this transaction for the Lyondell stockholders. Second, the Board never conducted a market check or otherwise shopped” Basell’s offer to determine if $48 per share was indeed the highest value reasonably attainable by the Lyondell stockholders. Third, Ryan claims that the deal protection devices agreed to by the Board were unreasonable and essentially “locked up” this transaction for Basell by precluding other bidders from making an offer for the Company. (footnotes omitted)
* * *
This case arises from the intersection of two fundamental tenets of Delaware corporate law. The first set of principles, known colloquially as “Revlon duties,” 8 requires a board, when it undertakes a sale of the company, to set its singular focus on seeking and attaining the highest value reasonably available to the stockholders. The Defendants extol the virtues of the “blowout” price paid by Basell. In this instance, however, the Board took no affirmative action to confirm that a better deal could not be obtained and, for summary judgment purposes, the record does not show that the Board was so knowledgeable about the value of the Company that no further effort was appropriate.
8 Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986).
The second set of principles, generally addressed in Unocal 9 and Omnicare,10 requires that deal protection measures must not be preclusive or coercive and, more importantly for present purposes, that such measures be reasonable in light of the circumstances. The Defendants support the deal protection measures by arguing that they were reasonable and necessary to secure Basell’s offer for the Lyondell shareholders. They have not, however, been able to explain why deal protection measures of the scope adopted were appropriate under these circumstances. In short, the Board did nothing (or virtually nothing) to confirm the superiority of the price but, nonetheless, it provided Basell a full complement of deal protections. Maybe the price was the “blowout” the Defendants proclaim it to have been—it certainly was a “fair” price—and maybe the deal protection measures were reasonable and proportionate to the risks that the deal would not materialize otherwise, but those conclusions cannot be reached on the current record on summary judgment where the Court is precluded from choosing between plausible inferences. Accordingly, for the reasons that will be developed below, the Lyondell Defendants’ motion for summary judgment with respect to Ryan’s Revlon claims and his challenge to the deal protection measures will be denied.
9 Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).
10 Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003).
What some may view as an "eye-opener" is the following summary of the court’s decision relating to the personal liability of admittedly independent directors, which I quote from the opinion:
The Lyondell Defendants invoke the exculpatory provision of the Company’s charter authorized by 8 Del. C. § 102(b)(7). As explained more fully infra in Section III(B)(2)(d), that
defense is not now available on summary judgment because the Board’s apparent failure to make any effort to comply with the teachings of Revlon and its progeny implicates the directors’ good faith and, thus, their duty of loyalty, thereby, at least for the moment, depriving them of the benefit of the exculpatory charter provision. The Lyondell Defendants also point to the overwhelming support of their shareholders for the transaction as a basis for claiming shareholder ratification. Ratification, at this point, does not meet the objectives of the Lyondell Defendants for the reasons discussed infra in note 129. (emphasis added).
Time constraints won’t allow me today to cover the decision in detail, but here are a few key parts that deserve closer treatment when time allows:
1. The exception to the active sale process generally contemplated by Revlon was discussed with reference to the decision in Barkan v. Amsted Indus., Inc., 567 A.2d 1279 (Del. 1989).
2. Deal protection measures were discussed at length. Footnote 99 observed that the shareholders were NOT given a Hobson’s Choice of selling the company or going into bankruptcy, as the company was viable with good long term prospects. Footnote 100 also emphasized that there is no algebraic formula for deal protections, which must be analyzed in the fact-specific context in which they are used.
3. The key quote that exposes the admittedly independent board to potential personal liability–despite Section 102(b)(7) of the DGCL, is on page 56 of the opinion (which the court’s reasoning lays the groundwork for on pages 51 to 55):
The record, as it presently stands, does not, as a matter of undisputed material fact, demonstrate the Lyondell directors’ good faith discharge of their Revlon duties—a known set of “duties” requiring certain conduct or impeccable knowledge of the market in the face of Basell’s offer to acquire the Company. Perhaps with a more fully developed record or after trial, the Court will be satisfied that the Board’s efforts were done with sufficient good faith to absolve the directors of liability for money damages for any potential procedural shortcomings. With a record that does not clearly show the Board’s good faith discharge of its Revlon duties, however, whether the members of the Board are entitled to seek shelter under the Company’s exculpatory charter provision for procedural shortcomings amounting to a violation of their known fiduciary obligations in a sale scenario presents a question of fact that cannot now be resolved on summary judgment.
4. Footnotes 128 and 129 (spanning over two full pages in length) discuss the need to seek prompt remedies for disclosure claims in the merger context–and how disclosure issues interface with the concept of shareholder ratification which must be blessed with appropriate disclosures in order to be effective.
It’s back to work for now, but I hope I will have more to add later.
UPDATE: Professor Larry Ribstein provides scholarly commentary on this case here. In addition, the good professor addresses here the interface between this case and the recent Delaware Supreme Court opinion in Wood v. Baum that upheld an exculpation clause in an LLC agreement.
UPDATE IV: Prof. Eric Chiappinelli (the new dean of Creighton University Law School) comments on the case here.
UPDATE V: Prof. Gordon Smith here provides an insightful analysis that includes an observation that a Revlon claim now comes in three flavors: breach of the duty of care; bad faith and disloyalty. He cites to a decision that supports that view that the 102(b)(7) protection still applies to a Revlon claim based on a duty of care violation (e.g., not following up on a higher bid), but that it may be easier to pursue a Revlon bad faith claim which does not require a showing of fraud or disloyalty.