Delaware Corporate and Commercial Litigation Blog : Delaware Litigation Lawyer & Attorney : Francis G. X. Pileggi : Corporate, Business, Commercial, Delaware Chancery Court

Lyondell Chemical Co. v. Ryan, Del. Supr. (March 25, 2009), read opinion here.  See revised opinion of  April 16, 2009 here. The Delaware Supreme Court rendered this unanimous en banc decision last evening. It was much anticipated in the corporate law world and in the few hours since its release it has already generated substantial commentary among corporate law professors and similar commentators.

Kevin Brady, a highly respected Delaware litigator, has provided us with the following review of the opinion:

In its decision on an interlocutory appeal, Delaware's High Court reversed the Court of Chancery’s July 29, 2008 decision denying summary judgment for the directors of Lyondell Chemical Company (“Lyondell”) as to the “Revlon” and “deal protection” claims and whether the directors of Lyondell acted in good faith in conducting the $13 billion sale of Lyondell.

The class action complaint alleged that the Lyondell directors breached their fiduciary duties of care, loyalty and candor and put their personal interests ahead of the interests of the Lyondell shareholders. In particular, the complaint alleged that: (i) the merger price was grossly insufficient; (ii) the directors were motivated by self-interest; (iii) the process by which the merger was negotiated was flawed; (iv) the directors agreed to unreasonable deal protection provisions and (v) the preliminary proxy statement omitted numerous material facts. By way of background, the merger price represented a substantial premium over the market price and the merger was approved not only by a disinterested board but also by more than 99% of the voted shares.

Lyondell’s charter contained an exculpatory provision pursuant to 8 Del. C. § 102(b)(7), protecting the directors from personal liability for breaches of the duty of care, so the case turned on whether there were any shortcomings on the part of the directors to implicate their duty of loyalty, a breach of which is not exculpated. Because the Court of Chancery had found that the board was independent and was not motivated by self-interest or ill will, the focus became whether the directors were entitled to summary judgment on the claim that they breached their duty of loyalty by failing to act in good faith.

Court of Chancery Focuses on Process and Deal Protection Provisions

The Court of Chancery rejected all of the plaintiffs’ claims except those directed at the process by which the directors sold the company and the deal protection provisions in the merger agreement. In particular, whether under Revlon v. MacAndrews & Forbes Holdings, Inc. (506 A. 2d 173, 182 (Del. 1986)), the directors failed to obtain the best available price in selling the company. The Court of Chancery decided that “unexplained inaction” by the Lyondell directors for two months permitted a reasonable inference that the directors may have consciously disregarded their fiduciary duties. The Supreme Court disagreed finding that there was no evidence from which to infer that the directors knowingly ignored their responsibilities, thereby breaching their duty of loyalty.

Justice Carolyn Berger writing for the Court examined the concepts of “bad faith” and “failure to act in good faith” as well as the range of conduct that might be classified as such in light of existing Delaware case law. See, In re Walt Disney Co. Deriv. Litig. (906 A. 2d 27 (Del. 2006)), Stone v. Ritter, (911 A. 2d 362 (Del. 2006) and In re Caremark Int’l Deriv. Litig. (698 A. 2d 959 (Del. Ch. 1996). While the Court of Chancery had denied summary judgment in order to obtain a more complete record before deciding whether the directors had acted in bad faith, the Supreme Court determined that the trial court “reviewed the existing record under a mistaken view of the applicable law.” The Supreme Court went on to note that there were three factors that contributed to that mistake: (i) the Court of Chancery imposed Revlon duties on the directors before they either decided to sell, or before the sale had become inevitable; (ii) the Court of Chancery read Revlon and its progeny as creating a set of requirements that must be satisfied during the sale process; and (iii) the Court of Chancery “equated an arguably imperfect attempt to carry out Revlon duties with a knowing disregard of one’s duties that constitutes bad faith.”

When Exactly Do Revlon Duties Arise?

In analyzing Revlon and its progeny, the Court of Chancery determined that the directors must actively engage in the sale process, and confirm that they have obtained the best available price either by conducting an auction, a market check or demonstrating “an impeccable knowledge of the market.” The Court of Chancery concluded that because the Revlon sale process must follow one of the these courses of conduct identified above and that the Lyondell directors had not followed any of the standards that the Court of Chancery extracted from Revlon and its progeny, the directors were unable to meet their burden under Revlon.

The Supreme Court disagreed noting that the problem with the Court of Chancery’s analysis was that Revlon duties arise not because a company is “in play” (such as in this case where there was a Schedule 13D filing) but rather when the company “embarks on a transaction – on its own initiative or in response to an unsolicited offer – that will result in a change of control.” In this case, that was when the Lyondell directors began negotiating the sale of Lyondell. The Supreme Court further noted that “there is no legally prescribed steps that directors must follow to satisfy their Revlon duties” and that the Lyondell directors failure to take any specific steps during the sale process could not have demonstrated a “conscious disregard of their duties.”

The Supreme Court concluded that the Court of Chancery “approached the record from the wrong perspective. Instead of questioning whether disinterested, independent directors did everything that they (arguably) should have done to obtain the best sale price, the inquiry should have been whether those directors utterly failed to attempt to obtain the best sale price.” Finding that the record clearly established that the Lyondell directors did not breach their duty of loyalty by failing to act in good faith, the Supreme Court reversed the decision of the Court of Chancery and remanded the matter for entry of judgment in favor of the Lyondell directors.

SUPPLEMENT: Professor Stephen Bainbridge provides a scholarly analysis here. Dean and Professor Eric Chiappinelli provides his learned overview of the case here. Professor Gordon Smith gives us the benefit of his professorial insights here. Attorney  Bernard Sharfman of the Cohen Milstein firm has written a thoughtful article that includes a discussion of this case here.

Some of the extensive commentary on the trial court's opinion is collected here.

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Ryan v. Lyondell  is a major Chancery Court decision issued about a month ago that has generated a substantial amount of commentary by experts and practitioners alike. A summary of the case and commentary by Professors Ribstein and Bainbridge are compiled here.

The newest development in this case came by means of a letter decision of the Chancery Court on August 29, 2008, here, in which the Court denied the interlocutory appeal by the defendants, but did, however, dismiss Lyondell as a nominal defendant.

Ryan II

There is so much to write about this important decision which clarifies and confirms the prior opinion, compared with the limited time I have today, that for now I will just highlight a few key "bullet points".

• The Chancery Court emphasized that: "the reports of the death of Section 102(b)(7) (and the consequent possibility for the "resuscitation" of a Van Gorkom-esque liability crisis) in Delaware law are greatly exaggerated both with regard to the application of Lyondell's exculpatory charter provision in this case, and certainly with regard to the application of a Section 102(b)(7) provision defense in any other case." (my italics)                                          
• The Court went out of its way to repeatedly emphasize the restricted procedural posture of its decision and the circumscribed nature of the meager--and by definition incomplete--record in the context of the summary judgment motion that was presented. (see, e.g., footnotes 13 and 14.)
• The Court emphasized the following five facts that were key to its conclusion:

1. The directors knew that the company was "in play" (although noting that the filing of a Schedule 13D will not always trigger Revlon duties.)
2. According to the Court, the directors did little or nothing to develop a strategy pursuant to Revlon to maximize shareholder value in connection with the possible sale of the company.
3. The Court held that the directors did little or nothing pre-signing to confirm that a better deal could be obtained.
4. The directors, the Court held, did little or nothing to negotiate the offer they did receive.
5. The directors, in the Court's view, did little or nothing post-signing to verify that a better deal could have been obtained.

•   The Court went to great lengths to explain why it did not conflate the duty of care with the duty of good faith component of the duty of loyalty. One might write an entire law review article based on the court's explication of the finer points of these concepts but for now I can only refer you, for example, to footnotes 26 to 33 and related text. Footnote 26 provides in part as follows:

  "the Court decided that there were material fact questions that raised an issue of whether the directors’ failure to act in the face of a known duty to act amounted to something more than a simple violation of the duty of care (i.e., gross negligence). In other words, this is an instance where issues of care and loyalty (good faith, in this context) bleed together under the facts presented in the summary judgment record, and, therefore, the Court was unable to ascertain, at least at this point, the ultimate effect of Lyondell’s exculpatory charter provision in this context. The Court was careful to explain, however that, ultimately, a determination that the directors’ failed to act in “good faith” could result in liability only because in that instance the directors will have violated their duty of loyalty. Opinion at 54-56. Thus, the Court did not conflate good faith into a theory that would result in legal liability for a breach of only the directors’ duty of care, notwithstanding a Section 102(b)(7) charter provision. Unfortunately, at this preliminary stage of this case, it is difficult to frame the issue in a manner that does not, to some extent, track closely with those facts suggesting only an apparent failure to act with appropriate care; it remains to be seen whether the directors’ acts (or failure to act) reach into the realm of non-exculpable bad faith. See, e.g., Desimone v. Barrows, 924 A.2d 908, 935 (Del. Ch. 2007)."

• At pages 12 to 14 of the letter decision, the court described the "three points in the spectrum of fiduciary conduct deserving of the "bad faith" pejorative label". The Court's description could be the topic of an entire separate article.

• Another key point: the Court  explained that: "when one views the totality of the directors' conduct on this record, that leads the Court to question whether they [the directors] may have disregarded a known duty to act and may not have faithfully engaged themselves in the sale process in a manner consistent with the teachings of Revlon and its progeny." ( Slip op. at page 19).

 There is so much more in this decision that is "red meat for the cage" of any (non-vegetarian) lawyer that wants to, or needs to, know about this area of the law, I regret that I don't have time to add more today, but I will leave one last quote.

• The Court made clear that the defendants' : "interpretation of the Opinion—that they have been “deprived” of the protection of the Company’s exculpatory charter provision—is not only inaccurate, but, in fact, the Court stated repeatedly throughout the Opinion that on a more developed factual record the directors may very well either prevail on the merits of Ryan’s Revlon claims or, alternatively, on their Section 102(b)(7) defense. (my bold)

Also, importantly, the Chancery Court did agree to a stay of its decision pending a decision by the Delaware Supreme Court about whether to accept the appeal.

SUPPLEMENT: As they used to say in some Western movies, "the reinforcements are arriving". We are fortunate to have the expert insights of several law professors who have already provided their learned commentary about this case. Professor Larry Ribstein weighs in here, and Professor Gordon Smith adds to his previous commentary on the case here. Professor Eric Chiappinelli (also Dean of the Creighton University Law School) analyzes the case here. 

SUPPLEMENT II: Broc Romanek on his DealLawyers.com Blog highlights the case here.

POSTSCRIPT: The Wall Street Journal's online edition here listed my post among the "top legal stories around the web".

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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 II: Prof. Jeff Lipshaw explains his analysis of the case here.
UPDATE III: The Wall Street Journal picked up my blog post here.

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.

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