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

In Gantler v. Stephens, (Del. Supr., Jan. 27, 2009), read opinion here, the Delaware Supreme Court, yesterday,  issued a major decision on important matters of Delaware corporate law. Delaware's High Court  for the first time confirmed and clarified that officers of Delaware corporations have the same fiduciary duties as directors of Delaware corporations.

In addition, the Delaware Supreme Court clarified and enunciated Delaware common law on the issue of  "shareholder ratification".

In a rare reversal of the Chancery Court,  the Supreme Court determined that the breach of fiduciary duty claims in this case should be allowed to proceed, and explained why the board should not enjoy the presumption of the business judgment rule at this stage of the proceedings,  based on the pled facts (contrary to the Chancery Court's dismissal of the case, based on an earlier opinion summarized here.)

 The Supreme Court's own succinct  introductory summary to its opinion follows:

The plaintiffs in this breach of fiduciary duty action, who are certain shareholders of First Niles Financial, Inc. (“First Niles” or the “Company”), appeal from the dismissal of their complaint by the Court of Chancery The complaint alleges that the defendants, who are officers and directors of First Niles, violated their fiduciary duties by rejecting a valuable opportunity to sell the Company, deciding instead to reclassify the Company’s shares in order to benefit themselves, and by disseminating a materially misleading proxy statement to induce shareholder approval. We conclude that the complaint pleads sufficient facts to overcome the business judgment presumption, and to state substantive fiduciary duty and disclosure claims. We therefore reverse the Court of Chancery’s judgment of dismissal and remand the case for further proceedings consistent with this Opinion.

 The distilled essence of the factual genesis of this case is the decision of the Board of First Niles Financial  to sell itself, but thereafter not taking seriously three offers that it received, and instead appearing to favor a privatization or a reclassification plan. The three basic claims in the complaint were that the board members breached their fiduciary duties to the First Niles shareholders by rejecting an offer from a potential buyer and abandoning the sale of the company.  Secondly, the claim was that the defendant directors breached their fiduciary duty of disclosure by disseminating a materially false and misleading proxy regarding the reclassification. Third, the amended complaint alleges that it was a breach of fiduciary duty to implement the reclassification plan.

The Chancery Court dismissed the amended complaint, ruling that it failed to allege facts that were sufficient to overcome the presumption of the business judgment rule and for failing to establish that the proxy was materially false and misleading, as well as based on the argument that the shareholders “ratified “ the decision of the board to reclassify the shares.

The Supreme Court reviewed the trial court’s grant of the motion to dismiss on a “de novo basis”  to determine whether “the trial judge erred as a matter of law in formulating or applying legal precepts.”

Although Count I of the complaint alleged that the directors breached their duties of loyalty and care by abandoning the sale of the bank in order to retain the benefits of incumbency, the trial court concluded that the Unocal  standard did not apply because the complaint did not allege any “defensive” action by the board. The trial court also determined that the entire fairness review was not applicable because the board did not interpose itself between the shareholders and a potential acquirer by means of defensive measures, and thus  the trial court applied the business judgment standard and concluded that the allegations in the complaint failed to rebut the presumption of business judgment.

The Supreme Court upheld the Chancery Court’s refusal to apply the Unocal standard because the essence of the transaction at issue was not defensive and the initial count in the complaint was based on disloyalty as opposed to defensive conduct. Nor does Count I allege any hostile takeover attempt or similar threatened external action from which it could be inferred that the defendants acted defensively, despite the allegation that they improperly delayed or sabotaged the due diligence process.

The Business Judgment Rule

Next, the Supreme Court addressed whether the trial court appropriately found that the plaintiff did not satisfy the burden of pleading facts sufficient to rebut the presumption of the business judgment rule that  “in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company.” (citing Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)).

Delaware’s High Court recognized that a board is generally entitled to the presumption of the business judgment rule in declining a merger opportunity because implicit in the statutory authority of the board to propose a merger, is also the power to decline a merger.

In order to determine whether the board merits the business judgment presumption, the court makes a two-part analysis. First, did the board reach its decision in the good faith pursuit a legitimate corporate interest. Second, did the board do so advisedly (see footnotes 29 to 31).

The first prong of the analysis requires that the duty of loyalty be examined. In this case, the plaintiff alleges that the directors had a disqualifying self-interest because they were financially motivated to maintain the status quo and to keep their current positions. The Supreme Court was wary of such an argument which it recognized to be tautological, to some extent, because a board decision to reject a merger proposal could always enable plaintiff to assert that a majority of the directors had an entrenchment motive. For that reason, the court explained that in addition to that argument, other facts that support a disloyal motive must be stated.

The Supreme Court determined that a sufficient showing to establish disloyalty at least at this early procedural stage was demonstrated. The court reasoned that the pled facts were sufficient to establish the disloyalty of at least three of the directors, which suffices to rebut the business judgment presumption because in this case three of the directors constituted a majority. Also, for purposes of Rule 12(b)(6) there was a sufficient “director-specific analysis” to demonstrate that a majority of the board was conflicted based on specific alleged conduct from which a duty of loyalty violation can reasonably be inferred. The court recites in detail in its opinion specific facts about each individual director and why such allegations support a conflict.

Officers Share Same Fiduciary Duties as Directors

Importantly, in this decision, the Delaware Supreme Court for the first time explicitly holds, what has been implicitly stated previously and has been also acknowledged by the Delaware Chancery Court, and that is: “officers of Delaware corporations, like directors, owe fiduciary duties of care and loyalty, and the fiduciary duties of officers are the same of directors.” (See footnote 36, but also note footnote 37 which acknowledges that DGCL Section 102(b)(7) does not exculpate officers from liability for breaches of their duty of care in the current statutory provision.)

On the issue of whether a delay in the due diligence process was a breach of the fiduciary duty of the directors, the Supreme Court disagreed with the trial court. The Supreme Court explained that  on a motion to dismiss, the trial court is “not free to disregard that reasonable inference, or to discount it by weighing it against other, perhaps contrary inferences that might also be drawn,” making reference to the decision of the trial court that a delay of a couple of weeks could not be the basis for a breach of fiduciary duties.

Disclosure Violations Held Material

In addition, the Supreme Court determined that the proxy disclosures concerning the deliberations of the board about the offer that was rejected, were materially misleading. The court reviewed the materiality standard and reached a different conclusion than the trial court, thus allowing that claim to proceed.

Duty of Loyalty Claim Allowed to Proceed

Lastly, the Supreme Court also reversed the trial court’s decision on Count III of the complaint which alleged that the directors breached their duty of loyalty by recommending the reclassification proposal to shareholders for purely self-interested reasons (that is, to enlarge their ability to engage in stock buy-backs and to trigger appraisal rights). The Supreme Court reasoned that the trial court’s ruling on “shareholder ratification grounds” was in error for two reasons. First, because a shareholder vote was required to amend the certificate of incorporation, without the approving vote it could not operate to “ratify” the challenged conduct of the interested directors. Second, the claim that the reclassification proxy contained a material misrepresentation, eliminates the essential prerequisite for applying the ratification doctrine, namely, that the shareholder vote was fully informed.

Common Law Shareholder Ratification Doctrine Clarified and Enunciated

The Supreme Court recognized that the current scope and effect of the common law doctrine of “shareholder ratification”  in Delaware is unclear. Thus, in order to

“restore coherence and clarity to this area of our law, we hold that the scope of the shareholder ratification doctrine must be limited to its so-called ‘classic’ form; that is, to circumstances where a fully informed shareholder vote approves director action that does not legally require shareholder approval in order to become legally effective. Moreover the only director action or conduct that can be ratified is that which the shareholders are specifically asked to approve. With one exception, the “cleansing” effect of such a ratifying shareholder vote is to subject the challenged director action to business judgment review, as opposed to “extinguishing” the claim altogether (i.e., obviating all judicial review of the challenged action.) " 

(emphasis in italics and underlining are mine)(See footnotes 52 through 54 for supporting citations).

Moreover, yet another major judicial statement in this opinion is contained in footnote 54. Referring to the last sentence in the foregoing block quote, footnote 54 states that “to the extent that Smith v. Van Gorkom holds otherwise, it is overruled.” (488 A.2d 858, 889-90 (Del. 1985)). Of special note in footnote 54 also is the clarification that the references in this opinion only refer to the common law  doctrine of shareholder ratification and are not intended to alter the jurisprudence governing the approving vote of disinterested shareholders pursuant to Section 144 of the Delaware General Corporation Law.

Much more can be written, and much more will be written, about this very momentous decision that announces very substantial clarifying statements of Delaware corporate law. This summary is already longer than most blog posts but I look forward to linking to additional scholarly commentary by others.
UPDATE: Prof. Usha Rodrigues on The Conglomerate blog comments on the case here and  she links to her own article on the topic as well as to seminal writings on the issue by Prof. Lyman Johnson here.   The Unincorporated Business Law Prof Blog comments on the case here. Also,  Prof. Lawrence Cunningham on the Concurring Opinions blog comments, with some aggregation of other remarks about the case, here.

UPDATE II: Here is a post about the opinion on DealLawyers Blog which agrees it is an important decision.

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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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