Independent directors should now be able to sleep better as a result of a much anticipated Delaware Supreme Court (Court) decision. The Court reversed a trial court determination that an allegedly flawed one-week sale process resulting in a “blowout price” could constitute bad faith for which the directors may be held personally liable. The Court noted that “[d]irectors’ decisions must be reasonable, not perfect.”
In Lyondell Chemical Company v. Ryan, on interlocutory appeal from the Delaware Court of Chancery (Chancery Court), the Court ordered summary judgment in favor of the directors of Lyondell Chemical Company (Lyondell) based on:
The Court ruled that the lawsuit constituted a run-of-the-mill gross negligence claim, for which the directors have immunity under the company’s charter and Delaware law, rather than a bad faith claim, for which monetary damages can be personally assessed against the directors.
Under the Revlon2 doctrine, when directors propose to sell a company, they must take reasonable measures to ensure that the stockholders receive the highest value reasonably attainable. The Chancery Court has recently issued a series of decisions3 addressing the sale process, including the desirability of “go-shop” provisions. In line with these cases, the Chancery Court initially criticized the Lyondell board, which voted to accept an unsolicited offer, for:
None of those criticisms of board conduct is new or unusual. What is surprising is the Chancery Court’s conclusion that a procedurally deficient sale process, albeit one conducted with advice of investment bankers and lawyers and one that produced an undeniably fair price that shareholders approved by more than a 99 percent vote, may give rise to a lack of good faith claim.4
In order to encourage individuals to serve as directors in an increasingly litigious environment, Section 102(b)(7) of the Delaware General Corporation Law permits a Delaware corporation to adopt a charter provision limiting the personal liability of a director for monetary damages for breach of fiduciary duty unless the director breached his or her duty of loyalty (e.g., because of a conflict of interest), derived an improper personal benefit from the transaction, or engaged in an act or omission not in good faith or involving intentional misconduct or a knowing violation of law. Lyondell's charter includes an exculpatory provision of this type. Despite the absence of any conflicts of interest or any improper personal benefit on the part of Lyondell's independent directors, the Chancery Court initially held that Lyondell's directors may not be entitled to immunity from monetary damages under this charter provision because deficient conduct under the Revlon standard could very well be found at trial to constitute lack of good faith.
The Court has identified several examples of bad faith that may expose directors to non-exculpable, personal liability. The first category involves subjective bad faith, where the director is motivated by an actual intent to do harm. The second category is the director’s intentional dereliction of duty or a conscious disregard for one’s responsibilities. Under the later category, imposition of liability requires a showing that the directors knew they were not discharging their fiduciary duty.5
The Chancery Court essentially equated the Lyondell board’s arguably imperfect attempt to carry out Revlon duties with a knowing disregard of one’s duties that constitutes bad faith. The Court reversed on appeal, holding “there is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard for those duties.” The Court’s ruling makes it more difficult for plaintiffs to avoid the effect of exculpatory provisions in charters by arguing that conduct constituting gross negligence, for which Lyondell’s charter provides immunity, constitutes bad faith, for which no immunity is available.
The decision also validates a “wait and see” approach. The Chancery Court criticized the Lyondell board for not being proactive when the buyer filed a Schedule 13D in May 2007 indicating an interest in a possible transaction with Lyondell. However, on appeal, the Court emphasized that Revlon duties do not arise until either the board decides to sell the company or a sale becomes inevitable. Even if it appears that the company may be in play, a wait and see approach is “an appropriate exercise of the directors’ business judgment.” Thus, the Lyondell directors’ duties under Revlon did not arise until July 10, 2007, when the directors began negotiating the sale of the company with Basel AF.
Although the Court’s Lyondell decision represents welcome relief from the growing number of suits against directors alleging bad faith, the sale of the company remains a risky area that requires special attention by directors. Independent directors must devote substantial energy and attention to properly consider whether a sale of the company is appropriate and to discharge their Revlon duties when they decide to sell the company.
Lyondell’s own history after the merger with Basel AF is a case in point. Lyondell’s shareholders received $48 per share in the merger, a price that represented more than 25 percent and 56 percent premiums to the volume-weighted average trading price of Lyondell’s common stock over the 30-day and one-year periods ending on the last trading day before the merger agreement was signed on July 16, 2007. In January 2009, as a result of the global recession and a heavy debt load, the combined LyondellBasell company filed for bankruptcy. In hindsight, Lyondell’s shareholders would have been livid if the board had decided not to accept Basell AF’s offer in July 2007, which Basell AF had conditioned on Lyondell signing a merger agreement by July 16, 2007.
3 In re Lear Corp. Shareholder Litigation, 926 A.2d 94 (Del. Ch. 2007); In re Topps Co. Shareholders Litigation, 926 A.2d 58 (Del. Ch. 2007); In re Netsmart Technologies, Inc. Shareholders Litigation, 924 A.2d 171 (Del. Ch. 2007)
4 A similar Delaware Bankruptcy Court decision, involving claims against independent directors for sale of a financial distressed company, reached a similar result. Bridgeport Holdings, Inc. Liquidating Trust v. Boyer, 388 BR 548 (Bankr. D. Del. 2008)
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If you have any questions about this alert or would like to discuss the topic further, please contact your Foley attorney or the following individuals:
Gardner F. Davis
Linda Y. Kelso