Lyondell Chemical Corp. v. Ryan: Delaware Supreme Court Holds Board's Accelerated Process for Sale of Company Did Not Constitute Bad Faith Breach of Revlon Duties
In Lyondell Chemical Corp. v. Ryan, C.A. 3176 (Del. Mar. 25, 2009), the Delaware Supreme Court, acting en banc, reversed the decision of the Delaware Court of Chancery and granted summary judgment to Lyondell's board of directors, dismissing the claim that it failed to act in good faith in conducting the sale of its company through an accelerated negotiation process. The Court reaffirmed important principles governing a board's Revlon duties in connection with the sale of a company and directors' good faith performance of those duties:
Revlon duties do not arise merely because a company has been put in play—a board may exercise its business judgment to decide not to respond to an indication of interest in an acquisition;
there is no "single blueprint" for discharging a board's duty, under Revlon, to get the best price for the stockholders on the sale of the company; and
a breach of Revlon duties that is so egregious as to constitute bad faith amounting to a breach of the duty of loyalty requires both knowledge of Revlon duties and a knowing disregard for those duties.
This Update provides key highlights of the Lyondell decision and offers practical advice.
Case Facts: The Board Approved a Merger of Lyondell and Basell After One Week of Consideration
Basell Expressed an Initial Interest in Lyondell. Lyondell Chemical Company was a successful company whose board of directors consisted of its chief executive officer, Dan F. Smith, and ten independent directors, all sophisticated in the field. Leonard Blavatnik, the Chairman and President of Basell's parent corporation, Access Industries, expressed an interested in acquiring Lyondell in April 2006. The initial offer was between $26.50 and $28.50 per share. Lyondell was not for sale, but the board nonetheless considered and rejected the offer.
Lyondell Was "Put in Play" When Basell Acquired a Substantial Interest in the Company. In May 2007, a Basell affiliate filed a Schedule 13D with the SEC disclosing a right to acquire 8.3% of Lyondell's stock, which if exercised would have made it the second largest stockholder. In the Schedule 13D, Basell also expressed interest in a transaction. The board held a special meeting, decided not to respond, and instead waited to see if other potential buyers would surface. Following the filing of the Schedule 13D, Lyondell's stock price increased from $33 to $37 per share.
Basell Made an Offer with a Short Timeline for Consideration and Acceptance. In the intervening months, Access Industries bid on another chemical manufacturer, Huntsman Corporation, but the bid was topped by Hexion Specialty Chemicals, Inc. On July 9, 2007, Blavatnik expressed an interest in purchasing Lyondell at $40 per share but, during a meeting with Smith, increased the offer to $44-45 per share. Smith suggested that Blavatnik make his "best" offer. Blavatnik offered $48 per share, with no financing contingency, but required that the board agree to a $400 million break-up fee and sign the agreement by July 16, 2007, leaving just one week for deliberations.
The Board and Stockholders Approved Merger. The board met on July 10, 2007 to evaluate the offer. The board considered valuation materials prepared by management, the current offers for Huntsman, and the likelihood of another buyer expressing interest in Lyondell. At a second meeting, in response to Basell's written proposal, the board then engaged a financial adviser and authorized Smith to negotiate a transaction. The board sought some improvements on terms—a higher price, a go-shop provision and a reduced break-up fee—but only succeeded in reducing the break-up fee to $385 million. In its fourth meeting to consider the Basell offer, the board met with its financial and legal advisers. Legal counsel briefed it on the terms of the agreement, including the fiduciary-out provision that would allow the board to consider any superior proposals. Its financial adviser reviewed valuation information and opined that the merger price was fair, and identified twenty other potential purchasers and reasons it was unlikely such purchasers would top Basell's offer. With this information, the board approved the merger and recommended it to stockholders, who also approved it by over 99% of the shares voted.
Court of Chancery Denied Summary Judgment Due to Revlon Bad Faith Claims. The lower court denied the Lyondell directors' motion for summary judgment on the claim that the directors' noncompliance with Revlon duties amounted to bad faith. The court acknowledged that, because Lyondell's charter contained an exculpatory provision under Section 102 of the Delaware General Corporation Law, the directors were not subject to liability for actions that breached their duty of care. The directors would only be liable if their actions amounted to bad faith—a breach of the duty of loyalty that cannot be exculpated under Section 102. The lower court cited disputed facts that raised doubt whether the directors exercised good faith in carrying out their Revlon duty to maximize stockholder value, focusing on the board's inaction after the filing of the Basell affiliate's Schedule 13D, the expedited negotiation period, the relatively short board meetings to consider the transaction, the board's failure to seriously press Basell for a better price or more limited deal protections and its failure to confirm that it had obtained the best available price, under Revlon, "by conducting an auction, by conducting a market check, or by demonstrating 'an impeccable knowledge of the market.'"
Delaware Supreme Court Grants Summary Judgment on Interlocutory Appeal, Finding No Bad Faith Breach of Revlon Duty and Clarifying Requirements for Good Faith
Revlon Does Not Create Additional Fiduciary Duties. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1986), requires directors, in a change‑of‑control transaction, to maximize the value of the company for stockholder benefit. The Court in Lyondell confirmed that Revlon did not create new fiduciary duties but rather established that, in the context of a sale of the company, directors have one fiduciary duty: "to '[get] the best price for the stockholders.'"
Revlon Duty Does Not Arise Prior to a Sale Transaction. The Revlon duty to maximize stockholder value exists when directors have "decided to sell" or the sale has "become inevitable." The Court found that the Schedule 13D indicating Basell's interest in the acquisition of Lyondell, two months prior to the execution of the merger agreement, did not make the sale inevitable, and therefore did not create a duty for directors to maximize stockholder value. Only "when a company embarks on a transaction" does a director's Revlon duty arise. This can occur either when a company seeks out a transaction of its own volition or responds to an unsolicited offer. The Lyondell directors' "wait and see" approach "was an entirely appropriate exercise of the directors' business judgment."
Revlon Duty Does Not Require Specific Actions. The Revlon duty does not specify a course of action directors must take in the context of a sale. Each company faces different circumstances, and the Court allows flexibility to directors in determining steps to maximize stockholder value. Although Delaware cases have identified certain steps, such as engaging in an active sale process and confirming a price through an auction, a market check or the directors' knowledge of the market, that may all help a board to maximize stockholder value, there is no requirement that any one of these acts be taken to meet the Revlon duty.
Breach of the Fiduciary Duty of Loyalty for Failing to Act in Good Faith Requires Knowing and Complete Failure of Directors to Undertake Their Fiduciary Duties. Because of the exculpation provision, the Lyondell directors would not be liable for a breach of their Revlon duty unless the breach constituted bad faith. The Court, citing In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 34-66 (Del. 2006), reaffirmed that bad faith includes actions demonstrating "intentional dereliction of duty" or "a conscious disregard for one's responsibilities," but does not include a lack of care amounting to gross negligence. To act in bad faith a director must not only fail to exercise his or her fiduciary duties, but have actual knowledge that he or she is failing to do so. Because there is no legal prescription for carrying out one's Revlon duty, the Lyondell directors' failure to take the steps identified by the Court of Chancery could not demonstrate a conscious disregard for a duty, and therefore did not constitute bad faith. An inadequate attempt to perform Revlon duties may constitute a breach of the duty of care, but it does not constitute a bad faith breach of the duty of loyalty.
Lyondell represents a fairly sweeping reaffirmation of the liability protection provided to directors under Delaware law for a decision to sell their company in a transaction that presents no conflict of interest. It reinforces the value of an exculpation provision, which should be standard in all corporate charters, to, subject to limited exceptions, shield directors from personal liability for decisions they make in good faith. Nevertheless, the case should not be taken as a blank check for an expedited or inadequate process in connection with the sale of a company. Given the near certainty of litigation in connection with such transactions, directors should bear in mind the following:
Directors can still "just say no" to a buyer's expression of interest, but should be prepared for subsequent developments. The Court clarified that directors' Revlon duty to maximize stockholder value arises only when the company "embarks on a transaction," and that directors are not expected to seek out potential buyers or negotiate with an interested party simply because the company has been put "in play." But a board should be on the alert when it receives an expression of interest, be it public or private, and should have its team of financial, legal, investor relations and other advisers in place to determine the best response to subsequent overtures. It should make a record that it has exercised its informed business judgment in making a decision whether to decline to discuss a potential sale or to proceed with a sale process.
Although the directors were not held personally liable for the expedited process followed in Lyondell, a rushed transaction may not necessarily achieve the "best available price" for stockholders. Although the Lyondell decision turned on whether the directors had acted in bad faith, the Court stated that, on the record before it, it might have independently concluded that the directors had met their duty of care in a Revlon context, if that had been the standard. Nevertheless, the Court also stated that under the duty of care, and on the same record, acting as the reviewing court, it would not have questioned the Court of Chancery's decision to deny summary judgment and allow the case to proceed to more fact-finding, indicating that the Lyondell directors would have had to face prolonged litigation of their decision. There is a plethora of case law in Delaware that outlines best practices in satisfying the Revlon duty: all stress that a board's decision to sell a company must be fully informed. Although buyers frequently seek to apply time pressure as a negotiating strategy, in many cases, it may take significantly more than one week for a board to become comfortable that it has obtained all the input it needs to reach an appropriately informed decision on a matter of such consequence. Accordingly, boards must carefully balance the need to act expeditiously to preserve an offer that may be highly beneficial to stockholders against their duty to obtain the information necessary to assure themselves that they are obtaining the best price reasonably available for the stockholders.
Unlike director liability claims under Revlon, claims by stockholders seeking to enjoin a merger based on a board's breach of Revlon duties may not require a showing of bad faith. The Court explained that to find liability for bad faith, directors must have "knowingly and completely failed to undertake their responsibilities," but when a court analyzes a claim for a pre-merger injunction, plaintiffs may only need to establish that the board breached its enhanced duty of care under Revlon. In Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d 34, 45 (Del. 1994), plaintiffs sought to enjoin Paramount's merger with Viacom. The Court found that the Paramount board's decision to favor a transaction with Viacom and protect it with a stringent no-shop provision, a high break-up fee and other defensive measures, in the face of a better offer from QVC, was subject to enhanced scrutiny of "the adequacy of the decisionmaking process," and "the reasonableness of the directors' action in light of the circumstances" under both Revlon and Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985). The Court agreed with the Court of Chancery that the Paramount directors' actions breached their fiduciary duties under these cases, and upheld the lower court's preliminary injunction against the merger. To protect against the possibility that a board's decision to approve a merger will be enjoined, following best practices to ensure that the board has met its Revlon and Unocal duties (including assessing the impact of deal protection provisions), and making a clear record that it has done so, is still the prudent approach
This Update is only intended to provide a general summary of the Delaware Supreme Court's decision in Lyondell. Read the full text of the Lyondell decision online. You can find discussions of other recent cases, laws, regulations and rule proposals of interest on our website.