1. Yesterday, the Delaware Supreme Court issued its much anticipated (see, e.g., here) opinion in Lyondell Chemical Company v. Ryan. In the opinion, authored by Justice Berger, the Supreme Court reversed and remanded the Court of Chancery's decision of July 29, 2008 (for a summary of that decision see here).
2. The case, a director liability proceeding in a 'sale of the company' setting, basically turned on whether the Vice Chancellor was correct in denying summary judgment in order to obtain a more complete record before deciding whether the directors had acted in bad faith (as alleged), although:
- the directors were found to be independent and not motivated by self-interest or ill will; and
- any duty of care violation was covered by the Section 102(b)(7) DGCL exculpatory provision in the company's charter, protecting directors from personal liability for duty of care breaches.
The Vice Chancellor's decision sparked quite some criticism in the blogosphere, that essentially focused on the threshold of a - potential - finding of bad faith (lack of good faith) as applied by the Vice Chancellor: see, e.g., here, here, here, here and here. Subsequent case law from other members of the Court of Chancery also showed some - only slightly hidden - scepticism about the approach taken by the Vice Chancellor, emphasizing the difference between established facts sufficient to find a lack of due care on the hand and bad faith (lack of good faith) on the other; see In re Lear Corp. Shareholder Litigation (especially footnote 62) and McPadden v. Sidhu.
3. The Supreme Court starts by explaining that the only claims not rejected by the Court of Chancery related to the process by which the directors sold the company and the deal protection provisions in the merger agreement. These are qualified as:
but two aspects of a single claim, under Revlon v. MacAndrews & Forbes Holdings, Inc., that the directors failed to obtain the best available price in selling the company. As the trial court correctly noted, Revlon did not create any new fiduciary duties. It simply held that the "board must perform its fiduciary duties in the service of a specific objective: maximizing the sale price of the enterprise."
I analyzed the contours of 'Revlon land' in Judicial Review of Director Conduct - Under Dutch and Delaware Corporate Law, Deventer: Kluwer 2007, pages 256-264 and 342-365. The Court then notes that according to the Vice Chancellor the plaintiff might be able to prevail at trial on a due care claim, but that in view of the exculpatory provision such a breach cannot result in liability; in view of this, the case turns on whether any arguable shortcomings on the part of the directors also implicate their duty of loyalty, a breach of which is not exculpated. Against this background, Justice Berger addresses the Supreme Court's decisions in In re The Walt Disney Company Derivative Litigation and Stone v. Ritter as to "good faith" (noting in footnote 8 that for purposes of this appeal, the Court makes no distinction between the terms bad faith and lack of good faith; see about this distinction post No. 4). In passing, she notes that:
Stone also clarified any possible ambiguity about the directors' mental state, holding that "imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations."
See about the connection between the duty of loyalty and the requirement of good faith post No. 21.
4. At that point, the Court gets tough:
The Court of Chancery recognized these legal principles, but it denied summary judgment in order to obtain a more complete record before deciding whether the directors had acted in bad faith. Under other circumstances, deferring a decision to expand the record would be appropriate. Here, however, the trial court reviewed the existing record under a mistaken view of the applicable law. Three factors contributed to that mistake. First, the trial court imposed Revlon duties on the Lyondell directors before they either had decided to sell, or before the sale had become inevitable. Second, the court read Revlon and its progeny as creating a set of requirements that must be satisfied during the sale process. Third, the trial court equated an arguably imperfect attempt to carry out Revlon duties with a knowing disregard for one's duties that constitutes bad faith.
As to the first issue, the Court notes that the problem with the trial court's analysis is that Revlon duties do not arise simply a company is "in play." According to the Court, the duty to seek the best available price applies only when a 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, apparently the directors responded to Basell's interest in acquiring Lyondell by promptly holding a special meeting to consider whether the company should take any action, at which meeting the directors decided that they would neither put the company up for sale nor institute defensive measures to fend off a possible hostile offer, but to take a "wait and see" approach. In view of this, and of the fact that the board did not begin negotiating the sale of Lyondell until some weeks thereafer, the "time for action under Revlon" had not begun. So basically, the Court rules that the Vice Chancellor's focus in time under his Revlon analysis was off: he should have analyzed the week in which the directors actually negotiated, not the preceding two months of inaction. By the way, the Supreme Court has suggested several times that a change in control scenario is a Revlon scenario, not necessarily the scenario. See, e.g., Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003):
Other circumstances requiring enhanced judicial scrutiny give rise to what are known as Revlon duties, such as when the board enters into a merger transaction that will cause a change in corporate control, initiates an active bidding process seeking to sell the corporation, or makes a break up of the corporate entity inevitable.
Here, the Court focuses solely on a transaction "that will result in a change of control." A change of direction?
As to the second issue, the Court refers to the Vice Chancellor's synthesis of the Revlon case law, which led him "to the erroneous conclusion that directors must follow one of several courses of action to satisfy their Revlon duties." The opinion stresses - again - that there is only one Revlon duty (i.e., to get the best price for the stockholders at a sale of the company), that no court can tell directors exactly how to accomplish that goal (because they will be facing a unique combination of circumstances, many of which will be outside their control), and that there is no single blueprint that a board must follow to fulfill its duties. The Court notes that, where the Court of Chancery was unable to conclude that the directors had met their burden under Revlon, in evaluating the totality of the circumstances - even on this limited record - they would be inclined to hold otherwise. I touched upon the rationale of the "no blueprint" reasoning in post No. 17.
Against this backdrop, and this is the third issue (and I would think the core of the opinion), the Court then explains that:
bad faith will be found if a "fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties." The trial court decided that the Revlon sale process must follow one of three courses, and that the Lyondell directors did not discharge that "known set of [Revlon] 'duties'." But, as noted, there are no legally prescribed steps that directors must follow to satisfy their Revlon duties. Thus, the directors' failure to take any specific steps during the sale process could not have demonstrated a conscious disregard of their duties. More importantly, there is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard of those duties. Directors' decisions must be reasonable, not perfect. "In the transactional context, [an] extreme set of facts [is] required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties." The trial court denied summary judgment because the Lyondell directors' "unexplained inaction" prevented the court from determining that they had acted in good faith. But, if the directors failed to do all they should have done under the circumstances, they breached their duty of care. Only if they knowingly and completely failed to undertake their responsibilities would they breach their duty of loyalty. The trial court 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 price, the inquiry should have been whether those directors utterly failed to attempt to obtain the best sale price.
Viewing the record in this manner leads to only one possible conclusion, according to the Court: "this record clearly establishes that the Lyondell directors did not breach their duty of loyalty by failing to act in good faith. In concluding otherwise, the Court of Chancery reversibly erred."
5. Bottom line:
- Violation of the good faith component of the duty of loyalty, to be derived from the circumstances of the case at hand, requires facts that are - from a culpability perspective - clearly more egregious than facts that justify a finding of a duty of care breach. This confirms that the 'lack of good faith' concept is to be applied quite narrowly, at least in the director liability setting.
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If there is no conflict of interests, and the company's charter has an exculpatory clause (the standard situation), it is terribly difficult for a plaintiff to succeed in a director liability proceeding on bad faith grounds in the absence of any clear direct evidence like memo's or e-mails; not just under the business judgment rule and in Caremark claims (duty of oversight), but also in a Revlon scenario.
UPDATE
Stephen Bainbridge and Jeff Lipshaw provide their views on the Supreme Court decision here and here. Bainbridge also provides a "roundup" here.
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