Business Litigation Bulletin – April 2009

Types : Alerts

The Delaware Supreme Court recently rejected breach of fiduciary duty claims in connection with a $13 billion merger transaction by which Basell AF, a privately held Luxembourg company, acquired Lyondell Chemical Company, then the third largest independent, publicly-traded chemical company in North America.  Lyondell Chemical Co. v. Ryan, No. 401-2008 (Del. March 25, 2009).  The opinion is noteworthy because it clarifies the duties of independent directors in a change of control transaction – in particular, the contours of good faith under Revlon’s “best price”¹ requirement.

The merger transaction.

Lyondell had eleven board members – its CEO and Chairman and ten outside directors, many of whom were or had been CEOs of other publicly traded companies.  In the spring of 2006, Basell expressed an interest in acquiring Lyondell and made a cash offer that was rejected by Lyondell’s board.  A year later, a Basell affiliate filed a Schedule 13D with the SEC disclosing its right to acquire an 8.3% block of Lyondell stock and that there was interest in possible transactions with Lyondell.  Recognizing that the 13D filing signaled to the market that Lyondell was “in play,” the Lyondell directors immediately convened a special meeting at which they decided to take a “wait and see” approach.

Months later, Basell announced that it had inked a $9.6 billion merger agreement with another specialty chemical company, but a competing bidder emerged and Basell again directed its attention to Lyondell.  On July 9, 2007, Basell proposed an all-cash deal at $40 a share.  The offer was rejected as too low, was increased to $44-45 a share, and in response to a request for a “best offer,” was raised to $48 per share with no financing contingency, a $400 million break-up fee and a July 16 deadline for a merger agreement.  A special meeting of Lyondell’s board was convened on July 10 to consider valuation materials prepared by Lyondell management for presentation at the regular board meeting schedule for July 11.  The board also discussed the Basell offer, the status of Basell’s other pending transaction and the likelihood that another party would be interested in purchasing Lyondell. 

At the board’s request, Basell provided a written offer and details about financing.  Basell also made an additional demand: Basell needed a firm indication of interest from Lyondell’s board by July 11, Basell’s deadline for a higher bid on the other chemical company.  The Lyondell board met on July 11 for less than an hour, agreed to provide a firm expression of interest, and agreed also to retain Deutsche Bank Securities, Inc. as its financial advisor.  Basell, in turn, announced that it would not raise its offer for the other chemical company.

From July 12 through July 15, the parties negotiated the terms of the Lyondell merger agreement, Basell conducted due diligence, Deutsche Bank prepared a fairness opinion, and Lyondell conducted its regularly scheduled board meeting.  The Lyondell board went back to Basell for a higher price, a “go-shop” provision, and a reduced break-up fee.  This was not well-received by Basell, which indicated that it had already provided its “best price” at a substantial premium over market.  Basell did, however, reduce the break-up fee to $385 million, and Lyondell’s counsel confirmed separately that superior proposals could be considered without a go-shop clause under the agreement’s existing “fiduciary out” provision.

On July 16, the Lyondell board again met with management and financial and legal advisors to consider the transaction.  Deutsche Bank reported that no other potential purchaser likely would top Basell’s offer, which the bank characterized as “an absolute home run.”  The board voted to recommend the merger, which was approved by more than 99% of the voted shares at a special stockholders’ meeting in November 2007.

The shareholder lawsuits.

Putative class actions were filed in Texas and Delaware contending that the Lyondell directors had breached their fiduciary duties of loyalty and care.  The Delaware complaint alleged that:  (1) the merger price was grossly insufficient; (2) the directors were motivated to approve the merger for their own self-interest (i.e., they would receive cash for their stock options); (3) the process by which the merger was negotiated was flawed; (4) the directors agreed to unreasonable deal protection measures; and (5) the preliminary proxy statement omitted material facts.  The Chancery Court granted summary judgment as to all but the process and deal protection claims based on the following undisputed facts: the Lyondell directors were active, sophisticated and generally aware of the value of the company and the conditions of the markets in which it operated and, second, they had reason to believe that no other bidders would emerge given the premium price Basell had offered and the limited number of companies that might be interested in acquiring Lyondell’s unique assets. 

As to the process and deal protection claims, however, the Chancery Court found that other facts potentially called to question the adequacy of the board’s knowledge and efforts.  Among them were:

• Even though the Schedule 13D signaled that Lyondell was “in play,” Lyondell’s board took no action to prepare for a possible acquisition proposal (the “wait and see” approach);
• The merger was negotiated and finalized in less than one week, during which time the directors met for only seven hours;
• The directors did not “seriously” press for a better price, nor did they conduct even a limited market check; and
• While the deal protection measures were neither unusual nor preclusive, they were troubling to the Chancery Court given that the deal had not, in the court’s view, been adequately vetted under Revlon.

The Delaware Supreme Court accepted an interlocutory appeal as to the denial of summary judgment, and found that the Chancery Court’s decision was erroneous in three respects:  First, the Court of Chancery improperly imposed Revlon duties on Lyondell directors before they either had decided to sell, or before a sale had become inevitable.  Second, the Court of Chancery wrongly read Revlon as creating a specific set of requirements that must be satisfied during the sale process.  And third, the Court of Chancery equated an arguably imperfect attempt to carry out Revlon duties with a knowing disregard of one’s duties (i.e., bad faith).

Revlon – What it is, when it is, and what it isn’t.

When it is:  The Court emphasized that Revlon duties do not arise simply because a company is “in play.”  Rather, 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 change of control.  The “wait and see” approach taken by Lyondell directors after learning that Basell was interested in acquiring the company was, according to the Court, “an entirely appropriate exercise of the directors’ business judgment.” The value-maximizing obligations of Revlon did not begin until the directors began negotiating the sale of Lyondell. 

What it is and isn’t:  Revlon did not create any new fiduciary duties.  The Court noted that under Revlon, directors have only one obligation – to “get the best price for the stockholders at a sale of the company.”  No court can tell directors exactly how to accomplish that goal, and there “are no legally prescribed steps that directors must follow to satisfy their Revlon duties.”  Because Lyondell’s charter included an exculpatory provision under 8 Del. C. § 102(b)(7) ², actionable liability only could be found if the board breached its duty of loyalty.  Because the Chancery Court found that the board was independent and not motivated by self-interest or ill will, the sole basis upon which actionable liability could be found would be failure to act in good faith.  Bottom line:  the directors’ failure to take any particular steps during the sale process could not have demonstrated a conscious disregard of their duties. 

Good faith, bad faith, and the domain of business judgment. 

The Court examined the subsidiary obligation (subsumed by the duty of loyalty) of good faith in view of two recent decisions:  In re Walt Disney Deriv. Litig., 906 A.2d 27 (Del. 2006) (bad faith encompasses not only an intent to harm, but also intentional dereliction of duty) and Stone v. Ritter, 911 A.2d 362 (Del. 2006) (adopting the Caremark standard of “sustained or systemic failure” in connection with bad faith in the discharge of oversight responsibilities, and holding that the imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations).  Taking from these decisions that bad faith will be found if a fiduciary intentionally fails to act in the face of a known duty to act, thereby demonstrating a conscientious disregard for his or her duties, the Court noted that “there is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard for those duties.”  The Chancery Court’s approach, which focused on whether the directors took or did not take certain steps to obtain the best sale price, was misguided.  Where directors fail to do all they should have under the circumstances, they breach only a duty of care. 

Here, because duty of care claims were exculpated, actionable liability could be found only if the directors utterly failed to attempt to obtain the best sale price.  Even assuming that the Lyondell directors did absolutely nothing to prepare for the merger and did not even consider conducting a market check before agreeing to the merger, but where the directors were generally aware of the value of their company and the market, they met several times to consider a premium offer, they solicited and followed the advice of financial and legal advisors, they attempted to negotiate a higher price, and they ultimately approved the offer because it was simply too good to keep from the shareholders for consideration, they did not breach their duty of loyalty by failing to act in good faith.  Which is to say, “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.”  In re Lear Corp. S’holder Litig., 2008 WL 4053221 at *11 (Del. Ch.). 

Alas, in Delaware, directors’ “decisions must be reasonable, not perfect.” 

1  Revlon v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1986), held that the “board must perform its fiduciary duties in the service of a specific objective: maximizing the sale price of the enterprise.” 

2 Section 102(b)(7) of the Delaware General Corporation Law authorizes an exculpatory provision insulating a Delaware corporation’s directors from personal liability for duty of care claims.