On Wednesday, March 25, 2009, the Delaware Supreme Court issued an opinion reversing the Chancery Court's decision in Ryan v. Lyondell Chemical Co., 2008 WL 2923427 (Del. Ch. July 29, 2008). We posted about the Chancery Court decision on the Corporate and Securities Law Blog here. In reversing the Chancery Court decision, the Delaware Supreme Court granted summary judgment in favor of Lyondell’s directors and in doing so held that a board of directors determination to adopt a “wait and see” approach in response to an unsolicited takeover bid was subject to the business judgment and that Revlon duties did not apply until the Board began negotiating with the bidder. This case provides important guidance for directors of Delaware corporations in discharging their fiduciary duties in connection with company sales.
Certain Lyondell stockholders (including the named plaintiff, Walter E. Ryan) initiated a complaint challenging a $13 billion all-cash merger and alleged that the Lyondell directors breached their "fiduciary duties of care, loyalty and candor…and…put their own personal interests ahead of the interests of the Lyondell stockholders." The Lyondell directors moved for summary judgment. On July 29, 2008, the Court of Chancery granted summary judgment on all claims except two: (1) whether Lyondell's directors had acted in good faith in fulfilling their Revlon duties and (2) whether the deal-protection measures in the merger agreement were preclusive. The Supreme Court accepted the directors’ application for certification of an interlocutory appeal in September 2008.
Before the merger at issue, Lyondell Chemical Company was the third-largest independent, publicly-traded chemical company in North America. Dan Smith was Lyondell’s Chairman and CEO. Lyondell’s other ten directors were independent and were experienced and sophisticated businesspeople. Basell AF is a privately-held Luxembourg polyolefin company controlled by Leonard Blavatnik (through his ownership of Access Industries). In May 2007, more than one year after Lyondell rejected an unsolicited bid from Blavatnik of $26.50-$28.50 per share of Lyondell, Access Industries obtained rights to purchase 8.3% of Lyondell's shares and filed a Schedule 13D indicating Blavatnik's interest in possible transactions with Lyondell. Immediately following the Schedule 13D filing, Lyondell's Board convened a special meeting. Although the Board recognized that the Schedule 13D filing signaled Lyondell was "in play" (Lyondell's stock price jumped more than 12% on the day the filing was made public), the Board decided to take a "wait and see" approach, but took no steps to value the Company, retain a financial advisor or develop a response strategy should a possible acquisition be proposed.
Smith and Blavatnik met on July 9, 2007 to discuss an all-cash deal at $40 per share. When Smith responded that the price was too low, Basell raised the bid to $44-45 per share. Smith told Blavatnik he would present the bid to Lyondell's Board, but thought the Board would reject it, since Lyondell was not really on the market. Later that day, Basell offered $48 per share, which represented a 45% premium over the market price immediately before the Schedule13D filing, and a 20% premium over the then-current market price. The bid was not subject to a financing contingency, but was conditioned on Lyondell executing a merger agreement within seven days and agreeing to a $400 million break-up fee (slightly more than 3% of equity value).
The following day, July 10, the Board considered the $48 per share proposal and valuation materials prepared by Lyondell's management in a Board meeting lasting slightly less than one hour. At this meeting, the Board instructed Smith to obtain a written offer from Basell. Blavatnik agreed to the request, but imposed an additional demand that the Board give a firm indication of interest by the end of the day on July 11. The Lyondell Board met again on July 11, again for less than one hour, and discussed the Basell offer and how it compared to the benefits of remaining independent. The Board determined it was interested, authorized the retention of a financial advisor to prepare a fairness opinion, and instructed Smith to negotiate with Blavatnik. From July 12-15, the deal teams worked to meet the July 16 signing deadline. Lyondell's regular board meeting was held on July 12, and on that day the Board instructed Smith to try to negotiate better terms. Specifically, the Board was seeking a higher price, a "go-shop" provision to allow Lyondell to seek other buyers for a period after signing (with a 1% break-up fee during the "go-shop" period) and a reduced break-up fee after the "go-shop" period. Blavatnik agreed to reduce the break-up fee to $385 million (3% of equity value) but rejected the other requests. At a July 16 meeting, the Board considered the proposed merger agreement, which included a typical fiduciary-out clause, but also included a "no-shop" clause and matching rights for any superior proposals. The financial advisor opined that the price was fair and Lyondell was not likely to attract a higher price from the limited universe of companies that might have been interested in acquiring it. The Board voted to approve the merger and to recommend it to the stockholders. At a special meeting of the stockholders on November 20, 2007, more than 99% of the voted shares approved the merger. No other bidders for Lyondell emerged in the four month period between the board's approval of the merger and the stockholders' meeting.
In denying the Lyondell directors' motion for summary judgment, the Chancery Court was critical of the Board’s failure to respond to a filing that put the company "in play," the short, seven-day negotiating process for the actual deal, the failure to conduct a pre-signing market check, the failure to negotiate successfully for a post signing "go-shop," and deal protections including a 3% break-up fee and matching rights for a superior proposal. The Chancery Court also found that Ryan might have been able to prevail at trial on a claim that the directors had breached their duty of care. However, Lyondell’s charter included an exculpatory provision under 8 Del. C. § 102(b)(7) protecting the directors from personal liability for breaches of the duty of care. Therefore, the case turned on whether any arguable shortcomings of the directors implicated their duty of loyalty. Because the Chancery Court determined that the Board was independent and not motivated by self-interest or ill will, the sole issue for determination was whether the Lyondell directors were entitled to summary judgment on the claim that they had breached their duty of loyalty by failing to act in good faith. The Chancery Court denied summary judgment in order to obtain a more complete record before deciding whether the directors had acted in bad faith.
However, the Delaware Supreme Court held that the Chancery Court had reviewed the existing record under a mistaken view of the applicable law. The Supreme Court identified three factors contributing to the mistake.
First, the Chancery Court imposed Revlon duties (i.e., the duty seek the best available price in the sale of a company) on the Lyondell directors before they had either decided to sell, or before the sale became inevitable. The Chancery Court focused on the Board's actions during the two-month period after Blavatnik's Schedule 13D was filed. However, the Supreme Court cited Delaware case law holding that that "the duty to seek the best available price only applies 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, the directors were not required to act under Revlon until July 10, 2007, when they began negotiating the sale of Lyondell. Rather, the decision to "wait and see" was subject to the deferential business judgment rule.
Second, the Supreme Court held that the Chancery Court misread Revlon and its progeny as creating a set of requirements that must be satisfied during the sale process. The Chancery Court focused on the two months of inaction following the Schedule 13D filing. However, the Supreme Court stated that the relevant period for analyzing whether the Board satisfied its Revlon duties was the one week in which the directors were considering Basell’s offer. During that week, the directors met several times; they directed the CEO to try to negotiate better terms; they evaluated Lyondell's value, the offer price, and likelihood of obtaining a better price; and then they approved the merger. Because the Lyondell Board did not conduct an auction or a market check, nor did they demonstrate "impeccable" market knowledge, the Chancery Court was unable to conclude they had satisfied their Revlon duties. Pointing to the single Revlon duty - to get the best price for the stockholders at a sale of the company - the Supreme Court stated 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." The Supreme Court stated that it would have held that the directors did meet their burden under Revlon, even on the limited record before it, because the issue was whether the directors had acted in good faith, not whether they had satisfied their duty of care.
Third, the Chancery Court improperly equated an arguably imperfect attempt to carry out Revlon duties with a knowing disregard of duties that constituted bad faith. 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 Chancery Court decided that in order to satisfy Revlon duties, the directors must follow one of three paths – auction process, market check or impeccable market knowledge. However, the Supreme Court stated that Revlon imposes no legally prescribed steps for directors to follow. Thus, the Lyondell directors’ failure to take any specific steps during the sale process could not have demonstrated a conscious disregard for those duties. Only if the directors had knowingly and completely failed to undertake their duties would they have breached their duty of loyalty. Since the Lyondell directors were disinterested and independent, the Supreme Court held that "the inquiry should have been whether those directors utterly failed to attempt to obtain the best sale price." The Lyondell directors met several times to consider Basell’s offer, were generally aware of Lyondell’s value and knew the chemical company market. The directors solicited and followed the advice of their financial and legal advisors and attempted to negotiate a higher offer (even though Lyondell's financial advisor described the price as a "home run"). The Board approved the merger agreement because it was simply too good not to pass along to the stockholders for their consideration. Therefore, the Supreme Court held that the Lyondell directors did not breach their duty of loyalty by failing to act in good faith.
The Delaware Supreme Court's decision should be placed in perspective in light of the unique facts surrounding it. The Basell bid represented a 45% premium over the closing stock price of Lyondell immediately before the Schedule 13D; the transaction was approved by an independent and disinterested board; and the merger was additionally approved by more than 99% of the voting shares. The merger lacked the conflicts of interest that typically predicate challenges to mergers, and which lead to much more difficult questions of whether fiduciary duties have been satisfied in connection with merger transactions.