A recent case from the Delaware Chancery Court (Ryan v. Lyondell Chemical Company, [unpublished opinion] Del.Ch. C.A. No. 3176-VCN, July 29, 2008) holds that even when a company secures a premium price in a sale, directors can be liable if they were not actively involved in the process. Although the case was decided in the context of the denial of the Lyondell directors' motion for summary judgment, the court's discussion of the substantive law of directors' duties when selling a company is likely to have significant impact.
Lyondell Chemical Company was a Delaware corporation with a broad following in the equity markets. The acquirer, Basell, a Luxembourg-based company with operations in 19 countries, first expressed interest in acquiring Lyondell in April 2006. Basell eventually expressed interest in acquiring Lyondell at a price between US$26.50 and US$28.50 per share, which the Lyondell board rejected as inadequate. In May 2007, Basell's affiliate filed a Schedule 13D with the US Securities and Exchange Commission, disclosing its acquisition of a large block of Lyondell's stock and indicating an intention to engage Lyondell in discussions regarding various types of business combinations.
Lyondell's board responded immediately by calling a meeting in which it decided to await further developments following the public filing of the Schedule 13D, regarding it as a strong signal to the market that Lyondell was in play. The price of Lyondell's stock went up 11 percent. The parties began negotiations with the Basell side proposing a price of US$40 per share. The CEOs of the two companies eventually negotiated a price of US$48 per share – the price Lyondell's CEO had indicated would be justifiable and acceptable to Lyondell's board. The offer was conditioned on a US$400 million breakup fee, but there were no financing contingencies.
Lyondell's board met several times over the next week to consider the offer. The board decided to accept it and secured a fairness opinion from a major investment bank. The conclusion that the price was within the range of fairness was not surprising because the US$48 share price represented a 45-percent premium over the closing price on the last trading day before Basell's 13D filing and a 20-percent premium over the closing price on the day before the merger was announced publicly. Throughout the process, the US$48 price was characterized by the parties as a "blow-out" price, and the record reflected neither evidence to the contrary nor the willingness of any party to pay more. The offer was submitted to the Lyondell shareholders for approval, and they voted overwhelmingly in support of the transaction.
The court refused to grant summary judgment in favor of the directors. Its conclusions show the primary importance given to process – that is, an imperfect process can trump an excellent economic result. The court concluded, in spite of the compelling price and arms-length nature of the deal, that the Lyondell directors' conduct might not have met their fiduciary duties under Delaware's Revlon line of cases. Most disturbingly, the court indicated that the board's failure to become actively involved in the sale process might not be an indemnifiable and exculpatory breach of the duty of care, but was instead potentially a non-indemnifiable breach of the duty of good faith. The court also held that the deal-protection measures – a matching right, a "no shop with a fiduciary out" and a large breakup fee – had not been justified by the board as the result of "reasoned business judgment based on reliable evidence." Finally, the court was critical of an erroneously weighted average cost of capital used in the fairness opinion, although the error did not affect the conclusion as to fairness.
Lessons From Lyondell
Public company directors will be well-advised to bear these considerations in mind if they are called on to consider selling a public company:
- Process is primary. Directors are expected to be actively and directly involved in all important decisions regarding the design and implementation of the sale process.
- The pre-emptive offer may be dead. Lyondell may mean that a pre-emptive offer should not be accepted by a public company board not facing financial distress without at least some pre-signing market check or meaningful post-signing go-shop rights.
- Let them see you sweat. Directors can't simply hire and rely on experts or management. They need to understand their alternatives, document the choices they make and the reasons for those choices, and ensure the record reflects their personal involvement and activity – or risk a finding that they breached their duty of good faith.
- "Reasonable and customary" may not be good enough. The Lyondell court signaled that the deal-protection measures in that case were subject to challenge because the evidence did not show they had been actively and aggressively negotiated, or that the board had concluded they were justified and reasonable based on the available evidence. Advice from legal and financial advisers should be sought and documented not only as to what is reasonable and customary, but why particular deal-protection measures make sense in the specific transaction.
- Read and understand the fairness opinion. Resist the temptation to skip to the bottom line. Understand which valuation methodologies were used, which were not, and why. Understand the assumptions and projections including any midstream revisions. Understand the potential effect of success fees on the adviser's independence.
- Avoid looking like a rubber stamp. Delaware courts clearly regard the sale of a company one of the most important events in a corporation's history, and they expect the board to be actively involved in every stage of the transaction. This means the board's involvement must go beyond approving a prepackaged deal negotiated by management – it must be actively involved in designing and monitoring the sale process, and its involvement must be carefully documented.
In the absence of an ability to show that the board itself has worked hard, the fact that it worked smart or presided over the achievement of a great result might not be good enough.