In a closely watched case, on March 25, 2009, the Delaware Supreme Court reversed the Court of Chancery and concluded that the directors of Lyondell Chemical Company did not breach their fiduciary duty of loyalty by failing to act in good faith in fulfilling their Revlon duties in connection with Lyondell’s merger with Basell AF. The decision stands for three propositions: (a) a board has no Revlon duty to seek the best price just because a bidder puts the company “in play”; (b) there is no blueprint of legally required steps that a board must follow to satisfy its Revlon duties as each change of control transaction has unique circumstances; and (c) the test for determining whether directors have breached their duty of loyalty by failing to act in good faith while fulfilling Revlon duties is whether the directors utterly failed to attempt to obtain the best sale price. This standard of review is very high and should give directors comfort that the Court will not second guess whether a board complied with its duty of loyalty in the absence of a showing that the directors “knowingly and completely failed to undertake their responsibilities.”
The case, Lyondell Chemical Company v. Ryan, involved the US$13 billion acquisition of Lyondell, a NYSE listed company, by Basell, a privately held Luxembourg company. On July 29, 2008, the Court of Chancery denied summary judgment to the Lyondell directors for claims that the merger negotiation process was flawed and that the directors agreed to unreasonable deal protection provisions. Basell filed a Schedule 13D in May 2007 disclosing Basell’s interest in possible transactions with Lyondell. The Court of Chancery found that the directors’ lack of action following the company being put “in play” by the filing may have created an inference that the directors may have consciously disregarded their fiduciary duties and therefore failed to act in good faith in violation of their duty of loyalty. As stated above, the Delaware Supreme Court reversed the decision of the lower court and ordered the entry of summary judgment in favor of the Lyondell directors on March 25, 2009.
Although the Lyondell directors were accused of breaching their fiduciary duties of care and loyalty, the Delaware Supreme Court did not consider the allegation that the directors breached their duty of care because Lyondell’s charter included a provision intended to protect directors from personal liability resulting from breaches of the duty of care as permitted by Section 102(b)(7) of the Delaware General Corporation Law. Therefore, the only issue decided by the Delaware Supreme Court was whether the directors breached their duty of loyalty, which would have been the case had the Delaware Supreme Court found that the directors failed to act in good faith in connection with the Lyondell-Basell merger.
In reversing the Court of Chancery’s holding, the Delaware Supreme Court expounded upon its understanding of the seminal 1986 case Revlon v. MacAndrews & Forbes Holdings, Inc., in which the Delaware Supreme Court held that in the context of a sale of a company, the “board must perform its fiduciary duties in the service of a specific objective: maximizing the sale price of the enterprise.” The Delaware Supreme Court identified three errors in the Court of Chancery’s reasoning underlying that court’s decision to deny the directors’ motion for summary judgment.
The Lyondell holding addresses the issue of when Revlon duties arise: “Revlon duties do not arise because a company is “in play.” 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.” The Delaware Supreme Court will find a company to have embarked on a transaction only when the directors have decided to sell the company or when a sale has become inevitable. The Delaware Supreme Court held that while the filing by Basell of a Schedule 13D in May 2007 disclosing Basell’s interest in possible transactions with Lyondell put Lyondell “in play,” the company did not embark on a transaction until July 10, 2007, when negotiations began. Thus the Delaware Supreme Court considered the conduct of the Lyondell directors only during the period from July 10 until board approval of the merger on July 16 in determining whether the directors met their fiduciary duties under Revlon; the directors’ two months of inaction during the “wait and see” period from the filing of the Schedule 13D until the commencement of negotiations were not relevant in determining whether the directors satisfied their Revlon duties. Based on this decision, when will courts decide when Revlon duties arise? For example, consider the situation where a company conducts an auction with an explicit statement in the solicitation materials that the board has not decided to sell. In this situation do the Revlon duties only apply when the negotiations with the chosen bidder begin even if the auction process was poorly run?
The Delaware Supreme Court in Lyondell confronted the question of what courses of action, if any, directors are required to pursue in order to satisfy their Revlon duties, and concluded that “there are no legally prescribed steps that directors must follow.” Although Delaware case law points to certain director conduct as tending to support a finding that Revlon duties have been satisfied and other conduct as tending to support the opposite conclusion, those general principles are not dispositive as a matter of law because “no court can tell directors exactly how” to satisfy Revlon duties in light of the unique set of circumstances that arise in the context of change of control transactions. As a result, although Delaware case law looks favorably upon such courses of action as auctions, market checks and directors possessing “impeccable” market knowledge, the mere absence of those factors from the record in Lyondell does not by itself support a holding that the directors fell short of meeting their Revlon duties, as those specific courses of action were not required of the directors. This is the first time the Delaware Supreme Court has clearly said that no market check is required. Prior to this decision, M&A practitioners generally believed that market checks were required (either pre-signing or post-signing). For the last several years, it has become common to include a go-shop provision. Such provision has proved to have limited efficacy. Therefore, go-shops, under the right deal circumstances, are likely to become less common.
Lyondell sets forth the proper inquiry for determining whether directors have breached their Revlon duties: “Instead of questioning whether disinterested, independent directors did everything that they (arguably) should have done to obtain the best sale price, the inquiry should have been whether those directors utterly failed to attempt to obtain the best sale price.” Thus a claim of breach of fiduciary duty may not proceed against directors in the absence of allegations that the directors “knowingly and completely failed to undertake their responsibilities.” Furthermore, the Court stated that the issue was whether the directors failed to act in good faith and noted that bad faith will be found if a “fiduciary intentionally fails to act in the face of a known duty to act.” Although the Lyondell directors did not pursue all possible avenues of maximizing shareholder value, as evidenced by their failure to take any action until July 2007 and their failure to conduct an auction or market check, the directors did make some efforts to satisfy their Revlon duties: they met numerous times in July 2007, they were generally aware of the company’s value, they had knowledge of the chemical company market, they solicited and complied with the advice of financial and legal advisers, and they attempted to negotiate more favorable deal terms. Under the rubric for analysis identified by the Delaware Supreme Court, the directors’ actions rather than their inactions are dispositive, therefore the Delaware Supreme Court in Lyondell held that the record could not support a finding that the directors failed to act in good faith and therefore the Court held that they did not breach their duty of loyalty to Lyondell in connection with the Lyondell-Basell merger. Notwithstanding that this case resulted in no liability for the directors it should not be used by directors as an excuse not to diligently, carefully and with good faith satisfy their fiduciary duties. Furthermore, it is important to emphasize the importance of having experienced and expert advisors with a board every step of the way.