The Delaware Supreme Court’s reversal of the Chancery Court’s decision in Ryan v. Lyondell Chemical marks a welcome confirmation of the fiduciary duty status quo. The Court reinforces the high bar required to establish a breach of the duty of loyalty, stating that there must be a showing of an intent to do harm or, as was implicated in this case, an intentional dereliction of duty (i.e., a knowing and complete disregard of the board’s responsibilities). If directors simply “failed to do all that they should have”, they may breach their duty of care, but not their duty of loyalty. This distinction is critical because the duty of loyalty, unlike the duty of care, is not exculpable under Section 102(b)(7) of the Delaware General Corporation Law. Further, the Court also confirmed that under Revlon, the duty of the target’s board is to maximize the sale price via a reasonable, not perfect, sale process. The Court stated that such duties attach only when a transaction is at hand, and not during the entire time that a corporation is arguably “in play”. Thus, any inaction on the part of the Lyondell board during the beginning of its encounter with Basell was entirely within the appropriate exercise of the directors’ business judgment.
The claim in Ryan arose from the sale of Lyondell Chemical to Basell AF. Basell initially approached Lyondell about a potential acquisition in April 2006, and formally offered $26.50 - $28.50 per share in the summer of that year. Lyondell’s board rejected the offer out of hand as being too low, and heard nothing more from Basell until May 2007, when Basell filed a Schedule 13D indicating that it had purchased 8% of Lyondell’s stock and was potentially interested in a takeover. The Lyondell board immediately met to consider responses, but, while acknowledging that the company may be “in play”, decided to take a “wait and see” approach. Two months later, Basell presented Lyondell’s CEO with an offer of $40 per share with a $400 million break-up fee. Basell’s offer was subject to a one-week deadline. The Lyondell board met several times during this one-week period to consider the offer. The board also retained financial and legal advisers and pressed the CEO to seek better terms, including a higher price, a go-shop provision and a reduced break-up fee. Ultimately, Basell agreed to increase its price to $48 per share, reduce the break-up fee to $385 million and include a fiduciary-out provision for the Lyondell board (though it rejected Lyondell’s request for a go-shop period). The Lyondell board accepted the offer without a meaningful market check in part because its financial advisers said the offer was an “absolute home run”.
Despite finding that the Lyondell board was independent and disinterested, the Chancery Court denied the defendant’s motion for summary judgment with respect to the stockholder’s claims that the process by which the merger had been negotiated was flawed and that the directors had agreed to unreasonable deal protection provisions. Plaintiffs argued a breach of the duty of loyalty because Lyondell’s charter included an exculpatory provision under Section 102(b)(7) and only a claim of a breach of the duty of loyalty could proceed. Further, because there was no suggestion that the board was self-interested, not independent or acting out of malice, the plaintiffs could proceed only under the “good faith” component of the duty of loyalty. On a motion for summary judgment and based on the limited record available at that time, the Chancery Court found that, among other things, the Lyondell board’s inaction during the two months between Basell’s 13D filing and the commencement of formal negotiation, its failure to negotiate with Basell directly or to seek alternatives to the transaction and the haste with which the deal was concluded gave rise to the possibility of a bad faith claim.
In reversing the Chancery Court decision, the Delaware Supreme Court reiterated the high bar that must be met to establish a breach of good faith claim against directors and clarified the application of Revlon duties. In its decision, the Delaware Supreme Court provides the following important guidance:
- A breach of the duty of good faith requires a knowing and complete disregard of a board’s responsibilities. The Supreme Court held that a claim for a breach of the good faith component of the duty of loyalty requires a showing that the board knowingly and completely disregarded their responsibilities. Where there is merely a failure to “do all that they should have under the circumstances”, the directors may have breached their duty of care, not their duty of loyalty.
- Revlon applies only when there is an actual transaction pending. The Supreme Court held that the duty to maximize the sale price under Revlon does not arise until the company is unquestionably up for sale. Until such time, the “wait and see” approach that the Lyondell board took may be “an entirely appropriate exercise of the directors’ business judgment”. The Supreme Court found that the Chancery Court erroneously imposed Revlon duties on the board before they had decided to sell or a sale had become inevitable and found that the Chancery Court erroneously focused on the board’s inaction during the two-month period between the filing of the 13D and the initial offer, when it should have limited its analysis to the brief period between Basell’s firm offer and the signing of the merger agreement.
- There are no prescribed steps for a board to follow in executing Revlon duties. The Supreme Court reaffirmed that Revlon and its progeny do not mandate “prescribed steps that directors must follow”, only that they make “reasonable” attempts to maximize price. What constitutes “reasonable” is highly situation-dependent, and an “extreme set of facts [is] required to sustain a disloyalty claim.”