The Delaware Court of Chancery has fired yet another shot across the bow of Corporate America by refusing to dismiss damage claims against the individual members of the board of directors of a company that agreed to be sold at a 45% market premium. Ryan v. Lyondell Chemical Company (Del. Ch. July 29, 2008). The Court held that even a “blowout” price does not justify a board’s failure to pursue a proactive process aimed at ensuring “the best price reasonably available” in a Revlon sale of control. Vice Chancellor Noble also held Lyondell’s standard DGCL §102(b)(7) charter provision (exculpating directors from damage liability for breach of their duty of care) did not provide grounds for dismissal on summary judgment because it might be proven at trial that the board’s Revlon violation went beyond a duty-of-care breach and constituted a non-exculpable breach of the good faith element of duty of loyalty. If such a breach were found at trial, individual directors could face significant personal and non-indemnifiable liability.
Ryan v. Lyondell Chemical does not make new law. It is, however, a vivid reminder that passively accepting a “premium” offer (and locking it in with deal-protection measures) without some combination of pre-signing market check, post-signing “go-shop” or other reasonable value-confirmation process is extremely hazardous, even if the board obtains a fairness opinion and stockholders overwhelmingly approve the acquisition.
Unsolicited “Blowout” Offer
Basell AF first expressed interest in Lyondell in April 2006, but Lyondell indicated it was not for sale and that Basell’s price range ($26.50 to $28.50 per share) was inadequate. In May 2007, Basell filed a Schedule 13D disclosing its acquisition of a right to acquire more than 8% of Lyondell’s outstanding shares and Basell’s intention to explore a business combination. Although the 13D filing fueled a sharp increase in Lyondell’s trading price (from $33 to $37 per share in one day) and signaled Lyondell was “in play,” its board decided simply to wait and see if the 13D generated other suitors. They took no affirmative steps to assess market interest or valuation in anticipation of an actual offer from Basell.
In the meantime, Lyondell’s CEO, Dan Smith, met repeatedly with Basell’s senior management to discuss acquisition terms, largely without the active supervision (or even the awareness) of the Lyondell board. On July 9, 2007, in response to Smith’s request, Basell’s CEO informed Smith that Basell’s “best” offer for Lyondell was $48 per share in cash, conditioned on a merger agreement being signed no later than seven days later, with a $400 million break-up fee.
CEO Smith hastily convened special meetings of the Lyondell board to present and discuss the Basell offer. After two very brief meetings (each lasting less than an hour) the board authorized Smith to finalize negotiations based on the Basell proposal and decided to reconvene on July 16, 2007 to consider what Smith had negotiated. Lyondell engaged Deutsche Bank to prepare a fairness opinion, but not to solicit competing offers.
Based on concerns regarding the board’s Revlon duties, Smith requested four concessions from Basell: (1) an increase in price; (2) a go-shop provision permitting the board to seek other potential buyers for 45 days after signing; (3) a reduced (1%) break-up fee during the go-shop; and (4) a reduction in the $400 million break-up fee after the go-shop. Basell agreed to reduce the break-up fee to $385 million (approximately 3% of transaction equity value), but otherwise rejected these requests.
The final merger agreement presented to Lyondell’s board on July 16, 2007 contained a number of deal-protection measures in addition to the $385 million break-up fee, including a no-shop clause (with typical “fiduciary out” language) and a matching right for Basell. In addition, Lyondell maintained its stockholder rights (“poison pill”) plan in place, other than for Basell.
Board and Stockholder Approval
Deutsche Bank presented its financial analyses and conclusions regarding financial fairness to the board at the July 16, 2007 meeting. Based on both “management-case” and more conservative “street-case” projections, Deutsche Bank concluded the $48 price was financially fair to Lyondell stockholders. Deutsche Bank also identified 20 other companies that might have an interest in acquiring Lyondell and presented reasons why no other bidder had materialized or was likely to top Basell’s bid. After listening to Deutsche Bank and a presentation on legal issues, the board unanimously approved the proposed transaction.
The merger was announced the next day. On November 20, 2007, stockholders overwhelmingly approved the transaction. The merger closed on December 20, 2007.
Revlon and Unocal-Omnicare Claims
Stockholders brought a class action claiming, among other things, that (1) the Lyondell board’s passive acceptance of Basell’s proposal without a proactive market check before or after signing breached its duty to seek the “best price reasonably available” under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986); and (2) the deal-protection measures were preclusive, coercive and unreasonable in light of the circumstances under Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), and Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003).
The board moved to dismiss these claims on summary judgment, arguing essentially that (1) it had fulfilled its Revlon duties by obtaining a “blowout” price that had cleared the market of other suitors (as evidenced by the absence of any serious competing bids) and (2) the deal-protection measures were neither preclusive nor coercive and were clearly justified by the superior price. In addition, the board argued that, even if it had breached its duties under Revlon or Unocal-Omnicare, directors had, at worst, breached their duty of care, and Lyondell’s charter exculpation protected them from damage claims by stockholders.
Noting that the board had approved the transaction in less than seven days based on only six or seven hours of meetings, no proactive pre-signing market check and little hope of a meaningful post-signing check due to deal protections, Vice Chancellor Noble refused to dismiss the claims on summary judgment. He reasoned that the board’s pattern of passivity raised serious questions: “It is difficult for the Court to conclude on this record, after giving Ryan the benefit of all reasonable inferences, that the process employed by the Board was a ‘reasonable’ effort to create value for the Lyondell stockholders.”
The Court concluded that the deal protections were not coercive because there were no voting agreements or management threats pre-ordaining stockholder approval. Stockholders could have rejected the proposal. Conceding that the protections in question were typical of deals of this magnitude, the Court nevertheless could not conclude on summary judgment that such measures were not, in the aggregate, preclusive and unreasonable in the specific context of this transaction – given the board’s lack of proactive market check prior to signing.
The Court also concluded there were material facts in dispute regarding whether the board had “failed to act in the face of a known duty to act” under Revlon and Unocal-Omnicare, thereby “demonstrating a conscious disregard for their responsibilities” and a “breach of duty of loyalty by failing to discharge that fiduciary obligation in good faith.” Consequently, the Lyondell charter exculpation provision could not serve as a basis for granting summary judgment dismissal because trial could reveal non-exculpable duty-of-loyalty breaches.
Warning to Directors
The Court clearly left open the possibility that the Lyondell directors could ultimately prevail at trial in proving that they had met their duties under Revlon and Unocal-Omnicare or, if they had not, that their failure did not involve conscious disregard of a known duty and a non-exculpable duty-of-loyalty breach. The case is, however, an important reminder of clear rules for the board:
- The board must actively supervise the process of negotiating a sale of control, not leave such process to an unsupervised CEO. Board supervision must begin up front, not after key decisions have already been made.
- Unless the board already possesses extraordinary knowledge of how the market currently values the company, Revlon duties require a proactive pre-signing or post-signing market check or other value-confirmation process. Vice Chancellor Noble made it very clear: a “premium to market alone does not satisfy Revlon – or necessarily warrant concession to any form of deal protection.”
- The board must ensure it has the time necessary to perform its Revlon duties and not be rushed to meet a timetable imposed by the buyer.
- Even garden-variety deal protections can be preclusive and unreasonable in a context in which a board has approved a sale without adequately informing itself regarding market valuation before signing.
- A fairness opinion may be a pre-requisite to satisfying Revlon duties, but it does not satisfy them by itself.
- The board cannot avoid its Revlon duties simply by “acting as a passive conduit” and passing transaction approval on to the stockholders. Stockholder ratification afforded the Lyondell board no relief on summary judgment because of material questions relating to defects in proxy disclosure.
These rules have been relatively clear under Delaware case law for over 20 years. Ryan v. Lyondell Chemical is just the latest reminder from the Delaware courts of the significant risks to directors who fail to take seriously their fiduciary duties, particularly in sale-of–control scenarios. Wholesale failure to heed these rules can raise the issue of “conscious disregard” of known duties, a failure of “good faith” and the resulting specter of non-exculpable, personal liability for directors in potentially crushing amounts.