In Ryan v. Lyondell Chemical Co., 2008 WL 2923427 (Del. Ch. July 29, 2008), a case involving an unsolicited, all cash offer from an unrelated strategic acquirer at a substantial premium to the market price, the Court denied the defendants’ motions for summary judgment on breach of fiduciary duties associated with the sale process and the deal protections. The Court also allowed monetary damages claims against the directors to proceed to trial based on the possibility that the directors’ conduct may have been so far below the standards of care that it involved a lack of good faith – despite there being no conflicts of interest. The Court was critical of the Board’s response to a filing that put the company “in play,” the 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.
Lyondell is a manufacturer of chemicals and plastics and it was not under financial strain or being marketed for sale at the time it received a proposal from Basell AF, a Luxenburg plastics company, to purchase the company at a very attractive premium. In May 2007, an affiliate of Basell obtained rights to purchase 8.3% of Lyondell's shares and filed a Schedule 13D indicating that it may seek to acquire Lyondell. Following such filing, the Board adopted a “wait and see” posture to gauge market reaction and determine if other bidders would emerge. The Board took no steps to value the Company, retain an investment banker or develop a response strategy should a possible acquisition be proposed. A private equity firm approached Lyondell CEO Dan Smith for a management-led buyout, but Smith rejected that proposal out of hand due to his concerns over the inherent conflicts of interest. Smith scheduled a July 9 meeting with the Chairman and President of Basell’s parent company, Leonard Blavatnik. Prior to that meeting, Basell announced a possible acquisition of a different chemical company, but was outbid, and by July 9, needed to decide quickly whether to increase its bid on the other company or pursue an acquisition of Lyondell. Through a series of negotiations between Smith and Blavatnik, Basell offered $48 per share, a 45% premium over the market price before the 13D filing, and a 20% premium over the then-current market price. Such offer was however conditioned on Lyondell signing a merger agreement within seven days and agreeing to a $400 million (slightly over 3% of equity value) break-up fee.
The Board considered the proposal in a 50 minute meeting on July 10 and a 45 minute meeting on July 11 and also discussed the transaction in executive session (but with Smith present) at its regularly scheduled meeting on July 12. The Board retained Deutsche Bank to prepare a fairness opinion, and the deal teams worked to meet the July 16 signing deadline. On July 15, Smith contacted Blavatnik and requested an increase in the offer price, a "go-shop" provision for 45 days with 1% break-up fee during the go-shop period, and a reduction in the $400 million break-up fee after the "go-shop." Blavatnik agreed to reduce the break-up fee to $385 million (3% of equity value) but rejected the other requests. The directors received the proposed merger agreement late in the day on July 15. It included a typical fiduciary-out clause, but also included a "no-shop" clause and matching rights for any superior proposals. At a July 16 meeting, the Board recognized that Basell’s negotiating tactics were constraining the actions they could take to discharge their fiduciary duties, but believed that the offer price was much higher than the company’s future valuation as a stand-alone, and higher than anyone else would bid. After hearing from management and legal and financial advisors, the Board voted unanimously to approve the merger.
The Court found that:
- the Board’s process was “troubling” under the requirements articulated in Revlon and later Delaware cases, and denied summary judgment on the plaintiff’s Revlon claims;
- in light of the Court’s doubt over the adequacy of the Revlon procedures, the Court could not conclude that the deal protection measures, although within customary norms, were reasonable, and denied summary judgment on claims that such deal protections violated fiduciary duties under Unocal and Omnicare;
- the directors' actions may have fallen so far short of their known duties that their conduct may have failed to satisfy the good faith standard required to uphold the exculpatory clause in Lyondell's charter, and accordingly, claims for monetary damages could proceed to trial.
The Court recognized that there is flexibility in how a board may discharge its Revlon duties, and that in some cases, a sale to a single bidder without canvassing the market may be appropriate. However, under existing precedent, sale to a single bidder requires that a board possess a body of reliable evidence with which to evaluate the fairness of a transaction. The Court considered a number of factors which suggested the Board had the requisite information, including sophisticated directors generally aware of the value of the company and market conditions, long range plans updated at least annually, other disposition transactions considered by the Board, detailed analyses by management and Deutche Bank, the lack of other serious bidders emerging since filing of the 13D, Smith’s initial negotiations with Blavatnik leading to a substantial increase in the offer from what Basell first proposed, and the lack of any proposals after the deal was announced.
However, the Court criticized the Board for what the Court believed were substantial inadequacies in the process. These included, in the Court’s view, the seven-day time frame from initial discussions to signed agreement, a total of six or seven hours of Board time to discuss the acquisition, with half of that time spent on the day the agreement was signed, and the lack of action following the 13D filing. The Court strongly suggests that following the 13D filing, the Board should have sought a valuation of the company, retained an investment bank, developed a strategy to address a proposal if received, and/or conducted some type of active market check. The Court was also critical of the Board’s lack of involvement in the negotiating process, as all negotiations were conducted by Smith, some without the Board’s knowledge.
The Court analyzed the deal protection measures, and while acknowledging that such measures were typical for deals of this magnitude, concluded that such deal protections may not survive an enhanced scrutiny analysis under Unocal and Omnicare as a result of what the Court viewed as significant defects in the discharge of the Board’s Revlon duties. In a footnote, the Court wrote that “enhanced judicial scrutiny of the Board’s decision to accede to such provisions in the merger agreement does not contemplate reflexive approval of a 'typical' mix of deal protections.”
The most remarkable aspect of the opinion is the Court’s finding that the failings of the Board described above may have been such a serious departure from the duties owed under Revlon that they could constitute a lack of good faith. Such lack of good faith in turn could render unavailable the provision in Lyondell’s charter exculpating directors from liability for monetary damages for breaches of fiduciary duty, as acts or omissions not in good faith are excluded from the scope of exculpation clauses. Accordingly, although there was no self-interest or breach of the duty of loyalty, claims for monetary damages against the directors could proceed to trial.
What does this case mean?
The decision in Ryan v. Lyondell represents a significant expansion of the range of conduct that can be deemed a breach of duty owed by directors in a sale of control, and an expansion of the type of conduct that can subject directors to money damages. The opinion suggests that directors cannot find safety in a substantial premium to market, credible threats of an offer being withdrawn if not acted upon quickly, a fairness opinion from a bulge bracket investment bank, deal protections within customary norms, lack of conflicts of interest, lack of any other proposals after being "put in play" or overwhelming stockholder approval. When faced with a serious expression of interest for corporate control, boards should make certain they are fully informed on company valuation, develop a proactive response strategy in the event an offer materializes, and strongly consider retaining an investment bank to evaluate strategic alternatives and potential bidders. In the face of an actual offer, boards will need to consider the adequacy of the pre-signing market check (for both financial and strategic bidders), and, if no such market check has been conducted, take even more seriously the need for a post-signing “go-shop” period in the merger agreement. Boards should also actively involve themselves in the negotiation process. They should be informed of all negotiations by management, preferably in advance, and should direct negotiations early in the process to improve the opportunity to have their concerns addressed.