On March 25, 2009, the Delaware Supreme Court in Lyondell Chemical Company v. Ryan1 reversed the decision of the Chancery Court by rejecting shareholder claims that the directors of Lyondell Chemical Company (“Lyondell”) had failed to act in good faith in connection with the sale of Lyondell to Basell AF (“Basell”) and granting summary judgment to the directors. The Supreme Court’s decision is important because:
- it clarifies that Revlon duties, which require a company’s board to obtain the highest price reasonably attainable for the company, do not arise merely because a company is put “in play” by a third-party’s action, but only when the target company, on its own initiative or in response to an unsolicited offer, pursues a transaction that will result in a change of control;
- it reinforces prior Delaware case law that “there is no single blueprint” that a board must follow to fulfill its Revlon duties and that, in order to pass judicial muster, such conduct must be “reasonable, not perfect;” and
- it sets a high bar for establishing bad faith in M&A transactions involving disinterested directors that benefit from an exculpatory provision in the company’s charter for duty of care breaches under Section 102(b)(7) by requiring that plaintiffs establish that such directors have “knowingly and completely failed to undertake their responsibilities.”
In April 2006, Basell’s controlling shareholder Leonard Blavatnik (“Blavatnik”) informed Lyondell’s chief executive officer, Dan Smith (“Smith”), that Basell was interested in acquiring Lyondell. A few months later, Basell sent a letter to the Lyondell board offering $26.50 to 28.50 per share. Lyondell determined that the price was inadequate and that it was not interested in selling the company.
In May 2007, an affiliate of Blavatnik filed a Schedule 13D with the Securities and Exchange Commission disclosing its right to acquire an 8.3% block of Lyondell common stock owned by a third-party. The Schedule 13D also disclosed Blavatnik’s interest in possible transactions with Lyondell. In response to the Schedule 13D, and recognizing that the company was now “in play,” the Lyondell board immediately convened a special meeting. After discussing possible responses, the board decided to take a “wait and see” approach.
On July 9, 2007, Blavatnik met with Smith to discuss an all-cash deal at $40 per share. Smith was successful in getting Blavatnik to increase his offer to $48 per share, which represented a 45% premium to Lyondell’s share price on the day before the Schedule 13D was filed. Smith then called a special meeting of the Lyondell board on July 10, 2007, to review and consider Basell’s offer. During the meeting, which lasted slightly less than one hour, the board reviewed valuation material and discussed the offer, the status of the sale of Huntsman Corp. (a competitor in the chemical industry, which had agreed to sell itself to Basell but subsequently received, and ultimately accepted, a topping offer from Hexion Specialty Chemicals Inc.), and the likelihood of other parties having an interest in acquiring Lyondell. The board then instructed Smith to obtain a written offer from Basell and get additional detail about Basell’s financing.
Over the next four-day period, the parties negotiated the terms of their merger agreement, Basell conducted due diligence, Lyondell’s financial advisor prepared a “fairness” opinion and Lyondell’s board had its regular meeting. At the meeting, Lyondell’s board instructed Smith to try to negotiate better terms with Basell, in particular, a higher price, a “go-shop” provision and a reduced break-up fee. Blavatnik was “incredulous” at the response and stated that, having offered his best price, he was not willing to increase it. As a sign of good faith, however, he agreed to reduce the break-up fee from $400 million to $385 million (which represented approximately 3.0% of the total equity value (on a fully diluted basis) of the proposed transaction and approximately 2.0% of the total enterprise value of the proposed transaction).
On July 16, 2007, the Lyondell board met to consider the Basell merger agreement. Lyondell’s advisors explained the mechanics of the agreement, including that the board would be able to consider any superior offers pursuant to the “fiduciary out” clause in the no-shop provision. The board’s financial advisor reviewed valuation models and opined that the proposed merger price was fair. (The financial advisor described the price as “an absolute home run”). The financial advisor identified other possible acquirers and explained why it believed no other entity would top Basell’s offer. After considering these presentations, the board then voted to approve the merger and recommend it to the stockholders. At a special stockholders’ meeting on November 20, 2007, the merger was overwhelmingly approved by more than 99% of the voted shares.
On August 20, 2007, a Lyondell stockholder filed a class action suit in Delaware Chancery Court against Lyondell’s directors claiming that they breached their fiduciary duties because (i) the merger price was inadequate, (ii) the directors acted in self-interest, (iii) the directors conducted a flawed sale process in violation of its duties under Revlon, (iv) the directors agreed to unreasonable deal protection provisions and (v) the preliminary proxy statement omitted numerous material facts. No injunctive relief was requested. The Lyondell directors filed a motion for summary judgment.
Chancery Court Decision
The Chancery Court issued its opinion on July 29, 2008, denying summary judgment as to the Revlon and deal-protection claims. The Chancery Court identified several factors supporting the entry of judgment in favor of the defendants, such as their sophistication, their success in getting Basell to raise its price from $40 to $48 per share (a price that Lyondell’s financial advisor determined was “fair”), and that no one had submitted a topping offer. However, the Chancery Court found other facts that led it to question the adequacy of the board’s knowledge and efforts, namely that:
- after the Schedule 13D was filed, the directors took no action to prepare for a possible acquisition proposal;
- the merger was negotiated and finalized in less than one week during which time the board met for a total of seven hours;
- the directors did not seriously press the offeror for a better price or conduct a limited market check; and
- although the deal protections were not unusual or preclusive, the board’s decision to grant such protections to a deal that may not have been adequately vetted under Revlon was troubling.
The Chancery Court pointedly referred to the directors’ “two months of slothful indifference despite knowing that the company was in play” and criticized the Board for having “languidly awaited overtures from potential suitors.” The Chancery Court found that it was this “failing” that warranted denying summary judgment.
Reversal of Chancery Court Decision
The Delaware Supreme Court accepted the directors’ application for certification of an interlocutory appeal on September 15, 2008. The Supreme Court noted that Lyondell’s charter includes an exculpatory provision, pursuant to Section 102(b)(7) of the Delaware General Corporation Law, protecting the directors from personal liability for breaches of the duty of care and, therefore, “this case turns on whether any arguable shortcomings on the part of the Lyondell directors also implicate their duty of loyalty, a breach of which is not exculpated.” According to the Supreme Court, “[b]ecause the trial court determined that the board was independent and was not motivated by self-interest or ill will, the sole issue is whether the directors are entitled to summary judgment on the claim that they breached their duty of loyalty by failing to act in good faith.” Bad faith will be found if a “fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.”
The Supreme Court concluded that the Chancery Court had reviewed the factual record “under a mistaken view of the applicable law.”
- First, the Chancery Court incorrectly imposed Revlon duties on the Lyondell directors before they either had decided to sell, or before the sale had become inevitable. The Supreme Court rejected the Chancery Court’s determination that Revlon duties applied when Basell filed its Schedule 13D and put Lyondell “in play.” According to the Supreme Court, “[t]he 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.” Therefore, it was only until July 10, 2007, when the directors began negotiating the sale of Lyondell, that Revlon duties were triggered
- Second, the Chancery Court incorrectly interpreted Revlon and its progeny as creating a set of requirements that must be satisfied during the sale process. The Supreme Court rejected this interpretation, stating that “there is only one Revlon duty—to ‘[get] the best price for the stockholders at a sale of the company’” and that “[n]o court can tell directors exactly how to accomplish that goal, because they will be facing a unique combination of circumstances, many of which will be outside their control.” As noted by the Court in Barkan v. Amsted Industries, “there is no single blueprint that a board must follow to fulfill its duties.”
- Third, the Chancery Court wrongly equated an arguably imperfect attempt to carry out Revlon duties with a knowing disregard of one’s duties that constitutes bad faith. Since “there is no single blueprint” to carry out Revlon duties, the directors’ failure to take any specific steps during the sales process could not have demonstrated a conscious disregard of their duties. According to the Supreme Court, “there is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard for those duties.” Directors decisions, the Supreme Court stated, “must be reasonable, not perfect.” And in the transactional context, an extreme set of facts is required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties. “Only if they knowingly and completely failed to undertake their responsibilities would they breach their duty of loyalty.” The Chancery Court approached the record from the wrong perspective by questioning whether disinterested directors did everything that they should have done to obtain the best sale price instead of focusing on whether those directors “utterly failed to attempt to obtain the best sale price.”
The Supreme Court then reviewed the record for itself and noted that the directors met several times to consider the offer, that they were generally aware of the value of the company and the industry in which it operates, that they solicited and followed the advice of their financial and legal advisors, that they attempted to obtain a higher price even though all the evidence suggested that Basell had offered a “blowout” price, and that they approved the merger agreement because “it was simply too good not to pass along [to the stockholders] for their consideration”. The Supreme Court concluded that the record clearly established that the Lyondell directors did not breach their duty of loyalty by failing to act in good faith and reversed the Chancery Court’s decision.