Canada: Delaware Supreme Court Overturns Ryan v. Lyondell And Provides Some Comfort To Boards Of Directors

Copyright 2009, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Mergers & Acquisitions, May 2009

In July 2008, the Delaware Court of Chancery dismissed a summary judgment motion by the directors of Lyondell Chemicals, an independent chemical manufacturer, to dismiss shareholder litigation asserting that they had not met their fiduciary duty in recommending the sale of Lyondell to Basell AF at a 45% premium over the pre-announcement share price. In a decision that will provide comfort to Delaware directors, the Delaware Supreme Court recently overturned the lower court's dismissal and granted the Lyondell directors the summary motion they sought.

While Delaware jurisprudence on directors' duty of loyalty (or fiduciary duty) is arguably now less relevant in Canada in light of the Supreme Court of Canada's (SCC) guidance in BCE Inc., the reversal of the lower court decision in Ryan v. Lyondell confirms that (i) as in Canada, Delaware directors who are diligent and informed will be afforded a high level of judicial deference even if their processes, when viewed in hindsight, may have been imperfect, and (ii) a high bar is required to establish a breach of the duty of loyalty where a board is independent and disinterested with regard to a particular transaction.

Lower Court Ruling

As discussed in our August 2008 Blakes Bulletin on Mergers & Acquisitions: Waiting for BCE – Lessons from Delaware on Sellside Fiduciary Duties, Basell initially approached Lyondell about a potential acquisition in April 2006, with an all cash offer of US$24 to US$27 per share. This initial offer was rebuffed. Ayear later, Basell acquired an 8.3% stake in Lyondell and filed a Schedule 13D (the U.S. equivalent of an early warning report) indicating its intention to revisit a possible transaction. Considering the Schedule 13D to be a signal to the market that the company was "in play", the Lyondell board immediately convened a special meeting but decided to take a "wait and see" approach. Two months later, Basell presented Lyondell with an offer of US$48 per share with a US$400-million break-fee and a one-week deadline for acceptance. The Lyondell board met several times during this one-week period to consider the offer. The board retained financial and legal advisers, pushed back on the break-fee and requested a go-shop provision, mostly to no avail. Basell agreed only to reduce the break-fee to US$385-million, insisting this was its best offer. The Lyondell board accepted the offer without conducting a meaningful market check and approved a merger agreement with relatively customary deal protections, in part because its financial advisers told them that, after identifying other possible acquirors, it was not likely that Basell's offer would be topped and that the US$48 per share merger price was "an absolute home run".

Despite finding that the Lyondell board was independent and disinterested, the Court of Chancery held that it was at least a triable issue as to whether the Lyondell directors had breached their duty of loyalty to the company in acquiescing to an arguably hasty sales process. In both Canada and the U.S., a director's duty of loyalty requires him or her to act honestly and in good faith with a view to the best interests of the corporation. In assessing the alleged breach, the Court of Chancery only considered whether the Lyondell directors had failed to act in good faith because there was no suggestion that the board was self-interested, not independent or acting out of malice.

The Court of Chancery was open to the possibility of closely scrutinizing the Board's actions, holding, among other things, that the Lyondell board's "wait and see" approach during the two months between Basell's 13D filing and the commencement of formal negotiations, its failure to successfully negotiate concessions to Basell's offer 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.

No Blueprint for Meeting Fiduciary Duty in Sales Process

While the Court of Chancery held that there is "no single blueprint" for meeting the Delaware directors' Revlon duty to seek the best price reasonably available in a change of control context (a phrase adopted by Canadian courts as well – see Pente Investment Management Ltd v. Schneider (1998) Ont. CA), it stressed that in most cases a board must engage in an active sale process, including a canvass of the market (or "an impeccable knowledge of the market"), with the board proactively engaged at all stages.

The Supreme Court disagreed with the Court of Chancery, holding that this was a mistaken view of the applicable law; Delaware directors' Revlon duties do not mandate any "prescribed steps that directors must follow" in a sales process, they only require that directors' decisions be reasonable. This is similar to the approach under Canadian law. The Supreme Court noted that no "court can tell the 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 the issue in the case was only whether the directors had failed to act in good faith, the Supreme Court held that judgment should have been in the directors' favour.

The standard in Canada, as highlighted by the SCC in BCE Inc., requires Canadian courts to give appropriate deference to the business judgment of directors as to what is in the best interests of the corporation in any particular situation, provided that the decision of the board lies within a range of reasonable, case-specific alternatives.

Standard for Breach of Duty of Loyalty of Independent Disinterested Board

The Supreme Court held that the Court of Chancery improperly equated an arguably imperfect attempt to carry out the Board's duty of loyalty (which could possibly have been a breach of a duty of care) with a knowing disregard of such duty that constituted bad faith. According to the Supreme Court, only if the Lyondell directors had knowingly and completely failed to undertake their duty of loyalty would they have breached such duty.

The Supreme Court further held that since there are no legally prescribed steps that directors must follow to satisfy their duty of loyalty, the Lyondell directors' failure to take any specific steps during the sales process could not have demonstrated a conscious disregard of such duty. What constitutes "reasonable" is highly fact specific, and an "extreme set of facts [is] required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties."

In Canada, the standard for assessing a breach of the duty of loyalty focuses on the subjective motivation of directors in acting in the best interests of the corporation and is measured against public standards of honest conduct (Re: People's Department Stores Ltd. (1992) Inc., SCC). Applying the business judgment rule, if a board exercises its duties reasonably, it will not be found to have breached its duty of loyalty.

Though BCE Inc. now sets out a definitive standard regarding the assessment of the duty of loyalty in Canada, the Delaware Supreme Court's reversal decision in Ryan v. Lyondell provides interesting guidance on the high bar required to breach such duty for an independent and disinterested Delaware board. Notwithstanding BCE Inc.'s rejection of Revlon duties in Canada, the Delaware decision confirms that there are areas of convergence between Canadian and U.S. courts as they interpret and scrutinize directors' duty of loyalty and defer to the business judgment of informed and diligent corporate boards. In the context of a weak economy and significant new economic barriers to getting transactions completed, such judicial deference to informed corporate actions is likely a welcome respite to directors and their advisers.

Highlights

  • Delaware Supreme Court reverses Chancery Court on directors' fiduciary duty case in Ryan v. Lyondell
  • Convergence between Canadian and U.S. judicial approaches on deference to directors' business judgment
  • High bar required for breach of the duty of loyalty where a board is independent and disinterested – extreme set of facts required
  • Court reiterates no prescribed steps for meeting fiduciary duty in sales process

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