United States: Ryan v. Lyondell Chemical Co.

On July 29, 2008 the Delaware Chancery Court decided the case of Ryan v. Lyondell Chemical Company ("Ryan")(Del. Ch., July 29, 2008), and found that despite a shareholder stock price well above the market rate, seemingly customary deal protection terms and overwhelming stockholder approval, independent directors could be held to be personally liable for their role in approving a cash merger. In Ryan, a shareholder class action suit, Plaintiff Walter E. Ryan challenged Defendant Lyondell Chemical Company's ("Lyondell") consummation of a $13 billion cash-for-shares merger with Defendant Basell AF. The court noted that the board may have not only breached its duty of care, but also its duty to act in good faith, when it failed to take a more proactive role in the merger transaction.

In April 2006, Basell AF approached Lyondell with an offer to purchase Lyondell. Lyondell was a financially sound company that was neither looking to raise capital nor seeking offers for purchase. Lyondell rejected Basell AF's initial offer, and it was more than a year later before Basell AF approached Lyondell again. After some price-based negotiations, Basell AF made a final, "best" offer of $48 per share, conditioned upon the execution of a merger agreement within one week and a $400 million break-up fee. After two hasty meetings, the Lyondell board authorized its CEO to negotiate a higher selling price, a post-signing "go-shop" provision, a reduced break-up fee during the go-shop time and a lower break-up fee after the go-shop time. However, Basell AF rejected all but the lower break-up fee, which was set at $385 million. Facing considerable time pressures and a "blowout" offer of $48 per share, Lyondell's board engaged Deutsche Bank to prepare a fairness opinion. Upon agreeing with Deutsche Bank's findings that, among other things, the $48 per share price was fair, Lyondell's board approved the merger. Lyondell's stockholders later overwhelmingly approved the merger as well.

The shareholders who challenged Lyondell claimed that(1) the Lyondell board breached its Revlon¹ duties, which require the board to seek and attain the highest possible value for the shareholders, and(2) the deal protection measures employed in the transaction were not reasonable in light of the circumstances, and were preclusive or coercive in violation of the duties set forth in Unocal² and Omnicare³. The shareholders noted that the Lyondell board took no proactive actions to confirm that it had obtained the highest possible value for the shareholders. The board began and concluded its review of the merits of the transaction within seven days, a pace which the shareholders contend could not have availed the board of the true value of Lyondell. Additionally, the board never "shopped" the market to determine if the $48 per share price was indeed the best offer it could obtain. The shareholders further contended that the deal protection measures upon which the board agreed, which prevented pre- and post-signing market checks, precluded any other potential buyers from bidding on Lyondell.

The court, despite noting that the board was "active, sophisticated and generally aware of the value of the Company," concluded that the board may have breached its duty to act in good faith because the directors failed "to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities." Although the Lyondell charter contained a provision which eliminates personal liability for a director's breach of their duty of care⁴, the court noted that "that defense is not now available on summary judgment because the Board's apparent failure to make any effort to comply with the teachings of Revlon and its progeny implicates the directors' good faith and, thus, their duty of loyalty...depriving them the benefit of the exculpatory charter provision."

As this case was not a decision on the merits, but was instead a motion for summary judgment, the court concluded that enough evidence exists to permit the case to proceed to trial. The court noted that the board's actions of (a) avoiding an "active role" in the merger negotiations, (b) failing to conduct a pre-signing market check, (c) failing to negotiate a go-shop provision, (d) agreeing to a 3% break-up fee, no-shop provision and matching rights, and (e) considering, negotiating and approving the deal in less that seven days was enough to deny the Defendant's request for summary judgment. Only time will tell whether the court considers the board's actions to be reasonable and prudent in light of the circumstances. However, for now, the Ryan case serves as an important reminder for boards to, among other things, (a) properly document each step of any active transaction, (b) actively supervise and control any process for which it will be held accountable, and (c) ensure that it has adequate time to perform its Revlon duties.

Update

The individual members of Lyondell's Board of Directors, also defendants in the action, sought certification of an interlocutory appeal of a portion of the July 29, 2008 Chancery Court's opinion, which denied them the protection of Lyondell's exculpatory provision. The exculpatory provision, as discussed above, eliminates personal liability for a director's breach of their duty of care. Although the motion for certification of an interlocutory appeal was denied because the directors failed to satisfy the interlocutory appeal standards set forth the by the Delaware Supreme Court Rule 42(b), which governs interlocutory appeals, the Chancery Court's August 29, 2008 response took an important sidebar to elaborate on it analysis of the Section 102(b)(7) exculpatory provision.

Following the precedent set forth in Revlon and its progeny, the Chancery Court reiterated that the Lyondell Board, although generally knowledgeable about the value of the company, "made no apparent effort to arm themselves with specific knowledge about the present value of the company," despite being put on notice that an offer for the sale of Lyondell could occur at any time.⁵ The Chancery Court further noted that in In re Walt Disney Company Derivative Litigation, the Delaware Supreme Court held that one possible definition of director misconduct that amounts to bad faith could be a director's "intentional dereliction of duty, [and] a conscious disregard for one's responsibilities."⁶ The Chancery Court stated that this intermediate standard of the "bad faith" spectrum falls between that behavior which is motivated by an actual intent to do harm and that behavior which is grossly negligent and without malevolent intent. The Chancery Court went further by noting that on summary judgment it is not the Chancery Court's duty to note where on the "bad faith" spectrum the directors' behavior falls, but that on that on this record there existed an "apparent and unexplained director inaction" despite knowing that Lyondell was "in play" and knowing their Revlon duties. Such apparent and unexplained inaction in the face of a well-established and well-known duty to act was enough to raise the question of material fact regarding the directors' entitlement to exculpation. Thus the Chancery Court reiterated its decision to deny the directors' motion for summary judgment.

Footnotes

1 Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986)

2 Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985)

3 Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003)

4 Delaware General Corporation Law §102(b)(7) permits a corporation to eliminate or limit a directors personal liability for breaches of their fiduciary duty.

5 In May 2007, Basell filed a Schedule 13D disclosing its right to purchase form than 8% of Lyondell's outstanding shares and its intentions to explore a business combination.

6 906 A.2d 27, 64 (Del. 2006)

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