In circumstances involving the sale of a corporation having an 80% shareholder, the Delaware Supreme Court recently ruled that a lower court improperly dismissed a case against the corporation's directors for allegedly failing to obtain full value for minority shareholders. In McMullin v. Beran, 2000 WL 1741717 (Del. Supr. Nov. 20, 2000), a minority shareholder of ARCO Chemical Company (Chemical) claimed that Chemical's directors improperly delegated to the majority shareholder, Atlantic Richfield Company (ARCO), the responsibility for negotiating Chemical's sale. The suit alleged that by failing to put in place certain procedural safeguards - such as asking the ARCO-related directors to recuse themselves - the Chemical directors did not adequately protect the interests of the minority shareholders. The Delaware Supreme Court found that the lower court improperly dismissed the complaint because the plaintiff had alleged facts that, if true, would rebut the "business judgment rule" presumption that generally protects corporate directors from liability.
Minority Shareholder Claims Sale Procedure Breached Fiduciary Duties
In February 1998, Lyondell Petrochemical Corporation (Lyondell) contacted ARCO expressing interest in acquiring Chemical. Shortly thereafter, ARCO informed Chemical's board of directors - consisting of eight directors affiliated with ARCO, three independent directors, and the president of Chemical - of the inquiries. The Chemical board authorized ARCO to explore the sale of the entire company. ARCO's financial advisor, Salomon Smith Barney (SSB), contacted a number of other potential buyers. Discussions between ARCO and Lyondell proceeded for several months, with Lyondell raising its offer several times, including a switch from a partial-cash bid to an all-cash bid. On June 13, 1998, Lyondell offered $57.75 per share in cash for the Chemical shares, and on June 17, Lyondell submitted a merger agreement that contemplated a tender offer and a second step squeeze-out merger that included the requirement that ARCO commit to tender its 80% shareholding. The Chemical board met one day later, and unanimously approved the Lyondell proposal based on recommendations from ARCO, SSB, and Chemical's financial advisor, Merrill Lynch. Shareholders tendered 99% of the outstanding shares in Lyondell's tender offer, with the second-step merger occurring shortly thereafter.
Mary E. McMullin brought suit against the Chemical directors, alleging that they breached their fiduciary duties in accepting the Lyondell offer. Specifically, McMullin claimed that the Chemical board acted improperly by:
authorizing ARCO to negotiate the merger agreement with Lyondell unilaterally; restricting the offers it would consider to all-cash offers, due to ARCO's immediate need for cash; meeting only once to consider Lyondell's offer; relying on disclosures made in a presentation by ARCO's advisor, SSB; allowing the ARCO-related directors not to abstain from the consideration of the Lyondell proposal; making no determination of Chemical's value as a going concern; and omitting certain material information from its public disclosure.
Boards Have Special Obligations To Minority Shareholders
The court stated that, in the absence of a majority shareholder, directors considering the sale of the corporation must diligently pursue the transaction offering the best value reasonably available for all shareholders. When a sale proposal instead comes at the behest of a majority shareholder, the duty of the directors is essentially the same - i.e., value maximization for all shareholders - but with a special obligation to protect the interests of the minority shareholders. The court held that, even though ARCO's voting power made the outcome a forgone conclusion, the Chemical directors were required to perform a full analysis of the sale to determine whether the proposal would result in maximum value for the minority shareholders. "Under the circumstances presented in this case, although the Chemical board could not effectively seek an alternative to the proposed Lyondell sale by auction or agreement, and had no fiduciary responsibility to engage in either futile exercise, its ultimate statutory duties … and attendant fiduciary obligations remained inviolable," the court stated. 2000 WL 1741717 at *6.
Minority Shareholder Must Rebut Business Judgment Rule Presumption
The standard applied by the court was the business judgment rule, a legal presumption that corporate directors have acted on an informed basis, in good faith, and with the honest belief that they are acting in the best interests of the corporation. A plaintiff shareholder in a case against corporate directors must initially meet the burden of rebutting the presumption by providing evidence that the directors breached any of their fiduciary duties of due care, loyalty, and good faith. If the plaintiff fails to do so, the business judgment rule attaches and protects the directors from individual liability for the board's actions. However, if the plaintiff shareholder succeeds in getting past this initial hurdle, the case against the directors may proceed with the burden shifting to the directors to prove the "entire fairness" of the transaction.
McMullin asserted that the Chemical board failed to exercise due care by allowing ARCO to negotiate without procedural safeguards in place to protect the interests of the minority shareholders, and by permitting ARCO to place its own restrictions through a cash-only offer requirement. Furthermore, the Chemical board met only once to consider the proposed transaction, and approved it based on representations made chiefly by ARCO's financial advisor. As a result, McMullin alleges that the Chemical directors "rubber stamped" a transaction that sacrificed value that the minority might otherwise have realized. The court held that McMullin's claims "suggest that the directors of Chemical breached their duty of care by approving the merger … without adequately informing themselves about the transaction and without determining whether the merger consideration equaled or exceeded Chemical's appraisal value as a going concern." 2000 WL 1741717 at *7.
Regarding the directors' duty of loyalty to the corporation, the business judgment rule presumption is rebutted upon a showing of improper influence on the directors that compromised their ability to independently evaluate the proposed sale. The court held that the Chemical directors owed an uncompromising duty of loyalty to the minority shareholders and that "[t]here is no dilution of that obligation in a parent subsidiary context for the individuals who acted in a dual capacity as officers or designees of ARCO and as directors of Chemical." 2000 WL 1741717 at *8. The plaintiff shareholder claimed that six of the twelve directors were employed by ARCO and two others had former affiliations with ARCO, and none of these conflicted directors abstained from the vote regarding the sale. The court held that the directors should be required to answer the well-pled loyalty allegations regarding the effects of the ARCO-related conflicts.
Boards Should Institute Procedures Demonstrating Regard For Minority Shareholders
The court remanded the case for further proceedings to determine whether the Chemical directors in fact breached their fiduciary duties and will face any personal liability as a result. It should be noted, however, that the board may have been able to satisfy the business judgment rule, and allow the court to sustain the dismissal, had it taken affirmative steps to insulate itself from liability. By failing to take actions such as setting up a special committee or requiring recusals by the ARCO directors, the board left itself vulnerable to accusations of breach of fiduciary duties. Boards considering sales, mergers or other major transactions should be mindful of the importance of demonstrating attention to minority shareholders' rights.
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