Delaware Good Faith Decision Reassures Management

On March 25, 2009, the Delaware Supreme Court reassured directors and officers by reversing the Court of Chancery’s Lyondell decision. Specifically, the higher court rejected the lower court’s determination that “unexplained inaction” in the context of a merger transaction permits a reasonable inference that directors may have consciously disregarded their fiduciary duties. Lyondell Chemical Co. v. Ryan, Del. Supr., C.A. No. 3176 (March 25, 2009).

This litigation began in the wake of a $13 million cash merger between Basell AF and Lyondell Chemical Company.  Lyondell shareholders alleged that Lyondell directors breached their fiduciary duties of care and loyalty and put their personal interests ahead of shareholders’ interests.

In this case, the duty of care was not a factor because of the exculpatory provision in Lyondell's charter, allowed by §102(b)(7) of the Delaware Code. This provision protects directors from personal liability for breaches of the duty of care.

The duty of loyalty requires that a board be independent and disinterested and that they act in “good faith.” The trial court determined that the board was independent and not motivated by self-interest. Consequently, the only issue remaining for the Supreme Court was whether the directors breached the duty of loyalty by failing to act in good faith.

Delaware law defines “good faith” as the absence of “bad faith.” “Bad faith,” in turn, is the intent to harm or the intentional dereliction of a duty. The trial court found that the board’s actions were not motivated by ill will. As a result, the Supreme Court considered only whether the board acted with conscious disregard for their responsibilities. A positive determination on that issue would signal that the board had engaged in the intentional dereliction of duty and accordingly, had failed to act in good faith.

As part of its bad faith analysis, the Court of Chancery concluded that the Lyondell deal triggered Revlon duties, which require a board of directors to seek the best possible price when it is clear the sale of a company that will result in a change of control is inevitable. The court found that Lyondell was “in play” following Basell AF’s filing of a Schedule 13D to indicate its intention to acquire Lyondell.

The Delaware Supreme Court found that the Court of Chancery erroneously applied Revlon duties to the Lyondell transaction. The Court enumerated three specific mistakes:

· The duties were imposed before the sale was inevitable.

· The lower court erroneously interpreted Revlon and subsequent cases as creating a set of requirements that had to be satisfied during the sale process.

· The trial court equated an arguably imperfect attempt to obtain the best possible price with a knowing disregard of duties.

After Basell AF filed the 13D, the Lyondell board decided not to take immediate action, and in fact did nothing for two months after the 13D filing. This “slothful indifference” was one of the facts that led the trial court to question the adequacy of the Board’s knowledge and efforts. However, the Supreme Court clearly stated that Revlon duties do not arise simply because a company is “in play.” Rather, the board’s Revlon duties arose only when they met to consider and begin negotiations in response to Basell’s initial offer which came several weeks after the 13D filing.

The Court of Chancery also took a negative view of the short time frame – less than a week – the board took to negotiate and finalize the merger. Further, the lower court was concerned that the directors accepted Basell’s offer without seriously pressing for a better price or conducting any type of market check.

In response, the Delaware Supreme Court stated that there is only one Revlon duty – to get the best price for the stockholders at the sale of the company. Justice Berger further explained that no court can tell directors exactly how to maximize the sale price because each transaction presents its own unique combination of circumstances. In addition, while Revlon duties would require an auction, market check, or “impeccable knowledge of the market” to confirm that the board had in fact obtained the best available price, a general “conscious disregard” analysis does not.

In reversing the decision and entering summary judgment for the Lyondell directors, Justice Berger reasoned that the Lyondell directors were generally aware of the company’s value and prospects. And, even though they considered Basell’s offer quickly, they were able to adequately assess the proposed deal with the help of financial and legal advisors.

The Delaware Supreme Court also reassured directors by finding that their decisions must be reasonable, not perfect, and that only if they knowingly and completely failed to undertake their responsibilities would they breach their duty of loyalty.

Primary materials are available on the DU Corporate Governance website.