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Delaware High Court Issues Game-Changer on Fiduciary Duty

By Sean T. Carnathan, Litigation News Associate Editor – May 27, 2009

Has the Delaware Supreme Court all but eliminated shareholder claims against corporate boards for violation of the duty of good faith? This is a question being raised among corporate litigators after the recent decision in Lyondell Chemical Co. v. Ryan, directing entry of summary judgment in favor of a board of directors who voted to approve the sale of their company.


Background of Lyondell
Lyondell Chemical was the third largest independent, publicly traded chemical company in North America. In May 2007, a shareholder filed a Schedule 13D with the Securities and Exchange Commission that disclosed the interest of a privately held company in acquiring Lyondell. Lyondell’s board convened a special meeting, but decided to take a “wait and see” approach.


In July, 2007, the privately held company offered 40 dollars per share in cash to acquire Lyondell. Lyondell’s CEO told the offeror that the offer was too low and that, although he would present it to the board, he expected it would be rejected.


The CEO recommended that the offeror make its best offer because Lyondell was not on the market. The offeror increased the offer to 48 dollars per share, with no financing contingency but a $400 million break-up fee. The offeror gave only one week to consider the offer.


After brief consideration, the board approved the offer and presented it to the shareholders, who approved the offer by a vote of more 99 percent in favor. A group of minority shareholders then sued the board.


Directors’ Standard of Good Faith
Lyondell’s corporate charter contained an exculpatory provision under 8 Del. C. § 102(b)(7), which protects the directors from liability for any alleged breach of their duty of care. The plaintiffs asserted that the directors had breached their duty of loyalty.


The chancery court found that the board was independent and not motivated by self-interest or ill will. Any potential liability, therefore, turned on whether the directors had failed to act in good faith.


The plaintiffs criticized the board for, among other things, failing to take steps to prepare for an acquisition proposal after the Schedule 13D was filed signaling an offer might be made, failing to press for a higher price, and failing to conduct a market check.


The Delaware Supreme Court held that the board was entitled to summary judgment. The court rejected the plaintiff’s contention that the board should have taken action after the filing of the Schedule 13D. It held that the well-known “Revlon duties” to secure the best selling price “do not arise simply because a company is ‘in play.’ The duty to seek the best available price applies only when a company embarks on a transaction.”


The court also approved the board’s actions after the offer was made. To violate the duty of good faith, a board must “knowingly and completely [fail] to undertake their responsibilities,” the court opined.


Predictability for Directors
The court noted that “[d]irectors’ decisions must be reasonable, not perfect.” This is the core of the opinion, says Bart L. Greenwald, cochair of the Section of Litigation’s Commercial and Business Torts Litigation Committee. “You can rely on your advisors and still have independent business judgment,” Greenwald says.


Lyondell exemplifies the Delaware Supreme Court’s efforts to provide predictable and clear rules for directors to follow,” agrees J. Travis Laster, Wilmington, DE, Section member and frequent author on Delaware corporate law.


“Under Lyondell, a majority independent board of a corporation with an exculpatory charter provision can confidently explore strategic alternatives without any realistic threat of a post-closing damages award, and they can eliminate the case on summary judgment,” says Laster.


Shareholder Claims for Violation of the Duty of Good Faith
Disgruntled shareholders will not be very happy about the Lyondell decision, suggests Pace University Law Professor Andrew Lund, who says the opinion “all but eviscerates the ability to bring [a good faith] claim” against a corporate board.


Not that Lund disagrees with the outcome. In fact, Lund has just authored an article recommending that the Delaware legislature enact a clear statutory right for corporations to opt out of good faith liability for their boards.


The Lyondell court did not need to go as it did, opines Lund, but “the court can’t force the Delaware legislature to act, so it was left with only imperfect solutions.”


Keywords: Lyondell Chemical Co. v. Ryan, good faith, summary judgment


 

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