As a result of a controversial Delaware Chancery Court (Court) decision, independent directors now face substantially greater personal risk when selling a company. In Ryan v. Lyondell Chemical Co., the Court refused to grant summary judgment in favor of the directors of Lyondell Chemical Company despite the Lyondell board's reliance on financial and legal advisors, a 45 percent premium to market, a fairness opinion, and the absence of any conflicts of interest.1 The opinion converted a run-of-the-mill gross negligence claim, for which the directors would have immunity under the company's charter and Delaware law, into a bad faith claim, for which monetary damages can be personally assessed against the directors.
Under the Revlon 2 doctrine, when directors propose to sell a company, they must take reasonable measures to ensure that the stockholders receive the highest value reasonably attainable. The Court has recently issued a series of decisions3 addressing the sale process, including the desirability of "go-shop" provisions.
In line with these cases, the Court criticized the Lyondell board, which voted to accept an unsolicited offer, for not engaging an investment banker soon enough, for failing to be more directly and actively involved in the sale process, for completing the process in less than a week, for failing to solicit competing offers for the company actively, and for agreeing to deal protection measures that included a "no shop" provision with a fiduciary out. None of those criticisms of board conduct is new or unusual. What is surprising is the Court's conclusion that a procedurally deficient sale process, albeit one conducted with advice of investment bankers and lawyers and producing an undeniably fair price that shareholders overwhelmingly approved, may give rise to a lack of good faith claim.
In order to encourage individuals to serve as directors in an increasingly litigious environment, Section 102(b)(7) of the Delaware General Corporation Law permits a Delaware corporation to adopt a charter provision limiting the personal liability of a director for monetary damages for breach of fiduciary duty unless the director breached his or her duty of loyalty (e.g., because of a conflict of interest), derived an improper personal benefit from the transaction, or engaged in an act or omission not in good faith or involving intentional misconduct or a knowing violation of law. Lyondell's charter includes an exculpatory provision of this type. Despite the absence of any conflicts of interest or any improper personal benefit on the part of Lyondell's independent directors, the Court held that Lyondell's directors may not be entitled to immunity from monetary damages under this charter provision because deficient conduct under the Revlon standard could very well be found at trial to constitute lack of good faith.
The Lyondell case appears inconsistent with the Delaware Supreme Court's recent holding in Stone v. Ritter4 that "a failure to act in good faith requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e., gross negligence)." It is hard to see how a board of independent directors who, after receiving presentations from management and its financial and legal advisors, concludes that a deal is simply too good not to pass along to the shareholders, may be guilty of more than gross negligence and therefore subject to personal liability notwithstanding the protection of an exculpatory charter provision adopted in accordance with Delaware law.
The case against the Lyondell directors will proceed to trial for a determination on the merits as to whether the facts and circumstances warrant a finding of lack of good faith on the part of the directors. However, the Lyondell directors may not want to face the time and expense of discovery and a trial on the merits, to say nothing of the risk of an adverse verdict, and may seek to settle the case. An exculpatory charter provision provides scant comfort to directors or prospective directors if claims for monetary damages can survive a motion to dismiss or a motion for summary judgment under the Lyondell Court's expansive view of what can constitute lack of good faith.
Footnotes
1. Ryan v. Lyondell Chemical Co., 2008 WL 2923427 (Del. Ch. July 29, 2008).
2 Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A2d 173 (Del. 1986).
3 In re Lear Corp. Shareholder Litigation 926 A2d 94 (Del. Ch. 2007); In re Topps Co. Shareholders Litigation, 926 A2d 58 (Del. Ch. 2007); In re Netsmart Technologies, Inc. Shareholders Litigation 924 A2d 171 (Del. Ch. 2007).
4. Stone v. Ritter 911 A2d 362, 369 (Del. 2006).
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