The Delaware Supreme Court, sitting en banc, has held that the Court of Chancery erred when it ruled that liability for breach of the duty of loyalty in a bad faith context could be imposed without a showing of intent.
In Lyondell Chemical Co. v. Ryan, Lyondell received an unsolicited all cash all shares offer at a substantial premium to the market. Lyondell had made no effort to sell itself or seek a strategic partner and the company was economically viable. The board delegated much of the negotiating work to its board chair and CEO, Smith. The final agreement did not contain a go-shop provision but did include several deal protective measures. Ryan, a Lyondell shareholder, brought the required shareholder suit challenging whether the board met its Revlon duties. The board was independent and not interested and Lyondell’s Certificate of Incorporation contained a 102(b)(7) exculpatory clause.
Justice Berger, speaking for a unanimous court, first described the Disney case on bad faith and Stone’s adoption of Caremark’s duty to monitor and its imposition of an intent requirement to a finding of a breach of the duty of good faith. She then held that the Vice Chancellor erroneously applied Revlon before the board actually decided to sell the company. Thus, many of the facts showing the directors did nothing to maximize the company’s value were irrelevant to the Revlon claim because Revlon did not yet apply. Justice Berger held that when one focused on the board’s actions after it decided to sell the company, it could not be accused of nearly complete inaction. In my earlier post on the Court of Chancery opinion in this case I said I thought the Vice Chancellor was clearly right about Revlon’s application. However, I didn’t consider the timing question and Justice Berger may well be correct on this point. All agree that Revlon applied at some point and that plaintiff’s claim is that Revlon wasn’t met but it’s obviously important to determine when Revlon applied before looking at facts that show whether the board complied with its Revlon duties.
She then held that the Vice Chancellor took too narrow a view of the ways in which Revlon can be satisfied and that, on these facts, the Supreme Court would be inclined to hold that the directors met Revlon. However, that inclination is irrelevant, Justice Burger says, because the directors’ failure to take any particular actions could not demonstrate a conscious disregard for their known duties, which is required for a finding of breach of the duty of loyalty via bad faith. There being no evidence of an intentional disregard for their fiduciary duties, the directors cannot be liable.
This result is definitely correct and I’m happy to see that the court has, in a relatively succinct and well written opinion, gotten the law right. I have one small (I hope) concern, however, that Justice Berger may have been slightly imprecise and may open the door to being misunderstood.
One of the questions in Caremark, as it stood for ten years before Stone transmogrified it, was what the standard of review for liability would be. Chancellor Allen, Caremark’s author, used extreme language, suggesting that nothing short of a complete failure to implement a monitoring system or to monitor would be enough to impose liability. When Stone made Caremark a duty of care loyalty case, it held that the directors could only be liable for intentionally disregarding their fiduciary duties. Here in Ryan, Justice Berger brings back some of Chancellor Allen’s language about utter failure and I worry that such a standard might work its way into the standard for duty of loyalty liability in bad faith cases.
For example, when she first mentions the standard she writes (p.11), “We adopted the standard articulated . . . in In re Caremark . . . [now she quotes from Caremark:] only a sustained or systematic failure . . . such as an utter failure to attempt to assure a reasonable information and reporting system exists – will establish the lack of good faith that is a necessary condition to liability.” Likewise, she later writes (p.18), “Only if they knowingly and completely failed to undertake their responsibilities would they breach their duty of loyalty”. Note the phrase, “and completely”. Further on that page she quote a Chancery Court opinion that could lend support to this analysis: “[an] extreme set of facts [is] required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties”. Does an extreme set of facts equate with a requirement that the plaintiff show that the directors not only intended to disregard their duties but did absolutely nothing? Finally (p.19) “[T]he inquiry should have been whether those directors utterly failed to attempt to obtain the best sales price.” Note the words, “utterly failed”. All this language might be seen as imposing liability for breach of the duty of loyalty via bad faith only when there is intent and when the directors completely fail to meet their duty or perhaps completely fail to take action.
This can’t be the law. Intent is surely a requisite for finding bad faith and hence a duty of loyalty violation but there’s no case law authority and no policy reason to impose an additional test of utter failure to meet the duty or take action. Surely a director is liable who intends not to meet the duty of loyalty by only a little bit.
Justice Berger has much language, though, that suggests the correct rule, as well, and I’m hopeful that courts will pick up on that language and not on the looser formulations quoted above. For example, she writes in the introduction (p.3), “There is no evidence, however, from which to infer that the directors knowingly ignored their responsibilities, thereby breaching their duty of loyalty.” Later (p.17), she writes, “[B]ad faith will be found if a ‘fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.’ ” Shortly thereafter (p.18) she writes, “Thus, the directors’ failure to take any specific steps during the sale process could not have demonstrated a conscious disregard of their duties.” No mention here of anything more than that as a requisite for liability.