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Boosters of "The Fiduciary Duty of Good Faith" Rejoice
By Gordon Smith, Christine, Hurt, Vic Fleischer, Fred Tung, Lisa Fairfax, David Zaring
In Ryan v. Lyondell Chemical Co., 2008 WL 2923427 (Del. Ch. 2008), Vice-Chancellor Noble of the Delaware Court of Chancery denied a motion for summary judgment by the directors of Lyondell Chemical Corporation because there is a chance that those directors did not act "reasonably" in the negotiations leading to the sale of the company. Others have commented extensively on the case already (Eric Chiappinelli, Jeff Lipshaw, Dale Oesterle, Larry Ribstein, and Francis Pileggi), and I am finally catching up. In this post, I emphasize the strange confluence of doctrines that deprive the defendants of a victory on their motion to dismiss.
The case involves a claim that the defendants breached their Revlon duties. In my least downloaded article -- a tribute to Chancellor Allen -- I trace the history of Revlon and show how Chancellor Allen originally treated it like a special application of the business judgment rule. Justice Moore was having none of that and made it clear that Revlon was to be considered a form of "enhanced scrutiny."
These early decisions led to Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d 34 (1994). in which Chief Justice Veasey reasoned that enhanced judicial scrutiny was justified not merely by the existence of an inherent conflict of interest on the part of the board of directors (the rationale relied on by the Unocal court), but also by the extreme importance of the transaction to the shareholders. The implication of this holding is that even independent and disinterested directors cannot escape enhanced scrutiny in the Revlon context.
But what if the corporation has a 102(b)(7) exculpatory provision? Can that provision cut short the enhanced scrutiny of Revlon? McMillan v. Intercargo Corp., 768 A.2d 492, 502 (Del. Ch. 2000) doesn't answer that question, but Vice-Chancellor Strine helpfully observes:
The fact that a corporate board has decided to engage in a change of control transaction invoking so-called Revlon duties does not change the showing of culpability a plaintiff must make in order to hold the directors liable for monetary damages. For example, if a board unintentionally fails, as a result of gross negligence and not of bad faith or self-interest, to follow up on a materially higher bid and an exculpatory charter provision is in place, then the plaintiff will be barred from recovery, regardless of whether the board was in Revlon-land
Thus, it appears that Revlon violations may come in three flavors: lack of care, bad faith, or disloyalty. If a claim implicates only the duty of care, the court will dismiss the claim. See In re Frederick's of Hollywood, Inc., 2000 WL 130630 (Del.Ch.). If the claim raises the possibility of bad faith or disloyalty, however, the claim will survive. In Ryan, Vice-Chancellor Noble relied on Stone v. Ritter to conclude:
The record, as it presently stands, does not, as a matter of undisputed material fact, demonstrate the Lyondell directors' good faith discharge of their Revlon duties -- a known set of "duties" requiring certain conduct or impeccable knowledge of the market in the face of Basell's offer to acquire the Company.
Given the precedents, this seems like a pretty safe and uncontroversial ruling, so why is it getting so much attention? Jeff Lipshaw rightly observes that the facts in Ryan track Smith v. Van Gorkom rather closely: "Correct me if I'm wrong, but doesn't this case present precisely the Smith v. Van Gorkom factual scenario that 102(b)(7) was intended to address!" Perhaps that wasn't a question after all, but I will take the liberty of offering an answer.
The answer is that Disney and Stone now have defined "bad faith" in a manner that does not require illegality or fraud (the traditional meanings of "bad faith"), or disloyalty -- at least in the traditional sense of self-dealing. "Bad faith" now has a more expansive meaning, that might include actions by directors who are admittedly independent and disinterested. For those who have championed the use of the fiduciary duty of good faith to claw back some of the ground lost to plaintiffs in the wake of Smith v. Van Gorkom, Ryan is validation of their efforts.
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