Reproduced with permission from Corporate CounselWeekly Newsletter, Vol. 23, No. 44, 11/12/2008, pp.350-352. Copyright � 2008 by The Bureau of NationalAffairs, Inc. (800-372-1033) http://www.bna.com

VOL. 23, NO. 44 350-352 NOVEMBER 12, 2008

COPYRIGHT � 2008 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN 0886-0475

CorporateCounsel Weekly

CorporateCounsel Weekly

A BNA’sBNA’s

CORPORATE PRACTICE SERIES

AnalysisOfficers and Directors

Recent Delaware Decisions TemperConcerns Arising From ‘Ryan v. Lyondell’BY ROBERT S. REDER, ALAN J.STONE, AND DEAN W. SATTLER

A July 29, 2008 ruling by the Chan-cery Court of Delaware in Ryan v.

Lyondell Chemical Co.1 provoked aflurry of commentary denouncing theimplications of this decision for per-sonal liability of directors under Sec-tion 102(b)(7) of the Delaware Gen-eral Corporation Law (‘‘DGCL’’).

This class action lawsuit arosefrom the December 2007 acquisitionof Lyondell Chemical Co. (‘‘Lyon-dell’’) by Basell AF (‘‘Basell’’).

The plaintiff stockholders accusedthe Lyondell board of directors offailing to discharge its Revlon duties 2

by neglecting to ‘‘set its singular fo-cus on seeking and attaining thehighest value reasonably available tothe stockholders,’’ even though thepurchase price represented a 45%premium over the then-current mar-ket value of Lyondell’s stock and thetransaction was overwhelmingly ap-proved by Lyondell stockholders.

Plaintiffs also attacked the reason-ableness of the seemingly customarydeal protection devices negotiated aspart of the merger agreement underthe familiar Unocal standard.3

The Lyondell directors argued thateven if the Court concluded that theirefforts in connection with the sale toBasell were insufficient under Revlon

and the deal protection measureswere objectionable under Unocal, thedirectors were nevertheless entitledto summary judgment because, atworst, their actions constituted abreach of their duty of care fromwhich they were absolved from per-sonal liability under Lyondell’s excul-patory charter provision adopted un-der DGCL Section 102(b)(7).

Vice Chancellor John Noble de-nied the defendant directors’ sum-mary judgment motion. Several com-mentators have expressed concernthat Vice Chancellor Noble’s rejec-tion of the directors’ DGCL Section102(b)(7) argument potentially repre-sents an unwarranted expansion ofthe range of conduct that could resultin directors of Delaware corporationsbeing held personally liable for theiractions in connection with M&Atransactions.

Subsequent DecisionsHowever, a series of subsequent

Chancery Court decisions has helpedto confirm that this concern was un-founded, as well as to clarify the rela-tively limited circumstances underwhich a director of a Delaware corpo-ration might be subjected to personalliability for breach of fiduciary duty.

First, in a letter opinion dated Au-gust 29, 2008, Vice Chancellor Noble,while declining to certify the Lyondelldefendants’ interlocutory appeal ofhis earlier decision, explained thathis ruling was not as far-reaching assome commentators had feared.

Then, within days, Chancellor Wil-liam Chandler, in McPadden v.

Sidhu,4 and Vice Chancellor LeoStrine, in In re Lear Corp. Share-holder Litigation,5 each addressedthe scope of director liability in thecontext of an M&A transaction underDGCL Section 102(b)(7). These deci-sions went to great lengths to distin-guish gross negligence (the level ofmisconduct required to establish abreach of the duty of care) from badfaith (a level of misconduct that canconstitute a breach of the duty of loy-alty) under Delaware law, and todrive home the point that only badfaith conduct will deprive directors ofthe protection of DGCL Section102(b)(7).

In this article, we discuss theChancery Court’s rulings in Lyondell,McPadden, and Lear, and parse theimplications of these decisions forDGCL Section 102(b)(7) and the typeof director conduct that may result indirectors being deprived of itsprotections.

DGCL Section 102(b)(7)DGCL Section 102(b)(7) provides

that a Delaware corporation may in-clude in its certificate of incorpora-tion a provision eliminating or limit-ing the personal liability of a directorto the corporation or its stockholdersfor monetary damages for breach ofhis or her fiduciary duty of care. Thisprovision was added to the DGCL inthe aftermath of the Delaware Su-preme Court’s controversial decisionin Smith v. Van Gorkom,6 reflectingconcerns in the business and legalcommunities that the Van Gorkomdecision would make it difficult to

(continued on page 350)

1 Ryan v. Lyondell Chemical Co., C.A.No. 3176-VCN (Del. Ch. Jul. 29, 2008).

2 See Revlon, Inc. v. MacAndrews &Forbes Holdings, Inc., 506 A.2d 173 (Del.1986).

3 See Unocal Corp. v. Mesa PetroleumCo., 493 A.2d 946 (Del. 1985).

4 McPadden v. Sidhu, C.A. No.3310-CC (Del. Ch. Aug. 29, 2008).

5 In re Lear Corp. Shareholder Litiga-tion, C.A. No. 2728-VCS (Del. Ch. Sept. 2,2008).

6 Smith v. Van Gorkom, 488 A.2d 858(Del. 1985).

Robert S. Reder is a New York-based partner and the co-PracticeGroup leader of the Global Corporate Group of Milbank, Tweed, Had-ley & McCloy LLP. Alan J. Stone is a New York-based partner in Mil-bank’s Litigation Department. Dean W. Sattler is an associate inMilbank’s Global Corporate Group, also located in the New Yorkoffice.

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(continued from back page)attract qualified individuals to serveas directors of Delaware corpora-tions. Importantly, while DGCL Sec-tion 102(b)(7) permits Delaware cor-porations to shield their directorsfrom personal liability for damagesarising as a result of a breach of theirduty of care, it does not provide simi-lar relief for breaches of their duty ofloyalty or for actions not taken ingood faith. Each of the corporationswhose directors were the subject ofthe stockholder lawsuits in Lyondell,McPadden, and Lear had adopted ex-culpatory charter provisions in accor-dance with DGCL Section 102(b)(7).

‘Ryan v. Lyondell Chemical Co.’Denial of Defendants’ Summary Judg-

ment Motion. The plaintiffs in Lyon-dell claimed that the process em-ployed by the Lyondell board in ap-proving the transaction with Basellwas ‘‘fatally flawed,’’ citing, amongother reasons, the facts that: (i) theboard concluded its review of thetransaction ‘‘over the course of amere seven day period’’ in which theboard ‘‘could not possibly have in-formed itself as to the value of theCompany and the wisdom of thistransaction for the Lyondell stock-holders,’’ (ii) the board did not con-duct a market check or otherwiseshop Basell’s offer, and (iii) the dealprotection devices included in themerger agreement were ‘‘unreason-able and essentially ‘locked up’ thistransaction for Basell by precludingother bidders from making an offerfor the Company.’’ The defendant di-rectors, in support of their summaryjudgment motion, argued that theyhad in fact complied with their Rev-lon duties because the board knew‘‘the market . . . and the status ofother potential acquirers, and it wasreasonably confident, particularlygiven Basell’s substantial initial offer,that another bid was unlikely.’’ As forthe Unocal claim, they argued thatthe ‘‘sheer magnitude of the transac-tion premium’’ and Basell’s demandsfor a measure of deal certainty justi-fied the deal protections included inthe merger agreement.

The Court was clearly troubled byseveral aspects of the record (or,more precisely, the lack of a record)supporting the directors’ summaryjudgment motion, and used unusuallyharsh language in referring to theLyondell board as ‘‘indolent,’’‘‘largely out of the loop,’’ and ‘‘a pas-sive conduit to the stockholders.’’While acknowledging that the board

‘‘was active, sophisticated and gener-ally aware of the value of the Com-pany and the conditions of the mar-kets’’ and ‘‘was presented with de-tailed financial analyses of theCompany and the Basell Proposalfrom both management and Deut-sche Bank,’’ Vice Chancellor Nobledenied the directors’ summary judg-ment motion, ruling that ‘‘[t]he Courtcannot conclude on the limitedrecord before it that, as a matter ofundisputed material fact, the direc-tors acted appropriately under thecircumstances of this case.’’

Addressing the directors’ argu-ment that they were entitled to sum-mary judgment on the basis of Lyon-dell’s exculpatory charter provision,the Court cautioned that ‘‘[w]here di-rectors fail to act in the face of aknown duty to act, thereby demon-strating a conscious disregard fortheir responsibilities, they breachtheir duty of loyalty by failing to dis-charge that fiduciary obligation ingood faith.’’ One consequence ofsuch a failure, the Court explained, isthe loss of the protection of an excul-patory charter provision adopted un-der DGCL Section 102(b)(7).

Because it was not able to con-clude from the record that the direc-tors had in fact acted in good faith,the Court determined that it could notaward summary judgment to the di-rectors on the basis of Lyondell’s ex-culpatory charter provision.

Denial of Defendants’ InterlocutoryAppeal. Undeterred, the defendant di-rectors sought certification from ViceChancellor Noble to appeal his rul-ing, contending that ‘‘the Court com-mitted reversible error by denyingthem the protection of Lyondell’s ex-culpatory charter provision because. . . the Court improperly conflatedpossible violations only of the board’sduty of care (i.e., gross negligence)with a violation of the good faithcomponent of the duty of loyalty . . .(i.e., intentional dereliction or con-scious disregard of fiduciary duties).’’Although he denied plaintiff’s certifi-cation motion, the Vice Chancellorindicated (no doubt somewhat grudg-ingly) that ‘‘the Court perhaps did notexpound in sufficient detail upon itsreasons for denying the directors theprotection of Lyondell’s exculpatorycharter provision.’’

Citing the Delaware SupremeCourt’s decision in the Walt DisneyCompany Derivative Litigation,7 the

Vice Chancellor confirmed that liabil-ity under DGCL Section 102(b)(7) ‘‘isnot predicated upon the breach of thefiduciary duty of care; rather, liabilityresults from the separate and distinctduty of good faith.’’ Then, perhaps toaddress the concerns raised by thecommentators as much as the defen-dants’ certification motion, the ViceChancellor wrote that ‘‘the reports ofthe death of Section 102(b)(7) (andthe consequent possibility for the ‘re-suscitation’ of a Van Gorkam-esqueliability crisis) in Delaware law aregreatly exaggerated.’’ In fact, theVice Chancellor explained that hisearlier ruling did nothing more than‘‘assess the application (or potentialapplication) of well-settled law underthe peculiar and underdevelopedfacts of this case.’’

In applying the ‘‘well-settled law’’concerning DGCL Section 102(b)(7)to the facts of Lyondell, the ViceChancellor remained steadfast in hiscriticism of the Lyondell board’s ap-parent handling of the merger withBasell and declined to entertain thedirectors’ appeal. In this connection,he noted that even in light of the‘‘blowout’’ premium offered byBasell, the board’s two months of‘‘slothful indifference,’’ despite know-ing that the company was ‘‘in play,’’along with the board’s apparent ‘‘donothing, hope for an impressive-enough premium, and buy a fairnessopinion’’ approach, raised a legiti-mate question whether the board, inbad faith, disregarded a known dutyto act and failed faithfully to engagein the sale process in a manner con-sistent with the teachings of Revlonand its progeny.8

‘McPadden v. Sidhu’McPadden v. Sidhu arose from the

approval by the board of directors ofi2 Technologies, Inc. (‘‘i2’’) of a man-agement buyout of its wholly-ownedsubsidiary Trade Services Corpora-tion (‘‘TSC’’). The plaintiff brought aclaim for damages arising from thealleged breach of fiduciary duty bythe i2 directors, asserting that theyapproved the sale of TSC to membersof TSC’s management ‘‘in bad faithfor a price that defendants knew wasa fraction of TSC’s fair marketvalue.’’

7 In re Walt Disney Company Deriva-tive Litigation, 906 A. 2d 27 (Del. 2006).

8 On September 15, 2008, the DelawareSupreme Court agreed to hear the plain-tiffs’ appeal of Vice Chancellor Noble’sruling. See Lyondell Chemical Co. v.Ryan, No. 401, 2008, C.A. No. 3176 (Del.2008).

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Chancellor Chandler was nearly ascritical of the i2 board’s conduct asVice Chancellor Noble had been ofthe Lyondell board’s approach in ap-proving the merger with Basell.Chancellor Chandler noted that theplaintiff had ‘‘pleaded a duty of careviolation [on the part of the i2directors] with particularity sufficientto create a reasonable doubt that thetransaction at issue was the productof a valid exercise of business judg-ment.’’ Illustrating this point, theChancellor noted that the board hadengaged in grossly negligent behav-ior by (i) allowing TSC vice presidentAnthony Dubreville, who headed thewinning management buyout group,to be in charge of the TSC sale pro-cess despite the clear conflict of inter-est created thereby, and (ii) ‘‘provid-ing no check on Dubreville’s half-hearted (or, worse, intentionallymisdirected) efforts in soliciting bidsfor TSC.’’

Despite this criticism, the Chancel-lor dismissed plaintiff’s claim basedon the DGCL Section 102(b)(7) excul-patory provision contained in i2’scharter. According to the Court, ‘‘it isquite clearly established that grossnegligence, alone, cannot constitutebad faith. Thus, a board of directorsmay act ‘badly’ without acting in badfaith. This sometimes fine distinctionbetween a breach of care (throughgross negligence) and a breach ofloyalty (through bad faith) is one il-lustrated by the actions of the boardin this case.’’

The Court then sought to explainthis ‘‘sometimes fine distinction,’’with gross negligence being definedas ‘‘conduct that constitutes recklessindifference or actions that are with-out the bounds of reason,’’ while only‘‘the intentional dereliction of duty orthe conscious disregard for one’s re-sponsibilities’’ rises to the level ofbad faith. And just in case the com-mentators on the first Lyondell deci-sion remained skeptical as to the con-tinued viability of DGCL Section102(b)(7), Chancellor Chandler madeit clear that ‘‘[t]here is no basis inpolicy, precedent or common sensethat would justify dismantling the dis-tinction between gross negligenceand bad faith.’’

‘In re Lear Corp.’The In re Lear Corp. Shareholder

Litigation arose from the proposedacquisition of Lear Corporation(‘‘Lear’’) by Carl Icahn, a 24% stock-holder. At the outset, Icahn offered to

purchase Lear for $36 per share. Con-cerned that Lear stockholders wouldnot approve this transaction, theboard of directors of Lear agreed thatif Icahn increased his offer by $1.25per share, Lear would pay Icahn a$25 million termination fee (repre-senting 0.9 percent of the total dealvalue) if Lear stockholders votedagainst the sweetened deal. The Learstockholders did in fact vote downthe transaction, and Icahn was paidthe $25 million fee. Predictably,stockholder litigation ensued. Theplaintiffs claimed that the defendantdirectors had acted in bad faith by ap-proving an offer that they shouldhave known would be rejected byLear stockholders.

These decisions clarify that the

protections conferred by charter

provisions adopted under DGCL

Section 102(b)(7) still offer

substantial protection to directors

of Delaware corporations.

Vice Chancellor Strine granted thedefendant directors’ motion to dis-miss, noting that ‘‘[d]irectors are en-titled to make good faith business de-cisions even if the stockholders mightdisagree with them.’’ Citing theDGCL Section 102(b)(7) exculpatoryprovision contained in Lear’s charter,Vice Chancellor Strine explainedthat, to prevail, plaintiffs must ‘‘pleadfacts suggesting that the Lear direc-tors breached their duty of loyalty bysomehow acting in bad faith for rea-sons inimical to the best interests ofthe Lear stockholders.’’

Unlike the fact patterns in Lyon-dell and McPadden, Vice ChancellorStrine found that the plaintiffs’ com-plaint did not ‘‘come close to allegingthat the board failed to employ a ra-tional process in considering whetherto approve the Revised MergerAgreement.’’ In support of this propo-sition, he noted that the Lear board(i) received advice from two repu-table financial advisors that the re-vised offer was fair to Lear stockhold-ers, (ii) knew that no other bidderhad come forward with a better offerafter Icahn’s interest was first an-nounced or during the ‘‘go shop’’ pe-riod, and (iii) held regular meetings

and received advice from several rel-evant experts as to the revised offer.On this basis, the Vice Chancellorconcluded that the Lear directorscould not be found to have ‘‘con-sciously and intentionally disre-garded their responsibilities andthereby breached their duty of loy-alty.’’ To emphasize the high bar todirector liability under DGCL Section102(b)(7), he added that ‘‘[i]n thetransactional context, a very extremeset of facts would seem to be requiredto sustain a disloyalty claim premisedon the notion that disinterested direc-tors were intentionally disregardingtheir duties.’’Conclusion

The clear language employed byVice Chancellor Noble in denying theinterlocutory appeal in Lyondell, aswell as the granting of motions to dis-miss in favor of the defendant direc-tors in McPadden and Lear, shouldbe of significant comfort to directorsof Delaware corporations involved inM&A transactions. These decisionsclarify that the protections conferredby charter provisions adopted underDGCL Section 102(b)(7) still offersubstantial protection to directors ofDelaware corporations, even in situa-tions where their actions are deter-mined to be grossly negligent.Rather, it is only when a director actsin bad faith, or otherwise breacheshis or her duty of loyalty, that theprotections afforded by exculpatorycharter provisions adopted underDGCL Section 102(b)(7) will bedenied.

In fact, although Vice ChancellorStrine does not mention the initialLyondell ruling in his Lear opinion,he does seem to indicate that hemight have ruled differently. At thevery least, directors and their advi-sors who are confronted with attrac-tive, pre-emptive bids or other time-sensitive decisions should welcomehis statement that: ‘‘Seizing specificopportunities is an important busi-ness skill, and that involves somemeasure of risk. Boards may have tochoose between acting rapidly toseize a valuable opportunity withoutthe luxury of months, or even weeks,of deliberation—such as a large pre-mium offer—or losing it altogether.. . . Courts should therefore be ex-tremely chary about labeling whatthey perceive as deficiencies in thedeliberations of an independentboard majority over a discrete trans-action as not merely negligence oreven gross negligence, but as involv-ing bad faith.’’

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