September 02, 2008

Chancery Denies Interlocutory Appeal on Ryan v. Lyondell

Posted by Gordon Smith

Ryan v. Lyondell generated a whole lot of consternation in the blogosphere (some of which is collected here), but in my view, the commentary was largely overblown in this case, as Vice Chancellor Noble clarified today in his letter opinion denying an interlocutory appeal by the defendants. (See the letter opinion here and Francis Pileggi's helpful summary here.)

Of course, the defendants could have saved themselves the trouble if they had read my post on the initial opinion. My post on their memorandum in support of this motion of interlocutory appeal further showed why they were barking up the wrong tree, and Vice Chancellor Noble wrote as much in today's opinion, repeatedly emphasizing that his initial opinion did not eviscerate Section 102(b)(7), nor did it signal the revival of a "liability crisis" like the one that followed Smith v. Van Gorkom. (Of course, even that historical curiosity is more complicated than just that.) The court contrasted this case with Van Gorkom as follows:

The directors in this instance walked into a potential liability trap with their eyes wide open: they knew the Company was “in play,” they knew what the proper discharge of their fiduciary obligations in connection with a sale of control demanded, and yet they appear, on the limited record before the Court, to have done nothing to prepare for a possible sale.

That's the central point of the new opinion: on the summary judgment record, the defendants "did nothing (or virtually nothing)" to fulfill their Revlon duties. Thus, "the directors may have consciously disregarded their known fiduciary obligations in a sale scenario." In other words, the defendants may have acted in "bad faith." Thus, the court wants to see a more developed record. That is all.

Permalink | Duty of Good Faith | Comments (0)

August 15, 2008

Lyondell Directors Appeal

Posted by Gordon Smith

If you are following the Ryan case, which I blogged about below, you will be interested to read the "Defendants' Memorandum of Law in Support of Their Application for Certification of Interlocutory Appeal and to Stay Proceedings Pending Appeal." (Whew!) The gist of the appeal is that  Vice-Chancellor Noble's decision would "eviscerate" section 102(b)(7) because it conflates the duty of care and the duty of good faith. The crux of the argument is that the defendants were "properly motivated, unconflicted and independent directors." As Meatloaf reminded us, two out of three ain't bad.

Vice-Chancellor Noble's opinion acknowledges that the defendants were unconflicted and independent, so he ends up focusing on motivation: "the Board’s failure to engage in a more proactive sale process may constitute a breach of the good faith component of the duty of loyalty as taught in Stone v. Ritter."

The only opening I see for the defendants here is the possibility that Vice-Chancellor Noble equates a breach of Revlon with a breach of the duty of good faith. Consider the following from footnote 11 of the opinion: "the Board’s apparent failure to make any effort to comply with the teachings of Revlon and its progeny implicates the directors' good faith and, thus, their duty of loyalty, thereby, at least for the moment, depriving them of the benefit of the exculpatory charter provision."

Necessarily implicates? Or may implicate? As noted in my first post on this case, the latter is the better view of Revlon because it implies that directors may violate their Revlon duties because they failed to act with due care, good faith, or loyalty. The Delaware cases do not seem crystal clear on this, but I think that is a fair reading.

But the defendants dont' take this path. Instead, they argue that Vice-Chancellor Noble's opinion conflates the duty of care and the duty of good faith because ... well, because there is no "record evidence that would support an inference that the Lyondell Directors intentionally breached their Revlon duties." Translated: we don't like the court's interpretation of the facts. That argument seems like a certain loser on an interlocutory appeal from a decision on a motion for summary judgment.

In the final analysis, however, the defendants have a bigger problem: nothing in Vice-Chancellor Noble's opinion would "eviscerate" 102(b)(7), as claimed by the defendants, because the Lyondell directors can still get the benefit of the exculpation provision if they are found after trial to have breached only their duty of care. The problem with the decision is that they can't get a lawsuit like this dismissed. But I don't see how you can pin that on Vice-Chancellor Noble. He is just taking direction from the Delaware Supreme Court.

Thanks to Steven Davidoff for the tip on the filing of the brief.

Permalink | Duty of Good Faith, Exculpation | Comments (0)

August 13, 2008

Boosters of "The Fiduciary Duty of Good Faith" Rejoice

Posted by Gordon Smith

Ryan v. Lyondell Chemical Co., 2008 WL 2923427 (Del. Ch. 2008), a edited version of which has been posted in the sidebar, is a case worth knowing about. Whether it is worth adding to the syllabus depends on how much time you want to spend on the "fiduciary duty of good faith." In this case, Vice-Chancellor Noble of the Delaware Court of Chancery denies 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 ChiappinelliJeff Lipshaw, Dale Oesterle, Larry Ribstein, and Francis Pileggi). 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.

Permalink | Duty of Good Faith | Comments (0)

August 04, 2008

CA v. AFSCME

Posted by Gordon Smith

After the second edition of the casebook was submitted to the publisher, the Delaware Supreme Court decided CA v. AFSCME, an important decision about the relative rights of shareholders and the board of directors in a Delaware corporation. We suggest assigning this case in place of Bebchuk v. CA, Inc. in Chapter 8 of the Second Edition, and we have posted the case in the sidebar for future reference. In a subsequent post, I will offer some thoughts on the opinion that may be useful in teaching this complex issue.

Permalink | Duty of Good Faith | Comments (0)

January 03, 2007

Posting Stone v. Ritter

Posted by Gordon Smith

An edited version of the Delaware Supreme Court's decision in Stone v. Ritter now appears in the sidebar. Later today, I will participate on the "Teaching Disney" panel. Last night, I had dinner with Justice Jack Jacobs, who wrote the Disney opinion. He also joined Justice Holland's opinion in Stone v. Ritter, in which the Delaware Supreme Court held that "good faith" was part of the duty of loyalty. What motivated the Court to decide Stone in the way it did?

According to Justice Jacobs, this was the Court's attempt to clarify some doctrinal points and to distance "good faith" from the duty of care. In light of that latter goal, the Court's decision to embrace Chancellor Allen's classic language from Caremark as one standard for measuring bad faith may seem strange because that case was expressly about the duty of care. The second sentence of Caremark reads: "The suit involves claims that the members of Caremark's board of directors (the 'Board') breached their fiduciary duty of care to Caremark in connection with alleged violations by Caremark employees of federal and state laws and regulations applicable to health care providers."

References to the duty of care are sprinkled throughout the case, which mentioned loyalty only once: "The complaint thus does not charge either director self-dealing or the more difficult loyalty-type problems arising from cases of suspect director motivation, such as entrenchment or sale of control contexts." Nevertheless, in Stone v. Ritter the Court associates Caremark with the duty of loyalty:

It is important, in this context, to clarify a doctrinal issue that is critical to understanding fiduciary liability under Caremark as we construe that case. The phraseology used in Caremark and that we employ here – describing the lack of good faith as a "necessary condition to liability" – is deliberate. The purpose of that formulation is to communicate that a failure to act in good faith is not conduct that results, ipso facto, in the direct imposition of fiduciary liability. The failure to act in good faith may result in liability because the requirement to act in good faith "is a subsidiary element[,]" i.e., a condition, "of the fundamental duty of loyalty." [citing Guttman v. Huang, 823 A.2d 492, 506 n. 34 (Del.Ch.2003).] It follows that because a showing of bad faith conduct, in the sense described in Disney and Caremark, is essential to establish director oversight liability, the fiduciary duty violated by that conduct is the duty of loyalty.

How did the Court get from point A to point B? The key is Leo Strine's opinion in Guttman. In that case, Strine tied the notion of "good faith" to loyalty. He focused on this oft-quoted paragraph from Caremark:

Generally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation ... in my opinion only a sustained or systematic failure of the board to exercise oversight--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. Such a test of liability--lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight--is quite high. But, a demanding test of liability in the oversight context is probably beneficial to stockholders as a class, as it is in the board decision context, since it makes board service by qualified persons more likely, while continuing to act as a stimulus to good faith performance of duty by such directors.

Notice the repeated reference to "good faith." According to Strine, Chancellor Allen was really talking about the duty of loyalty:

Although the Caremark decision is rightly seen as a prod towards the greater exercise of care by directors in monitoring their corporations' compliance with legal standards, by its plain and intentional terms, the opinion articulates a standard for liability for failures of oversight that requires a showing that the directors breached their duty of loyalty by failing to attend to their duties in good faith.

The footnote quoted in Stone v. Ritter reads in whole as follows:

A director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation's best interest. For this reason, the same case that invented the so-called "triad[ ]" of fiduciary duty, see Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del.1993) ("Cede II"), also defined good faith as loyalty. See In re Gaylord Container Corp. S'holders Litig., 753 A.2d 462, 475 n. 41 (Del.Ch.2000) (explaining the origins of this oddment of our law, i.e., the "triad[ ]").

It does no service to our law's clarity to continue to separate the duty of loyalty from its own essence; nor does the recognition that good faith is essential to loyalty demean or subordinate that essential requirement. There might be situations when a director acts in subjective good faith and is yet not loyal (e.g., if the director is interested in a transaction subject to the entire fairness standard and cannot prove financial fairness), but there is no case in which a director can act in subjective bad faith towards the corporation and act loyally. The reason for the disloyalty (the faithlessness) is irrelevant, the underlying motive (be it venal, familial, collegial, or nihilistic) for conscious action not in the corporation's best interest does not make it faithful, as opposed to faithless.

The General Assembly could contribute usefully to ending the balkanization of the duty of loyalty by rewriting § 102(b)(7) to make clear that its subparts all illustrate conduct that is disloyal. For example, one cannot act loyally as a corporate director by causing the corporation to violate the positive laws it is obliged to obey. See 8 Del. C. § 102(b)(7)(ii). Many recent events have only emphasized the importance of that obvious component of the duty of loyalty. But it would add no substance to our law to iterate a "quartet" of fiduciary duties, expanded to include the duty of "legal fidelity," because that requirement is already a subsidiary element of the fundamental duty of loyalty. The so-called expanded "triad [ ]" created by Cede II, I respectfully submit, is of no greater utility.

This is a fine enough argument, though I have a hard time understanding why it would be necessary in 2006. In the most recent Disney opinion, the Delaware Supreme Court effectively distinguished the "duty of good faith" from the "duty of care": "grossly negligent conduct, without more, does not and cannot constitute a breach of the fiduciary duty to act in good faith." Why was it necessary to take the additional step of placing the "duty of good faith" under the "duty of loyalty," especially after Chancellor Chandler and Justice Jacobs had taken such pains to define the "duty of good faith"?

Permalink | Duty of Good Faith | Comments (0)