Two recent decisions by the Delaware courts have provided important guidance regarding the fiduciary duties of corporate directors. Most recently, in Lyondell v. Ryan, the Delaware Supreme Court reinforced the high bar to establishing a breach of duty of loyalty claim. This decision followed the Delaware Chancery Court’s refusal in In re Citigroup to permit judicial second-guessing of corporate decisions by reiterating that the business judgment rule is the standard by which to analyze directors’ actions. What follows is a brief summary and analysis of these two significant decisions.

Delaware Court Reverses Lyondell Decision and Reinforces Duty of Loyalty Standard

On March 25, 2009, the Delaware Supreme Court reversed the Delaware Chancery Court’s controversial decision in Lyondell Chemical Co. v. Ryan.¹ In doing so, the Delaware Supreme Court reaffirmed the high threshold required to establish a breach of duty of loyalty claim against independent directors, and further clarified the Revlon duty of maximizing sale price.

The claim in Lyondell arose out of a series of events beginning in April 2006, when Basell AF approached Lyondell about a possible acquisition. Basell made an initial offer of $26.50 to $28.50 per share, which Lyondell’s board rejected. After a one year lull, Basell filed a Schedule 13D in May 2007, disclosing an 8.3% ownership position in Lyondell’s stock and announcing its intention to explore a takeover. Upon learning of the 13D filing, Lyondell’s board met to consider its options. While the board acknowledged that Lyondell was “in play”, it decided to take a “wait and see” approach. Soon after, in July 2007, Basell made a second offer of $40 per share, subject to a large break-up fee and one-week deadline. After Lyondell’s board met several times to consider this offer, retaining legal and financial advisors to assist in its review, the board asked Lyondell’s CEO to go back to Basell and negotiate better terms. Ultimately, Basell increased its offer to $48 per share and conceded on numerous points, including a reduction in the break-up fee and the inclusion of a fiduciary out provision. This offer was accepted by Lyondell’s board, as it was considered a “blowout price”.²

Lyondell’s stockholders subsequently brought a class action lawsuit claiming that Lyondell’s board had breached its fiduciary duty of loyalty in connection with the acquisition, a breach which would subject the directors to personal liability. The stockholders alleged a breach of the duty of loyalty because the board was shielded from personal liability for a breach of the duty of care due to an exculpatory provision in Lyondell’s charter under Section 102(b)(7) of the Delaware General Corporation Law. Despite the Lyondell board being independent and disinterested, the Chancery Court refused to dismiss these claims on summary judgment. Among other things, the Chancery Court was concerned that the directors had failed to take appropriate actions to prepare for a possible acquisition once Basell announced its intentions in its 13D filing, the transaction was negotiated in just one week’s time, and the board allegedly had failed to conduct even a limited market check.

In reversing the Chancery Court’s decision, the Supreme Court reinforced the following important points:

• The proper inquiry to sustain a breach of duty of loyalty claim should be whether the directors “utterly failed to attempt to obtain the best sale price,” instead of whether they did everything that they should have done to obtain such price.³ While directors may breach their duty of care when they simply fail to do all that they should under the circumstances, that does not constitute a breach of their duty of loyalty. The Supreme Court added that “in the transactional context, [an] extreme set of facts [is] required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties.⁴
• Revlon duties only apply when there is an actual transaction pending for the company. Revlon duties do not arise simply because a company is put “in play” by a potential acquirer’s announcement that it intends to pursue a takeover. In the Supreme Court’s view, taking a “wait and see” approach to a possible hostile offer is “an entirely appropriate exercise of the directors’ business judgment.”⁵ The Chancery Court, however, imposed Revlon duties on the Lyondell board during the two month period after Basell’s 13D filing, before the board had decided to sell the company and before a sale had become inevitable. The Supreme Court determined that Revlon duties did not apply until July 2007, when actual negotiations with Basell began.
• “There are no legally prescribed steps that directors must follow” to discharge their Revlon duties.⁶ The Chancery Court erroneously thought Revlon created a set of requirements, including a market check, auction, or other value-determining process. However, the Supreme Court held that “no court can tell directors exactly how” to satisfy their duties due to the unique circumstances that arise in a change of control transaction.⁷ They also stated that directors need only make “reasonable” attempts to maximize price.

The practical implication of the Delaware Supreme Court’s decision is that it reaffirms the notion that disinterested directors can attempt to comply with their Revlon duties in the unique, high-pressure environment in which they operate without being unreasonably exposed to personal liability for their decisions (assuming the company’s charter has a Section 102(b)(7) exculpation provision). This decision also makes it clear that plaintiffs will not be allowed to recast otherwise exculpated duty of care claims as duty of loyalty claims.

Delaware Court Upholds Business Judgment Rule in Dismissing Shareholder Derivative Action Against Citigroup Board

On February 24, 2009, the Court of Chancery of the State of Delaware upheld the continued application of the business judgment rule to director decision-making when it dismissed a breach of fiduciary duty claim against the board of directors of Citigroup Inc. stemming from losses arising from Citigroup’s exposure to the subprime lending market.⁸

The Court’s opinion sets a precedent for corporate boards whose actions may be the target of derivative lawsuits in light of the current financial crisis. It reiterates that the business judgment rule continues to be the standard by which to analyze the actions, or inactions, of company directors. The Delaware Court also reaffirmed the rationale that imposing liability on directors for making “wrong” business decisions would impinge on their ability to create value for shareholders by taking business risks.

Shareholders of Citigroup commenced this derivative action against the board of directors of the company, claiming that the directors breached their fiduciary duties by failing to monitor and manage risks and by allowing Citigroup to engage in highly risky credit transactions. The shareholders’ breach of fiduciary duty argument was based on a theory of director liability articulated in In re Caremark.⁹ In a typical action where the Caremark standard applies, plaintiffs argue that the defendants are liable for damages arising from a failure to properly monitor or oversee employee misconduct or violations of law. For example, in Caremark the board of directors allegedly failed to monitor employee actions in violation of the federal Anti-Referral Payments Law. Director oversight liability under the Caremark standard is “rooted in concepts of bad faith; indeed, a showing of bad faith is a necessary condition to director oversight liability.”¹⁰

Notably, however, the Delaware Court ruled that the Caremark standard was the wrong standard to apply to the actions of the Citigroup board. The Citigroup board did not exhibit the failure of oversight associated with the Caremark decision. Instead, the actions of the board were protected by the business judgment rule, which states that “[a] court will refuse to review the actions of a corporation’s board of directors in managing the corporation unless there is some allegation of conduct that the directors violated their duty of care to manage the corporation to the best of their ability.”¹¹ The Court noted that the shareholders’ claims were based on the board’s alleged failure to properly monitor Citigroup’s business risk, specifically its exposure to the subprime mortgage market, rather than, for example, an alleged oversight failure allowing widespread criminal activity. The Court pointed out that the plaintiffs were improperly attempting to hold the director defendants personally liable for making business decisions that, in hindsight, turned out poorly for the company.

The Court made it clear that Delaware law does not permit this kind of “judicial second-guessing” of directors’ business decisions – even decisions that turn out to have catastrophic results – so long as those decisions were not made in bad faith. As the Court further noted, Citigroup is in the business of taking on and managing investment and other business risk, and “[t]o impose oversight liability on directors for failure to monitor ‘excessive’ risk would involve courts in conducting hindsight evaluations of decisions at the heart of the business judgment of directors. Oversight duties under Delaware law are not designed to subject directors, even expert directors, to personal liability for failure to predict the future and to properly evaluate business risk.”

This decision should help reassure directors of Delaware corporations that the business judgment rule remains the standard in which directors’ business decisions are judged, and that shareholders will have a difficult time subjecting corporate decisions to scrutiny through hindsight. Short of showing that directors consciously disregarded their obligation to be reasonably informed about their company’s business and risks, or otherwise allowed pervasive fraudulent and improper conduct to occur, such claims will continue to be difficult to sustain.

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¹ No. 401, 2009 Del. LEXIS 152 (Del. Mar. 25, 2009).

² See, Lyondell, 2009 Del. LEXIS 152, at *3-*8.

³ Id. at *21.

⁴ Id.

⁵ Id. at *17.

⁶ Id. at *20.

⁷ Id. at *17.

⁸ In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106 (Del.Ch. 2009).

⁹ In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959 (Del.Ch. 1996).

¹⁰ In re Citigroup, 964 A.2d at 24.

¹¹ Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).