The Delaware Supreme Court finally issued its long-awaited opinion in Lyondell Chemical Company v. Ryan today. Remember, this is the case in which the directors of Lyondell Chemical Company were accused to breaching their fiduciary duties in connection with a sale of the company. The directors were admittedly independent and disinterested, but the plaintiff shareholders accused the directors of breaching their fiduciary duty of good faith by knowingly shirking their duties under Revlon. Vice-Chancellor Noble refused to grant the directors summary judgment because he wanted to know more facts about whether "the directors may have consciously disregarded their known fiduciary obligations in a sale scenario." (Ryan v. Lyondell Chemical Co., 2008 WL 2923427 (Del. Ch. 2008)).
In reference to that earlier decision, I expressed my frustration with the current state of Delaware law:
The problem with the decision is that [the defendants] 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.
Others, like Jeff Lipshaw, thought VC Noble was simply bootstrapping a duty of care claim into a non-exculpable duty of good faith claim. (Glom guest blogger Andrew Lund has written a paper about this possibility and how Delaware could more easily avoid it.) In its opinion today, the Delaware Supreme Court agreed with Jeff's assessment of the facts of this case: "At most, this record creates a triable issue of fact on the question of whether the directors exercised due care." (For Jeff's reaction to the opinion, see here.)
Importantly, this conclusion depends on a strikingly narrow understanding of "bad faith" in Delaware fiduciary law. In my first post on this case last August, I observed, "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." While all of this remains true, it appears that the Delaware courts still have an extremely narrow view of bad faith. Steve Bainbridge described it this way earlier today: "Ryan ... goes a long way towards constricting the scope of bad faith claims to egregious and highly unusual sets of facts."
To understand how narrow "bad faith" has become, consider VC Noble's initial decision to deny summary judgment. That decision was motivated by a desire to gather more facts before determining that the directors here had not acted in bad faith. VC Noble was under the impression that directors could do something to fulfill their Revlon duties, but still knowingly fall short of doing enough. This is not an unreasonable view, though it would require a fair amount of precision to determine the difference between a care claim and a good faith claim. Chancellor Chandler made a similar point in a recent opinion in In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106 (Del.Ch. 2009):
Business decision-makers must operate in the real world, with imperfect information, limited resources, and an uncertain future. To impose liability on directors for making a “wrong” business decision would cripple their ability to earn returns for investors by taking business risks. Indeed, this kind of judicial second guessing is what the business judgment rule was designed to prevent, and even if a complaint is framed under a theory, this Court will not abandon such bedrock principles of Delaware fiduciary duty law.
The Delaware Supreme Court wants to draw a brighter line in its opinion issued today:
The influence of Caremark is apparent here, and we know from experience that Caremark liability is almost unheard of in Delaware. Of course, Vice-Chancellor Strine recently found support for Caremark claims with respect to the former senior vice chairman of general insurance and former vice chairman of investments and financial services of AIG. See In re American Intern. Group, Inc., 2009 WL 366613 (Del.Ch.2009). In denying a motion to dismiss on this issue, VC Strine observed:
This sort of behavior, if proved at trial, would easily support a finding of "bad faith" under the traditional standards. In other words, the Caremark version of bad faith would be unnecessary. And if the Delaware courts are serious about the standards articulated in Lyondell, I suspect plaintiffs will need facts like these to prevail on a claim of bad faith. So while boosters of the fiduciary duty of good faith had reason to rejoice after VC Noble's initial opinion, they will not be pleased with this latest directive from the Delaware Supreme Court.
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1. Posted by Andrew Lund on March 27, 2009 @ 3:55 | Permalink
Thanks for plugging my paper (which, for all of you article editors out there, is still available for publication).
I agree with both your and Steve's reaction to Justice Berger's decision. It seems to me that good faith is pretty much dead for now except in the extreme legal compliance oversight case (AIG) and/or at the motion to dismiss stage (maybe) if Ryan is distinguishable because of its procedural posture (summary judgment).
The court had multiple opportunities to avoid doing so and seemed to go out of its way to address the due-care-into-good-faith bootstrap issue. As predicted a couple of weeks ago, the court held that Revlon didn't attach during the post-13D/pre-decision-to-sell stage. That effectively narrowed the case to the board's behavior during the one week negotiation period. With that accomplished, the court could have remanded, encouraging VC Noble to reconsider. Even if the court wanted to get into the weeds of separating due care from conscious disregard, it could have stopped at (1) approvingly quoting VC Strine's opinion in Lear re: needing an extreme set of facts in the transactional context to prove bad faith and (2) simply concluding these were not those facts. Either way, defendants win and the problem is solved for now.
Instead, the court went for the jugular. When I was interviewed about the case yesterday I pointed to the "completely failed" and "utterly failed to attempt" language, which I am happy to see you and Steve point to as well. That's pretty strong stuff, and it's hard to imagine a case that would satisfy the standard. Even at the earlier stages of the Disney litigation, for instance, the comp committee and board weren't really alleged to have completely or utterly failed, right?
None of this is to say the decision isn't a sensible one. The Chancery Court's decision highlighted the need for drawing the line between due care and conscious disregard. If due care exculpation is valuable and if conscious disregard remains non-exculpable, an underinclusive test for conscious disregard like the one now adopted is probably the right result. I say "probably" because we'll never really know. As I discussed earlier this month, we'd be better off permitting conscious disregard exculpation, which would allow the courts to be significantly less restrictive re: what constitutes conscious disregard.
2. Posted by Mike Guttentag on March 28, 2009 @ 15:13 | Permalink
For those of us who teach this material, is there a simple way to explain the current relationships between: good faith, bad faith, duty of loyalty, and duty of care?
3. Posted by Andy Appleby on April 1, 2009 @ 7:44 | Permalink
Im not sure there is a simple way to explain these relationships because they are so intertwined. But the following is how I explain director oversight at the most basic level:
Director oversight liability cases fall under the Caremark standard—utter failure to implement any compliance system, or utter failure to act in the presence of “red flags.” Further, essentially all oversight cases implicate the duty of care. However, most corporations have exculpated directors from liability under the duty of care based on section 102(b)(7). Thus, directors are generally only liable for breaches of the duty of loyalty. Even in the absence of traditional self-serving disloyalty, directors are liable for acts of bad faith under Disney and Stone in the oversight context. Fortunately, Lyondell recognizes that bad faith requires egregious director behavior—knowingly and completely failing to undertake their responsibilities.