During these tenuous market conditions and the frequently lamented failure of some directors in fulfilling their roles as fiduciaries, directors have come under increased scrutiny by the government, judiciary and public alike. The fallout from any perceived dereliction of director duties is predictable and will almost invariably manifest itself in the form of dissident shareholder actions which challenge the motivations and diligence with which directors exercise their business judgment. These types of suits will most likely emerge in the context of change of control transactions which have seen much activity lately, as depressed corporate values have created an optimal environment for corporate opportunists seeking to capitalize on companies whose intrinsic value might actually be quite higher than their current valuations might suggest. It is under these circumstances where the sale price obtained might not accurately reflect the value of a target corporation, as a going concern that target shareholders might be more inclined to pursue judicial redress and attack the decisions of boards made in the course of negotiating a change of control transaction.

Indeed, one such dissident class action shareholder suit, involving a merger between a public and private company, has already generated much commentary in recent months, given the impact of that decision on the oft-cited Revlon duties. In the widely anticipated March, 2009 decision of the Delaware Supreme Court (the “Court”) Lyondell Chemical Co. v. Ryan, the Court took the opportunity to expound upon the application of the Revlon duties and draw the proverbial line in the sand, which had been muddied after years of ensuing case law, to clarify when and how these duties should be applied in a takeover context.

This case involved two companies: the target company, Lyondell, which was a large publicly traded chemical corporation, comprised of a board of independent directors (the “Board”), and the bidder, Bassell AF (“Bassell”), which was a private internationally based company. In May 2007, Bassell filed a Schedule 13D with the Securities Exchange Commission indicating that it had a right to acquire 8.3 per cent of Lyondell’s shares. This disclosure document also revealed Bassell’s interest in possibly entering into other transactions with Lyondell. The directors of Lyondell responded to this disclosure by taking a “wait and see approach” for several months despite its acknowledgment that the filing of this document signaled to the market that the company was “in play”. On July 9, 2007, a few months after filing its Schedule 13D and after making several offers to acquire Lyondell which were all met with rejection, Bassell again made overtures towards Lyondell.

At that time, Bassell presented its best offer, which would provide Lyondell’s shareholders with a substantial return on their investment; however, as a condition of the offer, Lyondell only had a few days in which it could confirm its commitment to enter into a merger agreement. During the span of one week, the Board met briefly on a few occasions to discuss the offer and its terms. Upon the advice of the Board’s legal and financial advisors together with a review of prepared valuation materials and the low probability of competing bidders matching the Bassell offer, the Board made the decision to put the transaction to a shareholder vote for approval. Although more than 99 per cent of Lyondell’s voting shareholders approved of the transaction, approximately ten days after that vote, certain shareholders of Lyondell came forward seeking a preliminary injunction of the merger agreement. At issue in Lyondell was whether the directors, in negotiating the company’s acquisition by Bassell, failed to duly exercise their duty of loyalty towards the company in light of the principles articulated in the decisions of Revlon and its progeny. In the originating claim of this suit, the plaintiffs alleged that the directors of Lyondell breached their duties towards its shareholders by, among other things, negotiating the merger under a flawed process, acquiescing to unreasonable deal protection devices and agreeing to a grossly inadequate share acquisition price. In response to this action, the Lyondell directors moved for summary judgment and sought a dismissal of the plainitff’s claim. The trial court, in denying the motion for summary judgment, held that there was a triable issue as to the alleged breach of the directors’ duty of loyalty. Upon appeal by the defendants, the Court found that the record clearly demonstrated that the directors did not breach their duty of loyalty and that the trial court erred in not granting the defendants’ motion for summary judgment.

In assessing the defendant’s appeal, the Court found that the trial court made a number of missteps in its application of the law to the specific facts in question. First, the Court held that the trial court erroneously focused its analysis on the Board’s inaction from the time Lyondell was put in play, which led the trial court to its finding that there was sufficient evidence to sustain a claim of breach of duty of loyalty. The Court indicated that the proper line of inquiry should have instead been focused on the Board’s actions during the week in which it met to discuss the proposed acquisition and not on the two months of inaction. In so holding, the Court stated that the lower court “approached the record from the wrong perspective. Instead of questioning whether disinterested, independent directors did everything that they (arguably) should have done to obtain the best sale price, the inquiry should have been whether those directors utterly failed to attempt to obtain the best sale price.” The Court also held that the Revlon duties do not arise simply because a company is in play. Instead, these duties are triggered only when a company “embarks on a transaction-on its own initiative or in response to an unsolicited offer- that will result in a change of control.” In this case, the Revlon duties would have attached when the directors had made the conclusive decision to sell the company or when the sale of the company became inevitable. The premature imposition of these duties was therefore fatal to the trial court’s decision. The Court also held that that the trial court incorrectly interpreted the Revlon decision and its successor line of cases to have created a mandatory set of requirements that must be satisfied during the sale process. In so doing, the trial court wrongly equated “an arguably imperfect attempt to carry out Revlon duties with a knowing disregard of one’s duties” as evidence of the directors’ bad faith. The Court found that the trial court’s correlation here was a reversible error, as no blueprint exists which prescribes “steps that directors must follow to satisfy their Revlon duties…[such that] the directors’ failure to take any specific steps during the sale process could not have demonstrated a conscious disregard of their duties.”

Implications in a Canadian Context
Though set on an American stage, the Lyondell case has been closely monitored from its inception by Canadian directors and practitioners because of the reliance that Canadian courts frequently place on Delaware decisions relating to corporate governance practices. Although the Supreme Court of Canada (the “Supreme Court”) recently eschewed the application of Revlon duties in favour of a more contextualized approach to director duties in change of control transactions (i.e. the duty to treat all affected stakeholders fairly, commensurate with “the corporation’s duties as a responsible citizen” as opposed to the interests of shareholders alone), the Supreme Court did tacitly acknowledge that the principles articulated in Revlon (and its progeny) could play into the decision making process of a board in certain circumstances so long as the best interests of the Corporation remain paramount. As a result of the BCE decision, critics will need to focus on the process whereby a decision was made, rather than on the substance of the decision.

Insofar as judicial consideration is still given to American developments in corporate responsibility and governance, the Lyondell decision is important in several respects. First, it provides some authority for the proposition that even an imperfect attempt of a board to satisfy its fiduciary duties might be enough to defeat a claim of breach with respect to the duty of loyalty. Second, given the discussion of the high threshold of proof required to demonstrate that the business judgment of directors was exercised in bad faith, there might be a chilling effect on these types of claims being pursued by plaintiffs. Finally, Lyondell provides some guidance as to what stage in a corporation’s acquisition process that the duty of loyalty will be triggered.
Regardless of whether the principles articulated in this case are adopted by Canadian courts, the Lyondell decision underscores the importance of keeping adequate and detailed records of the actions taken by a target board at all stages that it is approached by a potential bidder. The existence of such records could arguably shield directors from the premature application of fiduciary duties in a change of control transaction which, if otherwise imposed, could attract a standard of enhanced judicial scrutiny and provide the basis for personal liability.

The content of this article is intended to provide general information for the reader and is not intended as advice or an opinion to be relied upon in relation to any particular circumstance. For specific applications of the law to a particular set of circumstances, the reader should seek professional advice. Nadia Somani practices in the areas of corporate finance and securities with McLean & Kerr LLP, a law firm based in Toronto.