Delaware Courts Reaffirm High Bar for Personal Liability of Disinterested Directors
September 5, 2008
In late July, Delaware Vice Chancellor Noble issued a decision in Ryan v. Lyondell denying the directors of Lyondell Chemical Company the protection of the company’s exculpatory charter provision for the alleged breach of their fiduciary duties in connection with the sale of Lyondell. Not surprisingly, V.C. Noble’s decision generated concern that directors may be subject to personal liability for breach of their fiduciary duties even where there is no allegation of self-interest. However, two separate Delaware Chancery Court opinions issued in the last week reaffirm the high bar required to prove that directors have breached their duty of loyalty via “bad faith conduct” that cannot be exculpated. As Vice Chancellor Strine states in his September 2nd opinion in In Re Lear Corporation, “a very extreme set of facts would seem to be required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties.”
DGCL Section 102(b)(7) provides that corporations may exculpate their directors from monetary liability for a breach of the duty of care, but not for conduct that is not in good faith or a breach of the duty of loyalty. In analyzing what constitutes conduct not in good faith, the Delaware Supreme Court in In Re Walt Disney and Stone v. Ritter has made clear that it is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e., gross negligence.) Courts have focused on the concept of an “intentional dereliction of duty,” which necessarily entails an intent component, in the finding of bad faith. However, in Lyondell, V.C. Noble held that the failure of the board of directors of a target company to actively engage itself in the CEO-dominated sale of the company—even though the negotiated price represented a substantial (45%) premium to market and no competing bids emerged post-signing—could constitute something more than gross negligence and may rise to the level of bad faith, posing a risk to directors of personal liability. While the Lyondell decision was arguably driven by the procedural posture of that case and the limited summary judgment record available at that stage of the proceedings, the decision sparked concern that the Court was rolling back the protection afforded by 102(b)(7) and expanding the potential sphere of personal liability for directors in a sale of control where there was no allegation of self-dealing.
These concerns should largely be allayed by the more recent decisions issued by Chancellor Chandler and V.C. Strine, respectively. In McPadden v. Sidhu, Chancellor Chandler examined the actions of the board of directors of i2 Technologies in the sale of its wholly owned subsidiary to a management team led by Anthony Dubreville, the subsidiary’s then vice president. The complaint alleged a number of fiduciary violations on the part of the board, including tasking Dubreville with leading the sales process even though it knew he had previously expressed concrete interest in purchasing the company, engaging in little or no oversight of the sales process even though it knew Dubreville had expended limited efforts to solicit offers for the company, and authorizing the use of management projections created under Dubreville’s direction. While the allegations in McPadden appear considerably more egregious than those alleged in Lyondell, Chancellor Chandler finds that the complaint alleges actions that were recklessly indifferent or unreasonable but fails to allege that the directors “acted in bad faith through a conscious disregard for their duties.” He therefore concludes that the directors were exculpated by the Section 102(b)(7) provision in the company’s charter and granted the directors’ motion to dismiss for failure to state a claim.
Similarly, in In Re Lear Corporation, V.C. Strine examined and dismissed for failure to state a non-exculpated claim for breach of fiduciary duty allegations against the directors of a target company. In this case, shareholders alleged that the Lear directors had acted in bad faith by agreeing to a “No-Vote Termination Fee” in exchange for a bump in merger consideration while knowing that the price increase would likely not be sufficient to attract a majority vote in favor of the transaction. Unsurprisingly, V.C. Strine held that the complaint failed to create an inference of mere negligence or gross negligence, much less the “far more difficult task of stating a non-exculpated duty of loyalty claim.” However, in his discussion V.C. Strine goes beyond the facts of the Lear case in comments that seem directed at Lyondell:
Boards may have to choose between acting rapidly to seize a valuable opportunity without the luxury of months, or even weeks, of deliberation—such as a large premium offer—or losing it altogether. . . . Courts should therefore be extremely chary about labeling what they perceive as deficiencies in the deliberations of an independent board majority over a discrete transaction as not merely negligence or even gross negligence, but as involving bad faith.
While there may continue to be some differences of approach towards this issue among the Chancery court judges, Chancellor Chandler’s and V.C. Strine’s reaffirmations of the high bar required to assert personal liability against directors for breach of their duty of loyalty are further buttressed by a letter opinion that V.C. Noble himself issued in Lyondell last Friday. In this letter opinion, V.C. Noble made clear his view the Lyondell decision “did nothing more than to assess the application (or potential application) of well-settled law under the peculiar and underdeveloped facts of this case.” Future rulings in this case (whether on appeal to the Delaware Supreme Court or on a more fully developed record in the Chancery Court) will provide greater clarity, but in declining to certify interlocutory appeal of his decision in Lyondell, V.C. Noble appeared eager to allay concerns that the decision may have raised, declaring that “the reports of the death of Section 102(b)(7) (and the consequent possibility for the ‘resuscitation’ of a Van Gorkom-esque liability crisis) in Delaware law are greatly exaggerated both with regard to the application of Lyondell’s exculpatory charter provision in this case, and certainly with regard to the application of a Section 102(b)(7) provision defense in any other case.”
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1. Separately, we note that Chancellor Chandler permitted the claim for breach of fiduciary duty to proceed as against Dubreville, the employee who led the management buyout. Chandler held that, as an officer of the company, Dubreville owed it the same fiduciary duties of care and loyalty as owed by the directors, but is not entitled to the protections of the exculpatory provision, which is only available to directors.