In my opinion, however, if Noble means to say that every sale of a corporation triggers "Revlon duties" in the sense that enhanced scrutiny applies to the board's conduct of every sale, I believe he is wrong both as a matter of policy and doctrine. I discussed the policy reasons why I think that's an error in the earlier post, The Borders of Revlon-land, so here let me focus on doctrine.
In 2003, the Delaware supreme court stated that: "This Court has held that a board's decision to enter into a merger transaction that does not involve a change in control is entitled to judicial deference pursuant to the procedural and substantive operation of the business judgment rule." Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914, 928 (Del. 2003). Indeed!
Some 9 years earlier, the court had explained that:The Court of Chancery held that Revlon was inapplicable under the facts of this case because the Merger did not involve a change in control. We agree....
The directors of a corporation "have the obligation of acting reasonably to seek the transaction offering the best value reasonably available to the stockholders," Paramount Communications, Inc. v. QVC Network, Inc., Del.Supr., 637 A.2d 34, 43 (1994), in at least ... three scenarios: (1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company; (2) where, in response to a bidder's offer, a target abandons its long term strategy and seeks an alternative transaction involving a break-up of the company, or (3) when approval of a transaction results in a sale or change of control.Arnold v. Society for Sav. Bancorp, Inc., 650 A.2d 1270 (Del. 1994). I believe that, in the phrase "sale or change of control," control must be understood to modify both the words sale and change. Indeed, that conclusion would seem to follow directly from the Omnicare passage quoted above.
The Delaware Supreme Court apparently agreed, although it did not address the issue in depth. The Court held that Revlon enhanced scrutiny does not apply simply because a company's board recognizes that the company has been put in play. (14) Instead, the duty to get the best possible price applies 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." (14-15) The transaction at issue did so because Basell was privately held.
Finally, I expressed concern that the Ryan Chancery Court opinion's view of the directors' good faith obligations would undermine the business judgment rule. In Turning Bad Faith into Full Employment for Lawyers, for example, I opined that: "Ryan v. Lyondell is "The Lawyer (and sometimes Investment Banker, Auditor, Compensation Consultant, Risk Management Guru, or Whatever Other Expert is Relevant) Full Employment Act of 2008." If this holds up, Ryan will continue the legacy of Smith v Van Gorkom as a source of excess investment in process."
In Good Faith and Risk Taking, I noted that:
Let's ... assume that a board conscious decided to make a decision even though the directors knew that there were factors as to which they were uninformed, and which might make the decision look bad in hindsight, but the opportunities available justified taking that risk and going forward on the basis of incomplete information. Under Stone v. Ritter--and, especially, Ryan v. Lyondell--this scenario raises a new and even more troubling question.
In Stone, the Delaware Supreme Court held that: "In Disney, we identified the following examples of conduct that would establish a failure to act in good faith: ... where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties." Would directors who conscious decided to take action even though they knew there were facts they didn't know therefore have acted in bad faith? It would seem as though they consciously failed to act in the face of their duty to gather all material information reasonably available to them.
One would hope that the doctrine of good faith will not deter risk taking. After all, a key rationale of the business judgment rule is to encourage risk taking. Good faith shouldn't be allowed to gut that key function.
Finally, I worried in the Borders of Revlon-land that:
One of my key concerns about these cases, especially Lyondell, thus is that the emerging post-Stone v. Ritter jurisprudence on questions of good versus bad faith tend to undermine the barrier to judicial review created by the business judgment rule. This post is already too long to address the question of whether VC Noble's latest opinion in Lyondell, which denied certification of the case for interlocutory appeal, is correct in suggesting that his good faith analysis does not gut the business judgment rule. Suffice it say that I believe there is a very serious risk that the post-Stone good faith jurisprudence does in fact pose that very risk. The business judgment rule is designed to prevent courts from asking "did the directors act with reasonable care?" But good faith allows courts to ask "did the directors conciously disregard their duty to act with rasonable care." There is a difference between the two inquiries, to be sure, but we're starting to have to slice the baloney pretty thinly. It would have better if the Delaware supreme court had just drawn discreet veil around the whole question of good faith so that people could go on ignoring it, as they had done for decades. Pernicious may be too strong a word for Stone and its progeny, but I still think that the Delaware courts are going to have do to do some serious repair work to ensure that the business judgment rule remains intact. See generally my article The Convergence of Good Faith and Oversight, 55 UCLA Law Review 559 (2008).
The Delaware Supreme Court's decision in Ryan does a long way towards assuaging those concerns. The Court views the case as really raising only issues of care. (18) It emphasized that an "extreme set of facts" is required to sustain a bad faith claim. (18) "Only if [the directors] knowingly and completely failed to undertake their responsibilities would they brach their duty of loyalty" by acting in bad faith. A claim would lie here only if the directors "utterly failed to attempt to get the best sale price." (19)
Coupled with Chancellor Chandler's recent Citigroup decision (about which see my article Caremark and Enterprise Risk Management), Ryan thus goes a long way towards constricting the scope of bad faith claims to egregious and highly unusual sets of facts.
Even so, I stand by my earlier recommendation that the Delaware courts "should make it clear that the conscious disregard prong of good faith relates only to duties involving self-dealing. This would clarify that good faith cannot be used to end run the prohibition on judicial review of substantive due care."
I also stand by my earlier recommendation that the time has come for the Delaware legislature to revisit the issues raised by section 102(b)(7). As I documented in that post, the statute is being steadily eroded and its purposes steadily undermined by the Delaware courts.
Update: Jeff Lipshaw posts:
Courtesy of Steve Davidoff, we've learned that the Delaware Supreme Court has just issued its opinion, reversing the Chancery Court's troubling denial of summary judgment (under §102(b)(7) of the Delaware General Corporation Law) in Ryan v. Lyondell Corporation.
I had noted some real concerns with the Chancery Court opinion; it feels good to be vindicated once in a while. In short, while it's at least conceivable that the directors didn't exercise sufficient care, the basis for the motion for summary judgment was that they were exculpated from damages under §102(b)(7) for duty of care violations; this case could only continue against them if they exhibited a failure of good faith. While the possibility still exists that lack of care in the extreme could invoke the duty of loyalty (i.e., were you really acting for the corporation?), this set of facts just doesn't present that concern.
As readers know, I focus on big questions of judgment, and particularly those where law intersects with business. Many areas of legal doctrine don't really rise to the level of impacting major business decisions. This one does. There's a fine balance between accountability and the need to act expeditiously, and something as small as a overly conservative approach to summary judgment when a board is acting on what appears to be a pre-emptive offer, really does put the directors between a rock and a hard place.
