Chen v. Howard-Anderson: Delaware Court of Chancery Limits Scope of Lyondell Chem. Co. v. Ryan for Bad Faith ClaimsSullivan & Cromwell LLP - April 23, 2014
In a summary judgment opinion issued on April 8, the Delaware Court of Chancery (VC Laster) held that in a change of control case governed by enhanced scrutiny, directors and officers could incur personal liability for a breach of their duty of loyalty if it is established that they acted unreasonably in conducting the sale process and allowed interests other than the pursuit of the best value reasonably available, i.e. an improper motive, to influence their decisions. The Court expressly rejected arguments that directors (or officers) could only be found to have acted in bad faith and thereby be personally liable for a breach of the duty of loyalty if it were determined that they were motivated by an intent to do harm or had consciously disregarded known obligations and utterly failed to attempt to obtain the best sale price, as articulated by the Delaware Supreme Court in Lyondell Chemical Company v. Ryan. Applying the new standard to the case before it, the Court concluded that the evidence against the director defendants was not sufficient to impose personal liability under the new standard, but that the evidence was sufficient to proceed to trial against the officers on the same theory.
In particular, the Court found that the record, viewed as a whole, supported the inference that the directors of Occam Networks, Inc. (“Occam”), a NASDAQ-listed Delaware corporation, based on the totality of the circumstances, acted unreasonably in connection with the sale process they ran by favoring the ultimate acquirer in the challenged transaction, Calix Inc. (“Calix”), over another viable bidder and by failing to adequately explore alternatives that could have generated a higher sale value, citing in particular a 24-hour ultimatum given to the other bidder and the decision to conduct a limited, 24-hour market check over a holiday weekend. However, the Court granted summary judgment in favor of the defendant directors because the Court found that the plaintiffs failed to present evidence of any improper director motive and, consequently, if the case proceeded to trial, the director defendants would be exonerated of any personal monetary liability for breach of the duty of care by the exculpatory provisions of Occam’s certificate of incorporation. The Court declined to grant summary judgment in favor of the defendant Occam officers who are not entitled to benefit from the exculpatory provisions of Occam’s charter, noting that the decision assumes without deciding that the same fiduciary principles apply to officers as directors.
The Court also declined to grant summary judgment in favor of the defendants with respect to whether Occam’s proxy statement was false or misleading in its description of management projections and the sale process, holding that there were triable issues of fact as to whether the director defendants could avail themselves of the exculpatory provision in Occam’s charter that would bar damages for disclosure violations resulting from breaches of the duty of care, particularly in view of the evidence that they had knowledge of the inaccuracies in the disclosure that could amount to bad faith.
The decision breaks new ground by limiting the director-protective standard for finding a bad-faith based breach of the duty of loyalty articulated in Lyondell to the narrow circumstances in which plaintiffs allege that a director demonstrates “conscious disregard” for his or her duties under Revlon v. MacAndrews & Forbes Holdings, Inc. in a sale of control, and by applying that narrowed standard to both directors and officers involved in the sale. Among other things, the decision concludes that fairly routine change-in-control benefits available to an officer defendant were sufficient to raise triable issues of fact with respect to his proper motive. While the decision was made in the context of summary judgment motions by the defendant directors and officers (and the evidence viewed most favorably to the plaintiffs as a result) and in circumstances in which the Court may have believed the defendant directors had misled the Court with respect to certain factual matters at the preliminary injunction phase of the case, the rulings, if sustained in further proceedings, could have significant implications for directors and officers of Delaware corporations (and the financial advisors that counsel them).
The Howard-Anderson decision suggests that directors and officers could be found to be personally liable for monetary damages in circumstances where they have run a somewhat flawed sale process (which is deemed to be unreasonable at the summary judgment stage) if there is sufficient evidence of some improper motive, even if that improper motive did not lead them to knowingly disregard their responsibilities. The implications of the decision are particularly troubling for officers, who lack the statutory and charter protection from monetary liability for duty of care claims but may face liability for a sale process that is later found to be unreasonable. In addition, the bad faith standard adopted by the Chancery Court may expose both officers and directors to personal liability for defects in a sale process that are later found to have been the result of an improper motive. Moreover, because the Court was willing, in the circumstances, to consider that disclosure violations could amount to breaches of the duty of loyalty under the Court’s newly articulated bad faith standard, the Howard-Anderson case also serves to emphasize the need for directors to review the proxy statement sent to stockholders in connection with the change of control. Finally, the emphasis placed by the Court on the potential disparate treatment of competing bidders highlights the importance of treating bidders equally or ensuring that any differences and the reasons for them are clearly discussed and documented.