Dismisses Shareholder Suit Challenging $18 Billion Acquisition by Dow of Rohm & Haas

In a decision issued January 11, 2009, the Delaware Chancery Court has dismissed a shareholder derivative lawsuit that claimed directors and officers of Dow Chemical Co. breached their fiduciary duty when they entered into an $18 billion merger agreement in 2008 to buy Rohm & Haas Co. ("R&H"). In re Dow Chemical Company Derivative Litigation, C.A. No. 4349-CC, 2010 WL 66769 (Del. Ch. Jan. 11, 2010).


Vice Chancellor Chandler found that the plaintiffs had failed to properly plead that demand upon the Dow Board of Directors to bring this action should be excused as futile under Delaware Chancery Court Rule 23.1 and under the so-called "Aronson" and "Rales" standards (Aronson v. Lewis, 473 A.2d 805 (Del. 1984) and Rales v. Blasband, 634 A.2d 297 (Del. 1993)) applicable to the review of decisions or non-decisions by a Board of Directors.

The court rejected plaintiffs' argument that the business judgment rule analysis should not apply in the context of a "bet the company" transformational transaction.

Background

For many years, Dow had focused on the commodities side of the chemical business. More recently, however, the company decided to embark on a "transformative strategy" by diversifying into the specialty chemicals business.

In December 2007, Dow's board of directors caused the company to enter a Memorandum of Understanding ("MOU") with Kuwait's Petrochemicals Industries Company. The MOU, which was subject to the execution of a definitive agreement, customary conditions, and regulatory approvals, provided for $9 billion in cash payments to Dow upon the transfer of a 50 percent interest in five global Dow commodities chemical businesses into a joint venture with Kuwait. The joint venture was known as "K-Dow," and each company was to take a 50 percent equity interest in the new company. At the time, Dow expected the K-Dow transaction to close in late 2008.


In July 2008, following an intense auction and six months after the K-Dow MOU, the Dow Board unanimously approved and caused Dow to enter into a strategic merger agreement with R&H (the "R&H Transaction"), pursuant to which Dow agreed to acquire all of R&H's stock for $78 per share, or roughly $18.8 billion. Recognizing that uncertainty was a dealbreaker for R&H, and that many competitors were standing ready to provide the certainty R&H sought, Dow did not condition the transaction's closing on obtaining financing. The transaction was slated to close within two business days of receiving all the required regulatory approvals.

Although proceeds from the K-Dow venture were one anticipated source of financing, the R&H deal was not conditioned upon, nor did it depend upon, the K-Dow deal closing. Accordingly, the Dow board informed stockholders that the financing for the merger did not depend on Dow entering into a binding contract with Kuwait. Specifically, Dow's President, Chief Executive Officer and Chairman, Andrew Liveris, and Dow's Chief Financial Officer, Geoffrey Merszei, disclaimed any temporal connection at a July 10, 2008 press conference. Liveris told an analyst: "we are not counting on [the K-Dow deal]. We can do [the R&H] deal without the Kuwait money, and we will stay at investment grade." Merszei expanded, stating: "[t]his deal is certainly not contingent on the closing of our Kuwait joint venture." Throughout fall 2008, defendants remained confident that the R&H Transaction would close "early next year."

At the time Dow entered the merger agreement with R&H, its earnings and stock price were
strong. Two weeks after signing the agreement, Liveris announced favorable second quarter results on behalf of Dow. Although oil prices surged from the first to second quarter of 2008, Dow "reacted quickly...enabl[ing Dow] to weather unparalleled increases in hydrocarbons, supply chain and other costs." All signs still indicated Dow would be able to arrange the financing necessary to close the R&H Transaction.

Unfortunately, a series of unforeseeable economic events unfolded over the next six months, which led to a drastic change in circumstances. As with other companies and the commodities and specialty chemicals industries, Dow's earnings and share price declined precipitously. Concurrently, Dow's cash reserves plummeted, and when coupled with the company's general financial health decline, Dow's ability to tap alternative lines of credit, including a proposed $13 billion bridge loan, quickly changed. Dow, along with many other companies, experienced multiple credit rating agency downgrades.

Despite these challenges, the Dow board remained committed to its transformative strategy and worked diligently to keep the R&H Transaction and K-Dow deals on track. However, on December 28, 2008, the Kuwaiti Petrochemicals Corporation and Petrochemicals Industries
Company informed Dow that the Kuwait Supreme Petroleum Council had rescinded its approval of the K-Dow joint venture. Though no reason was given for this initially, Kuwaiti press reports alleged that that bribery of senior Kuwaiti officials may have occurred.

As to the R&H Transaction, although the Dow Board proceeded with the transaction, it allegedly attempted to delay the closing after getting FTC approval, which was given January 23, 2009, triggering a closing date of January 27, 2009. Dow then refused to close the transaction, citing economic concerns and viability of the combined entities. R&H filed suit seeking specific performance. However, that suit was settled and the R&H Transaction was consummated April 1, 2009.

The Shareholder Suit

In two separate actions first filed February 9, 2009, then later consolidated, the plaintiff shareholders brought a derivative lawsuit against the 12 directors of Dow and three officers of Dow. Plaintiffs primarily alleged that the director defendants breached their fiduciary duties by entering into a merger agreement with R&H that unconditionally obligated Dow to consummate the merger. Plaintiffs challenged the wisdom of the board's July 2008 decision, and focused on the substantive provisions of the deal, rather than the procedures employed by the board, in particular, the fact that the board entered into a merger agreement without a financing condition.


Plaintiffs pleaded three derivative claims: Count 1, a breach of the fiduciary duty of loyalty because of alleged insider trading by certain directors and officer defendants; Count 2, a breach of fiduciary duty by the director defendants in approving the R&H Transaction, misrepresenting the relationship between the R&H and K-Dow transactions, failing to detect and prevent bribery in connection with K-Dow, failing to detect and prevent insider trading, and failing to prevent allegedly excessive and wasteful compensation; and Count 3, claims for contribution and indemnification against the directors for unidentified future claims.

Defendants moved to dismiss the complaint, claiming that plaintiff had failed to make a demand upon the board as required by Chancery Court Rule 23.1 before bringing suit, and had failed to adequately allege that demand upon the Dow Board would have been futile, and thus excused. As the court noted, Rule 23.1 places stringent requirements of factual particularity on allegations of demand futility that differ substantially from the permissive notice pleading standards "to ensure only derivative actions supported by a reasonable factual basis proceed."

In analyzing whether or not pre-suit demand upon the board would have been futile, the court reiterated that the two-pronged Aronson standard applies to board decision-making (here, claims arising from the board's approval of the R&H Transaction). The court noted that to satisfy Aronson, plaintiffs must plead particularized facts that raise a reasonable doubt as to whether (i) a majority of the directors who approved the transaction in question were disinterested and independent, or (ii) the transaction was the product of the board's good-faith, informed business judgment.

As to the remaining claims, the court characterized them as failure to supervise claims (i.e., of the type described in In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996)), which are governed by the Rales standard. Under Rales, noted the court, the only demand futility issue is whether "the board that would be addressing the demand can impartially consider its merits without being influenced by improper considerations." To meet the Rales test, plaintiffs must plead particularized factual allegations that create a reasonable doubt that the board could have, at the time the complaint is filed, validly exercised its independent and disinterested business judgment when responding to a demand.

Court Finds Demand Not Excused Concerning Board's Approval of R&H Transaction

The court found that plaintiffs had failed to satisfy either prong of the Aronson standard concerning the board's approval of the R&H Transaction.

At the time, Dow had a 12-member board consisting of nine outside directors. The court found that there were no allegations that any of the directors were "interested": no outside director was on both sides of the transaction; no outside director was alleged to have received a personal financial benefit; none of the 12 directors, in fact, was alleged to have been interested in the deal. The court found that because no director was an "interested" director (citing Brehm v. Eisner, 746 A.2d 244 (Del. 2000)), the independence of the directors need not be examined. Thus, under the first prong of Aronson, the majority of the Dow Board was disinterested and independent.

As to the second prong of Aronson, the court found no allegations in the complaint that the Dow Board was not adequately informed about the R&H Transaction. To the court, this was "highly suggestive" that plaintiffs were not focusing on the process but rather on the substantive content of the director's decision to undertake the R&H Transaction. Relying on its decision in In re Citigroup, Inc. Shareholders Litigation, 964 A.2d 106 (Del. Ch. 2009), the court held that such "substantive second-guessing of the merits of a business decision...is precisely the kind of inquiry that the business judgment rule prohibits."

To avoid the holding in Citigroup, plaintiff attempted to draw a line between a simple exercise of business judgment relating to a transaction, or a series of transactions and a "bet the company" transaction. The court held that "Delaware law simply does not support such a distinction." To the court, "A business decision made by a majority of disinterested, independent board members is entitled to the deferential business judgment rule regardless of whether it is an isolated transaction or part of a larger transformative strategy. The interplay among transactions is a decision vested in the board, not the judiciary."

As to allegations of bad faith under the second prong of Aronson, the court reiterated that recent case law requires "in the transactional context, an extreme set of facts is required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties" (citing Lyondell Chemical Co. v. Ryan, 970 A.2d 235 (Del. 2009). The gravamen of plaintiffs' claim was that the board approved misstatements about the connection between the R&H and K-Dow deals. However, the court rejected these claims, finding nothing was misrepresented about the relationship between the deals, and even if there were, there were no allegations connecting the board defendants to these statements.

Court Rejects Other Claims

The court also found that Plaintiff had failed to plead that demand was excused concerning the Caremark "failure to supervise" claims. Since the Rales test applies to director's "unconscious failure to act," the court stated that the only demand futility issue is whether the board that would be addressing the demand "can impartially consider its merits without being influenced by improper considerations." Thus, though directors who face "substantial likelihood of personal liability" are deemed interested under the Rales test, demand is excused only in the rare case when a plaintiff can show director conduct that is "so egregious on its face that board approval cannot meet the test of business judgment."

The court found nothing in the complaint that showed knowledge by the director defendants of alleged bribery nor any reason to suspect such conduct; the court repeated that it had already found there were no adequate misrepresentation or omission claims. Accordingly, the court found there was no "substantial likelihood of liability" to the directors that could prevent them from considering a demand concerning the Caremark claims, and the court dismissed these claims. (The court found that other allegations that had been made as the basis for Caremark claims—failing to detect and prevent insider trading (which was also the basis for Count 1 of the complaint) and payment of excessive and wasteful compensation – had been abandoned by plaintiffs when they failed to respond defendants' arguments about the Caremark claims in their motion papers.)

Count 3 of the derivative complaint—concerning contribution or indemnity for unidentified claims that might be asserted in the future against Dow—was also dismissed by the court on the grounds that since there was no longer any pending claims against Dow, as a result of the court's dismissal of the first two Counts of the derivative complaint, claims for contribution and indemnification were not ripe for resolution.

This article is presented for informational purposes only and is not intended to constitute legal advice.