In In re Walt Disney Company Derivative Litigation, 906 A.2d 27 (Del. 2006), the Delaware Supreme Court affirmed the Delaware Court of Chancery’s post-trial opinion in which the trial court found that members of the board of directors of The Walt Disney Company (“Disney”) did not breach any of their fiduciary duties and did not act in bad faith in connection with the 1995 hiring and subsequent 1996 firing of Michael Ovitz (“Ovitz”) as Disney’s president.
In January 1997, several Disney shareholders brought derivative actions in the Court of Chancery on behalf of Disney against Ovitz and the members of Disney’s board of directors. Plaintiffs claimed that after only 14 months of employment, a $130 million termination payout based on the terms of Ovitz’s employment contract was (i) the product of fiduciary duty and contractual breaches by Ovitz, (ii) breaches of fiduciary duty by the Disney directors, and (iii) a waste of the Company’s assets. After trial, Chancellor William B. Chandler entered judgment in favor of all defendants and dismissed all the claims in plaintiffs’ second amended complaint, holding that none of the defendants had breached any fiduciary duty or committed waste. Following copious briefing and oral argument en banc, the Delaware Supreme Court upheld the Chancellor’s opinion.
Following the death of Disney’s former president, the company needed to find a replacement. There was also consideration of the need for a potential successor to Chairman and CEO Michael Eisner (“Eisner”). In the summer of 1995, Ovitz, a high profile Hollywood talent agent, became a candidate to succeed Disney’s former president. Ovitz negotiated with Eisner and Irwin Russell (“Russell”), Chairman of Disney’s Compensation Committee. Those negotiations resulted in a proposed 5-year employment contract, the Ovitz Employment Agreement (the “OEA”). The OEA provided for a substantial grant of stock options, as well as non-fault termination (“NFT”) payments as long as Ovitz’s ultimate termination was not for “good cause.” The Compensation Committee, through its members Russell and Ray Watson (“Watson”), conferred multiple times with a compensation expert to coning that acquiescence requires a showing that the “plaintiff, by words or deed has acknowledged the legitimacy of the defendants’ conduct.” Having found that to be the case, the Court held that the claims of the stockholders who voted to approve the Merger were barred.
With regard to the members of the Plaintiff Class who did not vote in favor of the Merger but who later accepted the Merger consideration, the Delaware Court of Chancery held that acceptance of merger consideration is an abandonment of appraisal rights but not an acceptance, by words or deed, of the legitimacy of the directors’ conduct. Consequently, the Court ruled that these Plaintiff Class members were not barred from any recovery on the grounds of acquiescence. Some practitioners have suggested that this holding is contrary to the Delaware Supreme Court’s decision in Bershad v. Curtiss- Wright Corp., 535 A.2d 840 (Del. 1987), which held that the mere acceptance by stockholders of cash merger consideration constitutes acquiescence, barring recovery in an equitable action.
Finally, the Delaware Court of Chancery noted that while an exculpatory charter provision adopted pursuant to Section 102(b)(7) is a statutorily authorized immunity, because it has been characterized by the Delaware Supreme Court as being “in the nature of an affirmative defense,” it can be waived if not timely raised and asserted.
Delaware Supreme Court Affirms The Prevalence Of The Business Judgment Rule In Landmark Disney Ruling Applying The Duty Of “Good Faith” sider Ovitz’s proposed compensation. Russell and Watson also had telephone conversations with the two other members of the committee, Sidney Poitier (“Poitier”) and Ignacio Lozano (“Lozano”). During this same time period, Eisner informed each member of the Disney board that he supported the hiring of Ovitz. On September 26, 1995, the Compensation Committee met for what the Court found was one hour and (among other topics) discussed Ovitz’s proposed compensation package. Subsequently, the full board met and elected Ovitz President. Shortly thereafter, the Compensation Committee met on October 16 and awarded Ovitz stock options as per the OEA.
Ovitz’s brief period of employment with Disney was disappointing. Disney’s directors discussed this on multiple occasions and eventually discussed Ovitz’s anticipated termination. Despite the concerns of Disney’s board members, they were advised by the company’s General Counsel, Sanford Litvack (“Litvack”), that the company did not have cause to avoid the NFT payment. Eisner therefore terminated Ovitz on a not-for-cause basis. The Disney board was informed of and supported Eisner’s decision. Following a lengthy 37-day trial, the Chancellor concluded that none of the defendants were liable to plaintiffs or the company based on the facts summarized above. Plaintiffs appealed.
The Delaware Supreme Court commenced its review of the Court of Chancery’s decision by first separating plaintiffs-appellants’ claims: (i) those against Disney’s directors; and (ii) those against Ovitz.
The claims against Disney’s directors were that they breached their fiduciary duties of care and good faith by approving the OEA and approving the NFT payment to Ovitz upon his termination. This payment was also alleged to have amounted to corporate waste. Plaintiffs did not contend that the Disney directors were directly liable for these actions. Rather, plaintiffs argued that these alleged breaches of duty required the defendants to prove the entire fairness of their actions because they were no longer entitled to the protections of the business judgment rule. The Court rejected plaintiffs’ argument and held instead that it was plaintiffs’ initial burden to prove a breach of fiduciary duty in order to rebut the protections of the business judgment rule.
Plaintiffs insisted that they had met their burden and argued that the Chancellor had conflated the fiduciary duty of care and the duty to act in good faith in determining whether the defendants should be held liable in the first instance. However, the Delaware Supreme Court found that the Court of Chancery had, in fact, applied the legal tests separately. While plaintiffs argued that the trial court reviewed the good faith conduct of the directors in the context of a Section 102(b)(7) charter provision, the Delaware Supreme Court found that the Chancellor had correctly reviewed the good faith
plaintiffs had rebutted the presumptions of the business judgment rule. The Court held that although a finding of bad faith can eliminate a charter-based exculpation from liability for money damages after liability has been established in the first place, a finding of bad faith can also be used to rebut the presumptions of the business judgment rule before liability is established.
Turning to its review of the specific conduct of defendants, the Delaware Supreme Court considered whether the Court of Chancery properly applied the business judgment standard of review. The Court determined that there was no breach of the duty of care, no defendant acted in bad faith, and defendants did not commit corporate waste.
Claims Against the Members of Disney’s Board of Directors
Duty of Care
In determining whether any defendants had acted with gross negligence in the selection and firing of Ovitz or the approval of the OEA, the Delaware Supreme Court held that the Board was not required to approve the OEA as it had appropriately delegated decisions relating to employment and compensation of company officers to its Compensation Committee, and nothing in the Delaware General Corporation Law mandates that such decisions cannot be delegated.
Plaintiffs also asserted that the Chancellor erred in analyzing liability on a director-by-director basis rather than collectively, despite the fact that they themselves had analyzed the issue that way in their arguments below. The Delaware Supreme Court dismissed this assertion noting that plaintiffs could not show that they were prejudiced in any way by this means of analysis.
In determining whether the compensation committee members breached their duty of care in the creation and approval of the OEA, the Delaware Supreme Court found no reason to overturn the Chancellor’s conclusion that all of the members were adequately informed. This included Poitier and Lozano, who plaintiffs alleged had been uninvolved in the OEA negotiation process and, thus, were materially uninformed. The Court concluded that the evidence supported a finding that discussions regarding payout scenarios and total compensation under the OEA had occurred and had been analyzed among all of the Compensation Committee members. Most significantly, the Court held that under Section 141(e) of the Delaware General Corporation Law, Poitier and Lozano were entitled to rely on their fellow committee members to inform them of the status of the contract, just as the committee as a whole was entitled to rely on their executive compensation expert. The Court concluded that it was not legally relevant that the compensation expert had not attended the committee meetings nor had ever even met Poitier or Lozano—as long as the expert’s analysis and information was relayed by Russell, which they were, the committee members were entitled to rely on the expert’s analysis.
Duty of Good Faith
Plaintiffs also claimed that the Chancellor used a different definition of good faith in his post-trial opinion than he did when deciding an earlier motion to dismiss. In its analysis of the issue of good faith, the Delaware Supreme Court refrained from what many scholars and practitioners hoped it would do — analyze “whether the fiduciary duty to act in good faith is a duty that, like the duties of care and loyalty, can serve as an independent basis for imposing liability upon corporate officers and directors.” Instead, the Court discussed the categories of good faith (or lack thereof) that have developed as a function of Delaware common law.
The Delaware Supreme Court noted that there is the obvious type of lack of good faith that is motivated by an actual intent to harm. On the opposite end of the spectrum is conduct that is grossly negligent without accompanying malevolent intent. This latter category, the Court held, cannot be a basis for a breach of the duty to act in good faith. If it were, the Court opined, the Delaware General Assembly never would have drawn the distinctions that exist in Section 102(b)(7) and Section 145 of the Delaware General Corporation Law between due care and good faith.
A third category of conduct falls between these two categories. Behavior motivated by an “intentional dereliction of duty, a conscious disregard for one’s responsibilities” is the type of bad faith that would both rebut the presumptions of the business judgment rule. Such conduct also falls outside the boundaries of conduct that is exculpable under Section 102(b)(7) of the Delaware General Corporation Law or indemnifiable under Section 145 of the Delaware General Corporation Law.
Using these guidelines, the Delaware Supreme Court found that the Chancellor’s holding that the directors did not breach their duty to act in good faith in connection with Ovitz’s termination was correct. There was sufficient ambiguity in the company’s organic documents for the Court to conclude, based upon extrinsic evidence, that the board and Eisner as CEO had concurrent authority to fire Ovitz. Because Eisner already had undertaken the responsibility to fire Ovitz, the Board did not have to do so — i.e., the members of the Board did not disregard their duties. Finally, the determination that there was no cause to terminate Ovitz, and thus avoid making a NFT payment under the OEA, was made by Eisner and Litvack who, based upon facts supported by the Chancellor’s credibility determinations that must, unless erroneous, be accepted on appeal, found that no such cause existed. The Board was also allowed, for the same reasons discussed above relating to Section 141(e), to rely on this determination.
Lastly, the Delaware Supreme Court dismissed claims of waste noting that such claims arise only in rare circumstances and are extremely difficult to prove. Because the payment to Ovitz was based upon a contractual obligation, that payment could not be considered waste unless the underlying contractual obligation irrationally squandered or gave away corporate assets. Thus, instead of analyzing the NFT payment, the Court analyzed the rationale underlying the creation of the contract 14 months earlier and found that the NFT provisions had a rational business purpose — to induce Ovitz to leave his former employment as the head of a respected and successful talent agency in order to join Disney.
Claims Against Ovitz
Plaintiffs also claimed that Ovitz breached his fiduciary duties of care and loyalty to Disney in two ways: (i) by negotiating for and accepting the NFT provisions of the OEA; and (ii) negotiating a full NFT payout in connection with this termination. In short, both the Court of Chancery and Delaware Supreme Court held that until Ovitz became president and a director of Disney, he did not owe any fiduciary duties, and thus, could not have breached them in connection with any conduct prior to becoming an officer of the company. The Court was not convinced by plaintiffs’ argument that Ovitz had been a de facto officer before the start of his contract due to receipt of financial information, his use of company letterhead and other acts. Rather, the Court found that Ovitz did not assume the duties of an officer by engaging in such activity, but was merely preparing to take office as President.
After Ovitz’ employment ended, plaintiffs argued that he was not fired but was acting to “settle out his contract” and therefore had a duty to convene a Board meeting to consider terminating him for cause. The Delaware Supreme Court viewed the overwhelming evidence that Ovitz was, in fact, fired as dispositive of the question of whether Ovitz breached any duties in connection with settling up his contract. Having presented no factual or legal authority to support their argument that Ovitz was obliged to call a meeting to discuss his termination, plaintiffs failed to carry their burden of proof that Ovitz breached any duty in that regard. Just as Ovitz did not owe fiduciary duties prior to taking office as President, after his termination he was no longer an officer or director of Disney and likewise did not owe fiduciary duties to the company’s shareholders at that time.
The Delaware Supreme Court’s decision regarding the hiring and firing of Ovitz demonstrates the continuing application of the bedrock business judgment rule to boards of directors of Delaware corporations. Although the decision left unanswered the question whether the duty of good faith is a separate fiduciary duty, the decision did clarify the relationship between the fiduciary duty of care and the duty to act in good faith. Although the Court of Chancery’s decision and the Delaware Supreme Court’s decision on appeal describe what would have amounted to “best practices” for the Disney board to follow in the hiring and firing of Ovitz, such descriptions amount to aspirational guidelines. These guidelines are nevertheless informative. Although the defendants in the Disney case fell well short of meeting the guidelines of so-called “best practices,” their failure to do so did not, under these circumstances, result in a finding of liability. Of course, the events and transactions at issue took place approximately ten years ago and it is worth querying whether the conduct of the Disney board would pass muster in today’s arena of corporate governance.