Michael G. O'Bryan
Litigation, Securities Litigation, Securities Enforcement, Investigations + White Collar Defense, Financial Services, and Finance
On August 9, 2005, the Delaware Chancery Court issued its post-trial opinion in In re The Walt Disney Company Derivative Litigation. The facts of the case are set out in detail in the opinion. What follows is a preliminary analysis of some of the key messages that can be drawn from the opinion.
The court found that the Disney directors did not violate their fiduciary duties or commit waste in the 1995 hiring and 1996 termination of Michael Ovitz as president of Disney.
Fiduciary Duties and the Business Judgment Rule
Directors Should Take Comfort from the Business Judgment Rule. The court acknowledged the risks inherent in business and the advantages of allowing boards to accept risks. The business judgment rule accordingly prevents courts from second-guessing business decisions. Redress for bad business decisions "must come from the markets, through the actions of shareholders and the free flow of capital," rather than from courts.
Section 102(b)(7). Similarly, the court noted that one of the primary purposes of Section 102(b)(7) of the Delaware General Corporation Law is to "encourage directors to undertake risky, but potentially value-maximizing, business strategies, so long as they do so in good faith." A Section 102(b)(7) provision in a certificate of incorporation will prohibit recovery of monetary damages from directors for shareholder claims exclusively based on a violation of the duty of due care.
"Best Practices" May be a Step Beyond Fiduciary Duties. The court observed that "many aspects of the defendants’ conduct … fell significantly short of the best practices of ideal corporate governance." In particular, with respect to Mr. Eisner, the court found that:
Eisner’s actions in connection with Ovitz’s hiring should not serve as a model for fellow executives and fiduciaries to follow. His lapses were many. He failed to keep the board as informed as he should have. He stretched the outer boundaries of his authority as CEO by acting without specific board direction or involvement. He prematurely issued a press release that placed significant pressure on the board to accept Ovitz and approve his compensation package in accordance with the press release. To my mind, these actions fall far short of what shareholders expect and demand from those entrusted with a fiduciary position. Eisner’s failure to better involve the board in the process of Ovitz’s hiring, usurping that role for himself, although not in violation of law, does not comport with how fiduciaries of Delaware corporations are expected to act.
The court noted that, while it could "encourage" best practices, it could not require them, and did not attempt to describe best practices in detail. The court also noted that best practices may evolve over time, but that fiduciary duties should be constant.
Required Steps are Proportional. The actions required of directors are proportionate to the circumstances. The court distinguished the sale of the company at issue in the 1985 Van Gorkom case, in which directors were found to have violated their duty of care, from the compensation issues in Disney as, "[f]irst and foremost, …orders of magnitude more important."
Directors are Judged Individually. The court, citing the 2004 Emerging Communications decision, noted that both the nature of any breach and eligibility for exculpation may differ between individual directors.
The Duty of Good Faith
Still Not Entirely Clear. The court noted that the Delaware Supreme Court and other Chancery Courts have not been clear as to whether good faith is a separate duty, or as to exactly what good faith is. Issues of good faith are "inseparably and necessarily intertwined with the duties of care and loyalty," which themselves are "but constituent elements of the overarching concepts of allegiance, devotion and faithfulness that must guide the conduct of every fiduciary." The court nonetheless found that the distinction between these duties is significant because of the limits imposed by Sec. 102(b)(7). A showing that directors acted in bad faith also will overcome the presumption of the business judgment rule.
Requirements. The court felt it easier to define bad faith rather than good faith, but stated the requirements of good faith as follows: "To act in good faith, a director must act at all times with an honesty of purpose and in the best interests and welfare of the corporation…. [G]ood faith … includes not simply the duties of care and loyalty…, but all actions required by a true faithfulness and devotion to the interests of the corporation and its shareholders."
Potential Violations. The court expressly avoided trying to create a "definitive and categorical definition" of acts that would constitute bad faith. Instead, the court provided a short, non-exclusive list of examples of bad faith (with emphasis on the intentional nature of the acts added):
The Duty of Loyalty
The only duty of loyalty question addressed by the court was whether Ovitz breached his duty by negotiating his own termination. The court found, though, that Ovitz did not breach that duty because he did not "improperly interject himself into the corporation’s decision making process [or] manipulate[e] that process." Indeed, the court found that Ovitz played "no part" in the decisions to terminate his employment or to make the termination not for cause, and that once terminated he was entitled to receive the benefits he had negotiated before he became a fiduciary.
What Directors Should Do
The opinion’s conclusions emphasize a number of actions that the court felt directors generally should take. These actions should not be considered to be a check list and may not be appropriate in every situation.
Prepare for Meetings and Discussion.
The amount of notice, and the finality or formality of the written materials, will depend in part on the matters under consideration and the availability of those materials.
Board Discussions. Informal discussions among board members can help, but too much reliance on one-on-one discussions between board members and management has been criticized for lack of uniformity of information and absence of collegiality and deliberation.
Minutes. The court observed that, under the circumstances of this case, it would have been helpful if the minutes had indicated that the discussion related to Ovitz’s employment was longer and more substantial than the discussion of other topics on the agenda at a compensation committee meeting. However, that observation should not be taken as a general admonition to prepare detailed minutes reflecting discussions at committee or board meetings. What is important is that the minutes reflect the fact that material issues were considered and (if true) voted upon. The minutes also should indicate any materials or reports received by the board in connection with the meeting, and, where appropriate, that such materials were provided in advance of the meeting.
Be Proactive. Review materials and ask questions.
Red Flags and Yellow Flags. Watch for actions or inactions that may harm the corporation. Ask about important matters, even if not on the agenda, and, where appropriate, request that they be considered by the board itself. Some of these flags may occur to a director because of information that director has through experience outside the board, and not through materials prepared by the company or its advisors.
Try to Follow "Best Practices." Even if not required, these are encouraged by the court, and it will not always be easy to distinguish between the requirements of best practices and fiduciary duties. Best practices may differ between companies. Once a practice is established, however, it should be followed.
Beware the "Imperial CEO." The court noted that Eisner’s actions in "stacking" the Disney board and preempting its role may have handicapped the board’s decision making abilities. The court also noted that the concept of good faith may "prove highly meaningful" in a company with "an imperial CEO or controlling shareholder with a supine or passive board."
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