I have decided to post a few thoughts about the Disney case in advance of Chancellor Chandler’s impending decision. Most importantly, I have taken the liberty of posting the opinion, beating the Chancellor to the punch. The tradeoff for the reader is that this version will be somewhat less authoritative than the one the Chancellor will issue later, since this one is written by me, not him. But I think that I have accurately predicted what he’s going to say.
First some background. As I have said, this may be the case of the decade. It has all the ingredients: A very public company that we all know; a colorful and autocratic CEO; a dramatic fact situation involving an ill-fated friendship; a close case on the law; and a case whose adjudication has straddled several eras in the rapidly shifting corporate law landscape of the last 5 years.
The case involves Eisner’s decision in December 1995, per an agreement backdated to October 1, 1995, with some disputed amount of board participation, to hire Michael Ovitz under an agreement that gave Ovitz significant compensation if he were terminated at any time, and more if he were terminated without cause. In December 1996 Ovitz left with a severance package the original complaint in this case valued at over $140 million. Despite Ovitz’ ineffectiveness throughout the term of his agreement, he was terminated without cause. The complaint sought damages from Eisner, Ovitz, the members of the board that approved the original agreement, and the members of the board that later agreed to a non-fault termination.
The chancery and supreme courts initially dismissed the complaint, the supreme court decision coming in 2000 (Brehm v. Eisner, 746 A.2d 244 (Del. 2000). That, as you may recall, was a happier era for corporate law. Enron was still revolutionizing markets, we still had five big and healthy accounting firms, Sarbanes was an obscure senator from Maryland, and who ever heard of Oxley? Call it the pre-Enron era.
The basis for the dismissal was, of course, the business judgment rule. The board’s substantive judgment, as mistaken as it may have looked in hindsight, was entitled to the rule’s protection absent a conflict of interest or breach of the duty of care. There was no conflict, and the board fulfilled its duty of care by relying on a compensation expert, Graef Crystal – though Crystal’s statements to the media ultimately cast doubt on the reliability of his judgment. This was all consistent with the Delaware courts’ post-Van Gorkom view of the duty of care.
Then came Enron, and the post-Enron Sarbox world. The word on everybody’s lips was accountability. Now Eisner looked like the sort of runaway executive the law needed to control, and the board looked like the sort of supine dupes that needed a legal wakeup call.
Moreover, following the dismissal, the plaintiff amended the complaint. Following the court’s suggestion, plaintiff used a books and records request under Del. G.C.L. section 220 to obtain information about the Disney board’s participation in the decision to hire and subsequently terminate Ovitz. The amended complaint alleged, essentially, that the formal processes the Disney board followed indicated a willful disregard of relevant considerations – risks, costs, alternatives.
In 2003, Chancellor Chandler refused to dismiss the amended complaint. In re Walt Disney Company Derivative Litigation, 825 A.2d 275 (Del. Ch. 2003).
With this background, here’s a preview of Chancellor Chandler’s opinion. Of course I’ll not attempt to lay it out in full, but just give what I think will be the salient elements, based heavily on Chandler’s 2003 opinion, and insights that can be gleaned from E. Norman Veasey (who wrote the 2000 supreme court opinion in Disney) and Christine T. DiGuglielmo, What Happened in Delaware Corporate Law And Governance From 1992-2004? A Retrospective on Some Key Developments, 153 U. Pa. L. Rev. 1399 (2005), particularly 1439-42.
Opinion after trial, July, 2005 (Ribstein predicting Chandler):
1. First, I emphasize the principles underlying the business judgment rule. As I said in concluding my 2003 opinion: “after-the-fact litigation is a most imperfect device to evaluate corporate business decisions, as the limits of human competence necessarily impede judicial review.”
2. We must also remember that the corporation here, through a charter provision inserted pursuant to Delaware Code section 102(b)(7), explicitly restricted liability for breach of the duty of care.
3. In the opinions on the initial complaint, I was faced with allegations that went no further than a breach of the duty of care. Most importantly, the allegations did not overcome the presumption that the board’s relied in good faith on the advice of an expert pursuant to Delaware Code section 141(e).
4. However, the new complaint includes additional allegations. As I said in my 2003 opinion:
These facts, if true, do more than portray directors who, in a negligent or grossly negligent manner, merely failed to inform themselves or to deliberate adequately about an issue of material importance to their corporation. Instead, the facts alleged in the new complaint suggest that the defendant directors consciously and intentionally disregarded their responsibilities, adopting a "we don't care about the risks" attitude concerning a material corporate decision. Knowing or deliberate indifference by a director to his or her duty to act faithfully and with appropriate care is conduct, in my opinion, that may not have been taken honestly and in good faith to advance the best interests of the company. Put differently, all of the alleged facts, if true, imply that the defendant directors knew that they were making material decisions without adequate information and without adequate deliberation, and that they simply did not care if the decisions caused the corporation and its stockholders to suffer injury or loss. Viewed in this light, plaintiffs' new complaint sufficiently alleges a breach of the directors' obligation to act honestly and in good faith in the corporation's best interests for a Court to conclude, if the facts are true, that the defendant directors' conduct fell outside the protection of the business judgment rule.
I concluded:
[Our corporation law's theoretical justification for disregarding honest errors simply does not apply to intentional misconduct or to egregious process failures that implicate the foundational directoral obligation to act honestly and in good faith to advance corporate interests. Because the facts alleged here, if true, portray directors consciously indifferent to a material issue facing the corporation, the law must be strong enough to intervene against abuse of trust. Accordingly, all three of plaintiffs' claims for relief concerning fiduciary duty breaches and waste survive defendants' motions to dismiss. The practical effect of this ruling is that defendants must answer the new complaint and plaintiffs may proceed to take appropriate discovery on the merits of their claims. To that end, a case scheduling order has been entered that will promptly bring this matter before the Court on a fully developed factual record.”
5. Moreover, regarding Delaware code section 102(b)(7), I emphasized in my 2003 opinion that this section does not insulate a defendant from allegations that go beyond a mere breach of the duty of care, including “acts or omissions not in good faith, or which involve intentional misconduct.” I pointed out that
a fair reading of the new complaint, in my opinion, gives rise to a reason to doubt whether the board's actions were taken honestly and in good faith . . . Since acts or omissions not undertaken honestly and in good faith, or which involve intentional misconduct, do not fall within the protective ambit of § 102(b)(7), I cannot dismiss the complaint based on the exculpatory Disney charter provision.
6. So the question for decision today is whether the evidence at trial supports the complaint’s allegations and meets the standards for liability under the business judgment rule and Section 102(b)(7). After a thorough trial in which the facts were ably and fully presented on both sides, I conclude that this record does not support relief.
7. In reaching this conclusion I emphasize that my 2003 opinion relied on facts that plaintiff was able to determine through a records request under Section 220. This necessarily limited me to matters occurring at formal meetings and reflected in committee and board minutes. These records indicated that the board had failed to meet the good faith standard.
8. However, testimony in this case shows that, while formal discussions were sparse, the board was involved in informal discussions that established that they were, in fact, acting in good faith by considering the facts and alternatives. The evidence shows that the board was aware, among other things, of the need quickly to appoint a president given the gaps in management that the company was facing; the need to find someone who was both compatible with Eisner and had the requisite knowledge of the industry; the significant risks and opportunity costs Ovitz was facing in giving up his lucrative business and joining Disney, and therefore the need to compensate him handsomely and protect him from those risks; the need to quickly and cleanly terminate him when it became evident that he wasn’t working out; and the potential cost and embarrassment to the company at a critical time that would have been entailed had the company pressed a for-cause termination.
9. We must remember that while such informal discussions are not a proper substitute for the corporate procedures we have stressed in our opinions, the issue here is whether the board acted in bad faith. With respect to this issue, we must consider all of the board’s efforts to be involved in corporate decisions, whether or not it was following the best corporate practice. Moreover, given the highly sensitive and emotional nature of the employment decision here, I cannot conclude that it was bad faith for the board to engage in decisionmaking other than formal board and committee meetings and laid out in a formal record.
10. Regarding Ovitz’s liability, I said in my 2003 opinion:
[T]he Ovitz/Eisner exit strategy allegedly was designed principally to protect their personal reputations, while assuring Ovitz a huge personal payoff after barely a year of mediocre to poor job performance. These allegations, if ultimately found to be true, would suggest a faithless fiduciary who obtained extraordinary personal financial benefits at the expense of the constituency for whom he was obliged to act honestly and in good faith. Because Ovitz was a fiduciary during both the negotiation of his employment agreement and the non-fault termination, he had an obligation to ensure the process of his contract negotiation and termination was both impartial and fair. The facts, as plead, give rise to a reasonable inference that, assisted by Eisner, he ignored that obligation.
However, the facts proved at trial indicate that Ovitz was guilty of no more than following through on the terms of a contract that, as I have said, were designed to protect him from exactly the career risks that unfolded.
11. In denying liability, I am mindful that Disney management was hardly a model of good governance during this period. But I am also mindful of the supreme court’s admonition in its 2000 opinion:
All good corporate governance practices include compliance with statutory law and case law establishing fiduciary duties. But the law of corporate fiduciary duties and remedies for violation of those duties are distinct from the aspirational goals of ideal corporate governance practices. Aspirational ideals of good corporate governance practices for boards of directors that go beyond the minimal legal requirements of the corporation law are highly desirable, often tend to benefit stockholders, sometimes reduce litigation and can usually help directors avoid liability. But they are not required by the corporation law and do not define standards of liability.
12. Finally, I emphasize that the chancery court stands ready to act when officers and directors have breached their duties to the shareholders and the corporation. It is important to remember that this is not a case of fraud or looting. Whatever defects of governance that the record discloses, the officers and directors were performing their jobs in good faith. Unlike other companies in the past few years, no major scandals have been inflicted on Disney, and it remains a healthy, thriving company. Not only the directors, but also the shareholders, have proven up to the task of governing the firm without the court’s help. But when this is not the case, and managers have breached their legal duties, the Delaware courts will not hesitate to act.
Having outlined the opinion, I want to add some background. First, as I suggested above, this case straddles several recent eras of corporate history. It has moved from the pre-Enron era, to the post-Enron era of distrust of managers and of the laissez-faire Delaware approach, to the post-post-Enron era of distrust of regulation.
In this current era, Delaware no longer faces the threat of imminent federalization that seemed to loom a few years ago. So Leo Strine can comfortably bash Sox, as he did recently in London.
But the current political equilibrium, like any equilibrium in modern corporate law, is tenuous. As Mark Roe has pointed out, Delaware lives under the continual threat of federalization. Nothing could exacerbate that threat more than a perception that Delaware is simply not up to the task of monitoring corporate governance. And no single event could create that perception more than a highly visible opinion in a highly visible case that seems to let bad managers off the hook.
All of this suggests that Chancellor Chandler is under pressure to impose liability in this case. Nevertheless, I believe that he will do what he thinks is legally right even if it is not necessarily politically expedient. Moreover, the federal threat must be balanced against the consistency and reasonableness that Delaware’s clientele demands.
My only hesitation about the result in this case is not politics, but the actual facts. I did not attend the trial, and have only incomplete press reports of the testimony. I may be wrong about the evidence, and therefore about the result.
The chancellor will not, however, be unmindful of the political context. Though I don’t expect this to affect his result, it may affect the language of the opinion. Therefore I expect the opinion, like the supreme court’s 2000 opinion, to include admonitions about the relative roles of good corporate practice and legal liability. I also expect Chandler to emphasize that this case is not Enron.
As for the supreme court opinion, the first question is whether there will be one. As I have written, there are some pressures here, notably including from insurers, for clarification of the applicable rules, that may outweigh the risk of an appeal.
Assuming that there is a supreme court opinion, I expect the outcome to depend to some extent on the political environment at the time, which no one can predict. The supreme court has always been more sensitive to political considerations than chancery.
The biggest effect of this case in the little world of corporate law professors is that, whatever the result, maybe we can finally stop teaching Van Gorkom, and focus on the much more entertaining world of Eisner and Ovitz.
Obviously I have displayed considerable courage in this post. I do hope that the blogosphere will take this into account in comparing this post to the ultimate opinion.
Well done.
Posted by: Francis Pileggi | July 10, 2005 at 03:13 PM