The Disney affirmance: the end of the SOX era?

I had thought that the Delaware supreme court was getting ready to reverse the dismissal in Disney. Well, it wasn't, or at least didn't. (HT Francis Pileggi for linking the opinion). Not only did it affirm Chancellor Chandler's holding, but it affirmed the Delaware approach to corporate governance in the face of the post-Enron trend in the other direction.

First a recap of how my reasoning about the possible reversal stands up to the actual opinion. 

My overall judgment was not as much legal as political:

I suspect the court might conclude that, in light of SOX and the expansion of federal power, now is not the time for the Delaware courts to wimp out on fiduciary duties. Maybe the court believes that it needs to not only pay lip service to Van Gorkom, but also come up with a holding based on it.

More on the politics below.

On the law, I pointed out that the court would not second-guess the Chancellor’s gross negligence analysis, and it didn’t.

I also said the court would interpret bad faith for purposes of 102(b)(7) as requiring at least “conscious and intentional disregard of responsibilities.” As I said, “What's the alternative, unless the court eviscerates 102(b)(7) and go back to something like a gross negligence rule?”

I was right about that, and even close on the language.  The court said (p. 68):

To adopt a definition of bad faith that would cause a violation of the duty of care automatically to become an act or omission “not in good faith,” would eviscerate the protections accorded to directors by the General Assembly’s adoption of Section 102(b)(7).

I thought the court might reverse on the technicality that the mere fact that Eisner had the power to fire Ovitz on his own didn’t mean the board didn’t have a fiduciary duty to intervene, and then remand to determine whether that duty had been breached. I saw this as a way that the court could “preserve VG without too great an expansion of the board's duties,” and thereby not “wimp out” on fiduciary duties given SOX and the public spotlight on corporate governance.

Here I was wrong, and in that error lies the tale of this case. To summarize:

1. Van Gorkom is still dead.  Of course there's still gross negligence liability, but not a la Van Gorkom.  As I've said:

Van Gorkom did not involve conscious disregard. It did not involve a "supine" board's failure to pay attention to one of the highest-profile employment contracts in the history of business. It involved nailing an experienced, sophisticated board for selling the company for 40% more than the current market price. Would that happen again, at least in a 102(b)(7) situation? No way. No earthly way, unless, as I do not believe will happen, the Supreme Court reverses in Disney.

Also recall that in Van Gorkom the court held that the board had to jump through all the good governance hoops – look at the documents, have the meetings. It wasn’t enough that they actually knew what the company was worth without all that procedure – that, as Justice McNeilly said in dissent, “the 10 members of Trans Union’s Board of Directors were highly qualified and well informed about the affairs and prospects of Trans Union.”

Well, this time the court made very clear that the board’s background information was enough to avoid gross negligence. The documentation may not have been up to “best practices,” but they got information from other sources. In particular, as the court emphasized (p. 51) they didn’t have to be told what Ovitz would be getting if he were terminated without fault – they could put this together from the “downside protection” they knew he would be demanding to get him to leave his highly lucrative job at CAA.

2. It follows that the only way a board is going to be held liable for breach of fiduciary duty when it it isn't self-dealing is to (1) really not have any idea what it is doing; and (2) not have a 102(b)(7) clause in the charter; or (3) have such a clause but proceed in conscious disregard of the board's responsibility, which would be truly puzzling in the absence of self-dealing. In other words, the board will be liable for non-self-dealing conduct on a cold day in August in Miami under a blue moon.

3. The opinion resoundingly denounces the federal approach to corporate governance in SOX. The opinion says that the court is going to trust the board's judgment as long as the board shows any sign of actually exercising this judgment. The board is not going to be liable for not jumping through some prescribed set of hoops as long as it comes out in generally the right place. The board is not going to be liable because it pays an executive what looks like a lot of money for doing what looks like a bad job if that money in fact represented what it took to hire him, if there were reasons to think that he would do a good job, and judging his performance in light of the facts and circumstances that prevailed at the time. (Some of this reasoning is in connection with the court’s determination that there were no grounds for firing Ovitz with cause under the employment agreement.)

4. Mark Roe may have to revise his theory of the feds as “Delaware’s Competition” in light of this opinion. Given the observations in (3), the court did not act like it was under the thumb of the federal legislature that enacted SOX.

5. Alternatively, maybe any federal threat that once existed has at least temporarily subsided under weight of the all the criticism of SOX. Perhaps if the supreme court had decided this case a year ago the result would have been different. But right now the traditional Delaware way of doing things looks pretty good compared to the federal alternative, and there was no reason for the Delaware supreme court to change its approach.

I have called this the “case of the decade" and described it as “both high profile and the exact right facts to test whether there was anything left of a non-loyalty fiduciary duty.” I also said that Chancellor Chandler’s opinion last summer was “the official end of the Enron era.” Maybe the supreme court’s opinion was the official end of the SOX era.

Update:  I've posted some questions about Disney over at Conglomerate.

Comments

[Francis Pileggi]

Thanks for the hat tip.

[Jeff Lipshaw]

Larry, I think you give too much credit to SOX by characterizing its passage as a "federal approach." "Approach" suggests there is an underlying philosophy that creates an integrated and systematic legislative response to a problem (e.g., you can argue that the drafters of the UCC had an approach).

I think Roberta Romano's exhaustive treatment of the legislative history demonstrates that the only "approach" behind SOX was a series of statutory directives that responded to the particular sins of Enron and WorldCom. My far more puerile approach to SOX also tried to say that, but also to make the jurisprudential point that you simply cannot capsule the subtleties of business judgment (and fiduciary duties) in a series of rifle shot statements of positive law.

SOX wasn't an "approach." It was a reaction.