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Following eight years of litigation and a 37-day trial, the Delaware Chancery Court ruled in favor of the Walt Disney directors. As set forth in a 175-page opinion, Chancellor William B. Chandler III concluded that Disney’s Board of Directors did not breach their fiduciary duties to the Company or commit waste by approving CEO Michael Eisner’s decision to hire, and less than one year later to fire, ex-president Michael Ovitz. The long-running lawsuit has been widely seen as a test of the ability of shareholders to challenge corporate decisions and the scope of the protections afforded under the business judgment rule. Although Chancellor Chandler noted that the Board’s conduct fell “significantly short of the best practices of ideal corporate governance” in many instances, he observed that the actions that gave rise to the lawsuit took place a decade ago – before the current notions of best practices were shaped by events like the Enron and WorldCom debacles – and that, unlike ideals of corporate governance, a fiduciary's duties do not change over time. Concluding that even where the Board’s conduct departed significantly from notions of best practices, such conduct is still protected by the business judgment rule, this ruling affirms the strength of the business judgment rule in Delaware and the attendant deference courts will give to decisions made by an independent corporate board in good faith. It is widely expected that an appeal to the Delaware Supreme Court will be pursued. This case started with the sudden death of Disney’s president and COO in April 1994, and Eisner’s heart disease, diagnosed three months later, which forced the Company to launch the search for a successor. Eisner and the Board spent the following year trying to identify a new president, and in July 1995, Eisner undertook serious efforts to recruit Ovitz, who had been his friend for nearly twenty-five years. In September 1995, the Compensation Committee of the Board met for one hour and unanimously voted to approve the terms of Ovitz’s employment agreement. In an executive session, the Board was informed of the reporting structure agreed between Eisner and Ovitz: Ovitz would report directly to Eisner and not to the Board. The Board then unanimously elected Ovitz president. Ovitz’s tenure as president of The Walt Disney Company officially began on October 1, 1995, but by the following summer, it had become clear that he was “a poor fit with his fellow executives.” By the fall of 1996, the Disney directors began discussing Ovitz’s termination, and Eisner and Disney’s general counsel, Sanford Litvack, began discussing whether Ovitz could be terminated for cause. Under the terms of Ovitz’s employment agreement, if Disney fired Ovitz for any reason other than gross negligence or malfeasance, Ovitz would be entitled to a costly non-fault payment (“NFT”) payment. Eisner was therefore hopeful that termination for cause would be possible, but Litvack advised Eisner that he did not believe there was cause for terminating Ovitz under the terms of his employment agreement. At a November 25, 1996 executive session of the Board, Eisner notified the directors present that he intended to fire Ovitz, without cause, by the end of the year. Several meetings between Eisner and Ovitz followed, and Ovitz’s termination was memorialized in a letter dated December 12, 1996. Up to this point, however, the Board had never met to vote on, or even to discuss, Ovitz’s termination in full session and few (if any) directors conducted an independent investigation on whether Ovitz could be terminated for cause. Eisner attempted to contact each of the Board members on December 12 to inform them that Ovitz had been terminated, and none of the Board members objected then or ever to Ovitz’s termination. Following Disney’s payment to Ovitz for the NFT under his employment agreement, in 1997, Disney shareholders filed a derivative suit on behalf of the Company in Delaware Chancery Court. The Complaint alleged that the Board breached its fiduciary duties to the Company by rubber-stamping Eisner’s decision to hire Michael Ovitz, only to fire him fourteen months later. Specifically, Disney shareholders argued that the Board failed to carefully review Ovitz’s employment agreement, particularly the NFT provision, which entitled Ovitz to a severance package worth $140 million. On October 7, 1998, Chancellor Chandler granted defendants’ motion to dismiss, but on appeal, the Supreme Court of Delaware affirmed the decision in part and reversed in part and remanded the case. On remand, the defendants moved to dismiss again, but this time, Chancellor Chandler denied the motion, and the case proceeded to trial. Chancellor Chandler entered judgment for the defendants, holding that:
Furthermore, the Chancellor concluded that once Ovitz was terminated without cause (as a result of decisions made entirely without his input or influence) he was contractually entitled, without any negotiation or action on his part, to receive the benefits provided by his employment agreement for termination without cause – benefits for which he negotiated at arms-length before becoming a fiduciary. In short, as Ovitz did not play a part in the decision to terminate himself, and ordinary officers and directors of reasonable prudence in the same position would not have acted with more care, Chancellor Chandler concluded that Ovitz did not breach his fiduciary duty of loyalty in connection with his termination.
More specifically, the Chancellor held that the evidence at trial showed that Eisner knew Ovitz, was familiar with Ovitz’s career with his previous company, and knew that Disney was in need of a senior executive. In light of this knowledge, the Court concluded that Eisner’s actions were consistent with his subjective belief that he was acting in the best interest of the Company, notwithstanding the high cost of Ovitz’s hiring. Accordingly, Chancellor Chandler held that plaintiffs had not demonstrated by a preponderance of evidence that Eisner failed to inform himself of all material information reasonably available or that he acted in a grossly negligent manner by hiring Ovitz. Although Chancellor Chandler concluded that Eisner’s conduct was protected, he noted that it certainly did not serve as a model of corporate governance. Specifically, he stated that:
In reaching his conclusion, the Chancellor noted that (1) in negotiating with Ovitz, members of the Compensation Committee became privy to a great deal of information with respect to Ovitz; (2) before voting, they were informed of whom Ovitz was, the reporting structure that Ovitz had agreed to, and the key terms of the employment agreement; and (3) information about Ovitz was common knowledge to those in the entertainment industry. In short, the Chancellor concluded that the members of the Compensation Committee “for the most part” knew what they needed to know, did what they were required to do, and were doing the best they could to advance the interests of the Company. Although the Court backed Disney’s Board in the decision to hire and then fire Ovitz, Chancellor Chandler was clearly troubled by the directors’ conduct. Mindful that his ruling might serve as guidance for future directors and officers of Disney and other corporations, the Chancellor emphasized that, while the Disney Board’s actions did not rise to the level of breaching their fiduciary duties, “many lessons of what not to do can be learned from defendants’ conduct here.” At base, the decision is a pragmatic one. Notwithstanding his criticism of the action (and inaction) of the Disney Board in these particular circumstances, Chancellor Chandler’s opinion notes the important distinction between the liability standards governing director/officer conduct and “aspirational ideals” set forth in various standards of best practices. This is an important distinction because it suggests that a director/officer will not be held liable for breach of fiduciary duty if his or her conduct does not conform to the current notions of best practices. Chancellor Chandler emphasized this aspect of his ruling by stating, “the standards used to measure the conduct of fiduciaries under Delaware law are not the same standards in determining good corporate governance.” Along the same pragmatic lines, Chancellor Chandler observed that the market – not the court – must determine when corporate governors have failed to do their jobs. As the Court observed, “redress for failures that arise from faithful management must come from the markets, through the action of shareholders and the free flow of capital, and not from this Court.” Chancellor Chandler emphasized the importance of encouraging directors and officers to make decisions that would maximize value over minimizing risk and cautioned against apportioning liability based on the ultimate outcome of decisions taken in good faith but ending in failure, which would defeat the “entire advantage of the risk-taking, innovative, wealth-creating engine that is the Delaware corporation, … with disastrous results for shareholders and society alike.” Recognizing that “the essence of business is risk — the application of informed belief to contingencies whose outcomes can sometimes be predicted, but never known,” Chancellor Chandler confirmed that, under Delaware law, a court will not second-guess a decision made by an independent board in good faith, even if that decision “ends in a failure, once hindsight makes the result of that decision plain to see.” Accordingly, pending any decision on appeal, the ruling provides some comfort to directors and officers that decisions they make, even those that turn out to be wrong with the benefit of hindsight, will be protected by the business judgment rule, when made in good faith. In re the Walt Disney Company Derivative Litigation (Delaware Court of Chancery, New Castle County C.A. No. 15452) This e-mail note is a summary for general information and discussion only and is not intended as legal advice or as a legal opinion. This note is not intended to represent the views of the Firm or its clients. Attorneys Evan Shapiro, Cecilia Kaiser and Maurice Pesso in New York and David Burrowes in Chicago contributed to the content of this note; the views expressed are those of the authors. For more information or to discuss this matter further, please do not hesitate to contact any of the authors or your usual BSWB contact. |
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