On August 9, Chancellor William Chandler of the Delaware Court of Chancery issued his long-awaited opinion finding the directors of The Walt Disney Company not liable for breach of fiduciary duty related to the hiring, terms of employment and termination of Michael Ovitz.  The 174-page opinion (available here) includes over 100 pages of detailed findings of fact relating to the hiring of Ovitz as Disney’s President in 1995, his fourteen months of generally lackluster performance and his no-fault termination in 1996 entitling him to severance benefits totaling as much as $140 million.

The Chancellor was critical of many aspects of the process leading to the hiring of Ovitz, the determination of his terms of employment and, to some extent, his termination. “For the future,” he noted, “many lessons of what not to do can be learned from defendants’ conduct here.”  He singled out Disney CEO Michael Eisner, who he characterized as “imperial” and “Machiavellian,” for special criticism.

Nevertheless, he concluded that the Disney directors (including Eisner) had not been grossly negligent in breach of their fiduciary duty of care in that process and that Ovitz’s large severance package did not amount to a “waste” of corporate assets.  He confirmed that directors may be personally liable for damages for breach of an independent fiduciary duty of good faith, even in the absence of self-interest or fraud, if they consciously disregard or are deliberately indifferent to their duties.  He found, however, that the Disney directors (including Eisner) had not breached this duty of good faith – a crucial finding, since breach of good faith (as opposed to duty of care) is not subject to director exculpation under Section 102(b)(7) of the Delaware General Corporation Law and may not be subject to indemnification under Delaware law or to D&O insurance coverage.

The Chancellor also found that Michael Ovitz had not breached his fiduciary duty of loyalty in connection with his termination since he played no part in the decisions made to terminate him or to characterize that termination as not-for-cause under his employment agreement.

Several important lessons emerge from this opinion, which is the culmination of one of the most highly publicized corporate legal battles in history and one of the longest trials ever in the Delaware courts.

The Independent Duty of Good Faith Lives

The Chancellor’s opinion does more to define the third rail of director fiduciary duty than any case to date.  In addition to conscious and intentional disregard for duties, the Chancellor notes that the most salient examples of bad faith would be where a fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation or where a fiduciary acts with the intent to violate applicable positive law.

Director liability that is not subject to exculpation, indemnification or D&O insurance may be a solution of last resort, but it is definitely on the table.  Although the Chancellor found the Disney directors (including Eisner) to have acted in good faith, he warns that it “is precisely in this context – an imperial CEO or controlling shareholder with a supine or passive board – that the concept of good faith may prove highly meaningful.”

The Business Judgment Rule Also Lives

The Chancellor also confirmed that reports of the demise of the business judgment rule have been greatly exaggerated.  The presumption that disinterested directors making a decision in the best interests of the corporation in good faith and with reasonable information are acting consistently with their fiduciary duty of care is an essential bulwark against post hoc judicial second-guessing of business decisions and an essential element in Delaware corporate law.

The Chancellor considered the “more than ample record” both with respect to the board acting as a whole and with respect to each individual director.  He consistently found that the plaintiffs had failed to show gross negligence in the process or failure to be informed and had, consequently, failed to rebut the business-judgment-rule presumption.

Plaintiffs likened the Disney board’s deliberative process to that of the Trans Union board in the landmark decision of Smith v. Van Gorkom (Del. 1985).  In that case, the Delaware Supreme Court found that a disinterested board was not protected by the business judgment rule because of gross negligence in failing to be informed when it decided to sell the corporation in a two-hour board meeting without reviewing key documents and without receiving a fairness opinion or other meaningful report on corporate value.  The Chancellor distinguished Van Gorkom from the Disney facts in a number of ways.  Perhaps most important, he noted that reasonable process and information bear a relation to the magnitude of the matter considered.  Even though $140 million is a large sum, it was not material to Disney overall and was not analogous to a decision to sell the entire corporation.

Process Is Key; Minutes Are the Official Record

The opinion is an assessment of the process surrounding the hiring, terms of employment and termination of Ovitz.  The minutes of Disney’s board and compensation committee were primary evidence not only of the actions taken, but of the quality of the deliberative process:  what documents were reviewed, what questions asked, what expert reports heard, what information disclosed, how much time spent? Most of the events in question in Disney took place nearly 10 years before the trial, and memories regarding review and deliberation not clearly reflected in the minutes were often faded.

The plaintiffs in Disney tried to take advantage of perceived weaknesses in the minutes.  They repeatedly argued that if it was not in the minutes, it did not happen.  They also relentlessly parsed and analyzed the minutes, for example, taking the position that topics given little ink must have been given perfunctory treatment by the directors.

Good minutes must accurately and clearly memorialize good process.  And, in the age of Disney and Sarbanes-Oxley, it is clear that committee minutes require as much attention in this regard as full-board minutes.

For a thorough discussion of best practices in preparation of corporate minutes, see our June 2005 Corporate Update entitled “Up-to-the-Minutes:  Best Practices in Memorializing Board and Committee Meetings” (available here).

Make Sure Process and Practice Are Consistent with Bylaws and Charters

A key finding with respect to the termination of Ovitz was that, under Disney’s bylaws and committee charters, the CEO had the authority to terminate an officer.  The Chancellor came to this conclusion only after analyzing closely the relevant documents and hearing extensive interpretive argument.  Because Eisner had that authority, the board was not required to consider and approve the termination of Ovitz, and their failure to do so was not subjected to further scrutiny.

Bylaws and committee charters should be reviewed regularly.  Directors, committee members and officers should be familiar with their respective responsibilities and authorities.  If those responsibilities and authorities are not clearly delineated or do not mesh with governance process and practice, then changes should be made.

Conclusion

The Disney decision should be reassuring to directors in many ways.  In a sweeping introduction to the opinion, the Chancellor emphasized that best practices in corporate governance have changed substantially since 1995.  But he also emphasized that failure to comply with aspirational best practices does not result in liability for breach of fiduciary duty and that protection of disinterested directors from liability related to honest decisions that go bad is still an essential tenet of corporate law and a key factor in maximizing shareholder value.