(August 2005, Business & Securities Litigator)
By E. Norman Veasey and Stephen A. Radin
On August 9, 2005, the Delaware
Court of Chancery issued its long-awaited decision in In re Walt Disney
Co. Derivative Litigation
, No. 15452 (Del. Ch. Aug. 9, 2005). Following
a 37-day trial with over 1000 exhibits, the court entered judgment in favor
of the Walt Disney Company directors sued in the case and against the stockholder-plaintiffs
on all counts.
As widely reported, the case involved
alleged breaches of fiduciary duty by Disney’s directors in connection
with the hiring of Michael Ovitz as president of Disney in 1995 and termination
of Ovitz in 1996 pursuant to a non-fault termination. The termination agreement
provided Ovitz “roughly $38 million in cash” and the immediate vesting
of 3 million options to purchase Disney shares. Disney acted after [i]
in the court’s words, “[t]o everyone’s regret, . . . Eisner was unable
to work well with Ovitz,” leaving Eisner “with the only alternative he
considered feasible - termination,” and [ii] Disney determined - correctly,
according to the court - that Ovitz had not committed gross negligence
or malfeasance and could not have been terminated for cause. The court
noted that the case “has become something of a public spectacle - commencing
as it did with the spectacular hiring of one of the entertainment industry’s
best-known personalities to help run one of its iconic businesses, and
ending with a spectacular failure of that union, with breathtaking amounts
of severance pay the consequence.”
Chancellor William B. Chandler
III held that each of Disney’s directors, including Eisner, Eisner’s
personal attorney who served as chairperson of the compensation committee,
and each of Disney’s outside directors, “fulfilled his or her obligation
to act in good faith and with honesty of purpose.” The court reaffirmed
the vitality of the business judgment rule and embraced the venerable rule
that courts should not discourage risk-taking - the court called this “the
essence of business” - by using “perfect hindsight” to second-guess
decisions by disinterested and independent directors who act on an informed
basis and in good faith, even when those decisions go “awry, spectacularly
At the same time, the court observed
[i] that Disney’s directors were “taken on a wild ride, and most of it
was in the dark” and that “there are many aspects of defendants’ conduct
that fell significantly short of the best practices of ideal corporate
governance;” [ii] that “the actions (and the failures to act) of the
Disney board that give rise to this lawsuit took place ten years ago,”
before “the Enron and WorldCom debacles, and the resulting legislative
focus on corporate governance,” and [iii] that “applying 21st century
notions of best practices in analyzing whether those decisions were actionable
would be misplaced.” Future decisions will develop and clarify the extent
to which “21st century notions of best practices” will be used by courts
to define the scope of the duties of directors in board decisions made
No short paper written in the hours
following the decision can summarize - much less do justice to - the detailed
facts and many important legal issues addressed in the court’s 175 page,
591 footnote decision. We simply summarize what we believe are some of
the key lessons of the decision and provide - in Chancellor Chandler’s
words - “guidance for future officers and directors.” In sum, directors
should take comfort in the court’s re-affirmation of traditional corporate
governance principles and refusal to assess liability simply because board
conduct was neither perfect nor close to perfect. Directors also should
continue to seek to perform their duties in a vigilant manner: this is
the right thing to do for shareholders, and this will minimize the risk
1. Fiduciary Duties, Not
Aspirational Standards of Conduct, Establish Standards of Liability. But
Compliance with Aspirational Standards of Conduct Certainly Helps Avoid
The court emphasized the distinction
between “compliance with fiduciary duties” and “best practices of corporate
governance”: the latter includes the former, but the former does not necessarily
include the latter. The court stated that “[t]his Court strongly encourages
directors and officers to employ best practices, as those practices are
understood at the time a corporate decision is taken,” but that “Delaware
law does not . . . hold fiduciaries liable for a failure to comply with
the aspirational ideal of best practices, any more than a . . . court deciding
a medical malpractice dispute can impose a standard of liability based
on ideal - rather than competent or standard - medical treatment practices.”
Rather, courts determine whether to assess liability on a director by “measur[ing],
in light of all the facts and circumstances of a particular case, whether
an individual who has accepted a position of responsibility over the assets
of another has been unremittingly faithful to his or her charge.”
Of course, following aspirational
ideals often is the best way by which a director can be “unremittingly
faithful to his or her charge.” As stated by the Delaware Supreme Court
in an earlier decision in the case, “[a]spirational ideals of good corporate
governance practices . . . can usually help directors avoid liability.
But they are not required by the corporation law and do not define standards
of liability.” Brehm v. Eisner
, 746 A.2d 244, 256 (Del. 2000).
2. Courts Defer to Business
Judgments by Disinterested and Independent Directors.
The decision makes clear that recent
reports of the death of the business judgment rule are incorrect. The court
emphasized that “[i]t is easy, of course, to fault a decision that ends
in a failure, once hindsight makes the result of that decision plain to
see.” The court also emphasized that “the essence of business is risk
- the application of informed belief to contingencies whose outcomes can
sometimes be predicted, but never known.” The court stated that if courts
were to assess liability “based on the ultimate outcome of decisions taken
in good faith by faithful directors or officers, those decision-makers
would necessarily take decisions that minimize risk, not maximize value”
- an outcome the court condemned.
In short, “[t]he redress for failures
that come from faithful management” continues to “come from the markets,
through the action of shareholders and the free flow of capital, and not
from this Court.”
3. Section 102(b)(7) “Director
Protection” Charter Provisions Work.
The court noted that the “vast
majority of Delaware corporations” have adopted charter provisions prohibiting
recovery of money damages from directors for duty of care claims. Plaintiffs
in the Disney
case thus could not prevail even if they could prove
gross negligence (which, the court found, plaintiffs did not prove). Rather,
plaintiffs were required to prove conduct that was not in good faith -
an even more difficult showing.
4. Good Faith, for the Purposes
of Both The Business Judgment Rule And Section 102(b)(7) Charter Provisions,
Requires More than Just Care and Loyalty, Defined Narrowly.
The court stated that the fiduciary
duties owed by directors are the duties of care and loyalty and that “[d]ecisions
from the Delaware Supreme Court and the Court of Chancery are far from
clear with respect to whether there is a separate fiduciary duty of good
faith.” Indeed, the court stated, the concept of good faith (or bad faith)
is shrouded “in the fog of . . . hazy jurisprudence.”
The court sought to provide guidance concerning good faith. The court stated that “[t]he good faith required
of a corporate fiduciary includes not simply the duties of care and loyalty
. . . in the narrow sense . . . but all actions required by true faithfulness
and devotion to the interests of the corporation and its shareholders.”
The court identified the following three “most salient” examples of “[a]
failure to act in good faith” or “bad faith,” all of which include the
element of intent:
- “where the fiduciary intentionally
acts with a purpose other than that of advancing the best interests of
- “where the fiduciary acts with
intent to violate applicable positive law,” or
- “where the fiduciary intentionally
fails to act in the face of a known duty to act, demonstrating a conscious
disregard for his duties.” [emphasis added]
The court added that “[t]here
may be other examples.”
Applying this standard to the facts
proven at trial - not just the facts alleged in plaintiffs’ complaint,
which the court had been required to assume to be true in its decision
at the motion to dismiss stage of the litigation - the court concluded
that Disney’s directors “did not intentionally shirk or ignore their
duty” and “acted in good faith, believing they were acting in the best
interests of the Company.” The court reached this conclusion notwithstanding
its view that “many aspects of Ovitz’s hiring . . . reflect the absence
of ideal corporate governance.”
5. Director Conduct Is Judged on a Director-By-Director Basis.
The court noted that in the past
courts often have judged the conduct of a board as a whole but that “[m]ore
recent cases understand that liability determinations must be made on a
director-by-director basis.” The court accordingly conducted separate
analyses of the conduct of each of Disney’s directors, including, in the
case of the approval of Ovitz’s employment contract, [i] Eisner, [ii]
each of the two directors who participated in the negotiation and analysis
of the contract before the contract was presented to the compensation committee,
[iii] the directors on the compensation committee who approved the contract,
and [iv] the directors on the board who relied on the compensation committee’s
The implications of this analysis
- for compensation and audit committee members, for example - are clear.
6. Good Minutes Help.
The court’s decision denying the
motion to dismiss in the case pointed to board and committee meeting minutes
as evidence of what was and was not discussed at board and committee meetings
and whether questions were asked at those meetings and, if so, about what
subjects. The court also noted that less than 1-1/2 pages of 15-page minutes
of the board meeting at which Ovitz’s contract was approved were devoted
to that subject and “most of that time appears to have been spent” discussing
a $250,000 fee paid to Eisner’s personal attorney, who, as chair of the
compensation committee, negotiated the contract.
The court’s post-trial decision
echoes the importance of minutes. The court stated with
respect to one executive session at a board meeting that “[t]here are
no minutes to show who attended the executive session,” and, with respect
to a compensation committee meeting that “[i]t would have been extremely
helpful to the Court if the minutes had indicated in any fashion that the
discussion related to the OEA [the Ovitz Employment Agreement] was longer
and more substantial than the discussion relating to the myriad of other
issues brought before the compensation committee that morning.”
The importance of minutes or other
documentation demonstrating informed and good faith board consideration
of actions of material importance to the corporation is particularly significant
given the frequency with which shareholders now use Section 220 demands
to obtain board and committee minutes without first commencing litigation,
and then use the minutes to allege insufficient deliberation by directors
in a manner that may be - and in the case of Disney
sufficient to survive a motion to dismiss and require a trial.
7. Experts Can Be Relied
Upon In Good Faith - Even When They Make Mistakes, And Their Advice Need
Not Always Be Followed.
The court stated that “there are
many criticisms that could and have been made” of the advice provided
to Disney’s board and compensation committee by Graef Crystal, a compensation
expert retained to advise concerning Ovitz’s employment agreement, and
of the board’s reliance on that advice. These criticisms included, among
other things, Crystal’s failure to calculate the cost of a potential non-fault
termination before the agreement was approved.
The court held that the compensation
committee reasonably believed that Crystal was selected with reasonable
care and had the necessary professional competence to advise the committee,
and that “nothing in the record leads me to conclude that any member of
the compensation committee had actual knowledge that would lead them to
believe . . . that Crystal’s analysis was inaccurate or incomplete.”
The court therefore concluded that Disney’s directors were protected by
Section 141(e) of the Delaware General Corporation law because “the compensation
committee acted in good faith and relied on Crystal in good faith, and
that the fault for errors or omissions in Crystal’s analysis must be laid
at his feet, and not upon the compensation committee.”
Equally significant, the court
noted that “the compensation committee relied in good faith on Crystal’s
report and analysis even though they chose not to follow Crystal’s recommendations
to the letter.” The court stated that the role of experts “is to assist
the board’s decisionmaking - not supplant it.” There is no requirement
that boards must “follow the advice of experts” - “substantially,”
“completely,” or “in part.”
8. Beware Of What The Court
Called “The Imperial CEO” - And The Court’s Perception Of Outside Directors
Serving An Imperial CEO.
It is important to keep in mind
that the events at issue in the case took place a decade ago. That was
a very different era in American corporate governance. In the intervening
years, it has been said and written many times that “the days of the Imperial
CEO” are - or should be - over.
The court’s important observations
concerning the governance implications of the case included the court’s
view that “Eisner to a large extent is responsible for the failings in
process that infected and handicapped the board’s decisionmaking abilities.”The
court stated that he “hand-selected” directors and “stacked his . .
. board . . . with friends and other acquaintances who, though not necessarily
beholden to him in a legal sense, were certainly more willing to accede
to his wishes and support him unconditionally than truly independent directors.”
The court criticized what the court found to be the “fail[ure] to keep
the board as informed as he should have,” “stretch[ing] the outer boundaries
of his authority as CEO by acting without specific board direction or involvement,”
and “prematurely issuing a press release that placed significant pressure
on the board to accept Ovitz and approve his compensation package in accordance
with the press release.”
The board’s apparent failure,
in the court’s view, was allowing this conduct, and the court warned future
boards 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.”
9. What Boards Should Do.
There is, of course, no “one size
fits all” checklist that will protect all directors in all cases. Adherence
to the following suggestions, however, should protect directors under almost
- Before agreeing to serve as a director
- and while a director - carefully consider the financial position of the
company and the integrity of its board and management. Is the board comfortable,
active and diligent in providing oversight of management performance, or
does it take its cues from, and defer to, the CEO?
- Understand the business, its strategy,
the competitive environment and how it makes money. Understand significant
risks, financial controls and compliance systems.
- While not all best practices apply
to all corporations, directors should aspire to comply with those ideals
of good corporate governance that, in the directors’ considered business
judgment, can be adopted to the corporation’s particular circumstances
and enhance the board’s and the corporation’s performance in a meaningful
- Embrace best practices in all of
the board’s governance processes. Start by checking the right boxes, but
do more than just check the right boxes. Eschew a compliance-driven, just
check-the-box approach to governance.
- Always be active and attentive
- look not just for “red flags,” but also “yellow flags.”
- Independent directors need to be
truly independent - not “hand picked” or perceived to be “hand picked”
by the CEO. Directors need to think objectively and act independently.
- Remember that independence requires
satisfaction of each of the NYSE or NASDAQ criteria for independence and
a broad consideration of all other relevant facts and circumstances. When
specific issues arise, remember to reconsider independence contextually
and in a manner tailored to the precise situation at issue.
- Appoint a strong independent board
leader - either a separate, independent chair or a lead independent director.
- Hold regular executive sessions
among independent directors - as frequently as needed to ensure optimum
communication among independent directors, and as frequently as circumstances
facing the corporation warrant. Use those sessions to share viewpoints
about the quality of the management team, its performance, and its proposed
- Forge a constructive, collegial,
but independent, relationship with the CEO. Beware of a CEO who tries unduly
to manage the board.
- Resist a culture of complacency
when things look to be running well.
- Rely in good faith on carefully
chosen experts, but do not in all cases feel obliged to do what they advise.
- Pay special attention to the board
agenda. Is the board focused on the right issues, and has the board prioritized
those issues correctly?
- Pay special attention to the board’s
information needs. Does the board have access to the information it needs?
Is the board in control of determining what information it needs?
- Actively engage in board discussions
and deliberations with healthy and constructive skepticism - and do not
hesitate to offer helpful advice or criticism when needed.
- Review all board and committee
materials and attend all meetings well-prepared to participate in discussion.
- Review board and committee minutes
carefully. Ensure that they reflect the board’s deliberation by including
the times that meetings begin and end and the times when persons present
at the meeting enter and leave the meeting - particularly when people are
leaving the meeting due to conflicts or potential conflicts. Seek to ensure
that there is some relationship between the length of the minutes devoted
to a particular issue and the time devoted to that issue. Ensure that the
minutes accurately reflect the matters considered, and capture the general
extent and nature of the board’s questions, discussions, and decisions.
Where information was provided to the board before the meeting or discussions
among directors occurred before the meeting, reflect those facts in the
minutes. (Minutes of executive sessions need not - and probably should
not - be as detailed as other minutes, but should, at a minimum, indicate
when the session began and ended, who attended, and what topics were discussed.)
- Insist that management keep track
of and report progress on items that came before the board that resulted
in board decisions or directions.
- Make sure public filings are clear
and that you understand them. Ask management (and, when appropriate, outside
auditors and other professional advisors) for assurances, including assurances
with respect to the process used to ensure that public filings are accurate.
- Insist on receiving drafts of public
filings you will be asked to sign in a timely fashion. Ask questions about
anything you don’t understand or causes you concern.
- Insist that shareholders are given
a fair representation of the condition of the corporation by asking both
the corporation’s management and the corporation’s independent auditors
for specific assurances concerning the integrity of the reporting, their
respective due diligence, and their respective confidence in what they
are reporting. Ask auditors what they would do differently than management.
- Take special care in reviewing
registration statements - the strictest requirements applicable to directors
are triggered by registration statements, as the Enron and WorldCom directors
learned when they were required to go to trial to prove due diligence under
the federal securities laws in connection with registration statements,
and they decided instead to use personal assets to settle the cases. Be
comfortable that sufficient diligence is being undertaken on your behalf,
and ask yourself whether you are comfortable that that diligence has been
- Understand any item, transaction
or public filing put before the board for approval.
- Take special care as to any issue
or transaction that involves compensation or a potential conflict for a
member of management, a director or a controlling shareholder.
- Periodically review risks inherent
in the corporation’s business and the oversight of those risks - both
by the board and by management and, where appropriate, by accountants and
other outside advisors.
- Periodically review corporate policies
such as the company’s code of ethics, confidentiality policies, trading
policies, and training policies.
- Ensure that the corporation’s
charter includes a provision prohibiting recovery of money damages from
directors for duty of care claims similar to the provisions that the court
in Disney noted the “vast majority of Delaware corporations” have
- Review your D&O policy. Is
the amount of coverage adequate? What are the exceptions to coverage? Understand
the severability provisions and ask whether there are circumstances under
which the insurer may deny coverage to some directors due to the actions
of others. Understand the circumstances under which the insurer can rescind
the policy or deny coverage.
- Keep asking questions, and listen
to the answers. There is no such thing as a “stupid question.”
- When in doubt, ask for help.
- Use your common sense.
In short, a director’s best protection
continues to lie in his or her diligent and objective attention to board