Last week I, along with millions of other people, spent part of my Spring Break in California at Disneyland. While there I could not help but think about, and in fact reconsider my impressions of, the Disney decisions. Today when I refer to Disney I view it as a case with important corporate governance implications. Moreover, because I teach the Disney cases as well as the implications of the “vote no” campaign at Disney, I tend to view Disney in terms of its crisis points. As a result, I was frustrated by the final Disney decision, which appeared to enable that company’s officers and directors to get away with observing lax governance standards. However, I too often forget that Disney is a company that produces products that have a tremendous influence on people's lives and our culture. For many people, Disney represents the “magic kingdom.” And perhaps the fact that the kingdom remained in tact in the midst of Disney’s corporate governance troubles validates the business judgment rule’s application to what many viewed as less than ideal governance practices.

Indeed, by all markers, Disneyland appeared to be thriving--at least on the day I visited the park. There were many many children (and some adults) dressed in various Disney costumes, willing to stand in lines up to two hours long to get a glimpse of Mickey Mouse or ride on a simulated Star Wars ship. And visitors paid handsomely for their experience. In fact, I have been told that some days the park gets so full that it must close. Being in Disneyland underscores the fact that Disney sells a remarkable product that holds a special place for many in the US and abroad.

On the one hand, maybe this means that we should care more about the conduct of its board and officers because we want such an iconic company to be a symbol of best practices. On the other hand, so long as the Disney brand remains undisturbed, perhaps we should give the company room to make mistakes. Of course, that is what the business judgment rule is all about. And walking through the park, I could not find fault with such a rule. Because at the end of the day, it appeared that the conduct about which corporate governance experts spilled so much ink, did not impact the experience of park goers. In fact I feel certain that very few people in the park that day gave a passing thought to Michael Ovitz and a case called In re Walt Disney. And as long as that is the case, perhaps the business judgment rule has served its purpose.

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The AALS has posted podcasts from the Annual Meeting. You can browse the sessions from this page. If you would like to listen to the Section on Business Associations program on Disney, click here. By the way, I was the first speaker in that session.

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In 1993 Justice Horsey of the Delaware Supreme Court penned this unfortunate sentence in the second major Technicolor opinion: "To rebut the [business judgment] rule, a shareholder plaintiff assumes the burden of providing evidence that directors, in reaching their challenged decision, breached any one of the triads of their fiduciary duty -- good faith, loyalty or due care."

Triads?

In Gaylord, Vice-Chancellor Strine tweaked the Delaware Supreme Court for its use of the plural "triads" and for identifying "good faith" as a separate fiduciary duty: "Indeed, the very Supreme Court opinion that refers to a board's 'triads [sic] of fiduciary duty [sic] -- good faith, loyalty [and] due care,' equates good faith with loyalty."

In subsequent opinions, the Delaware courts and commentators charitably reduced the number of triads to one, but confusion remained about the role of "good faith" in fiduciary litigation. We had a lot to say here about the Disney litigation, and if you were following that conversation, you might remember a lingering issue from the Supreme Court's most recent opinion: does the duty of good faith provide an independent basis for director liability?

My initial take on the Disney opinion was unequivocal:

The Court clearly embraces the duty of good faith as a distinct duty, separate from care and loyalty. For example, "grossly negligent conduct, without more, does not and cannot constitute a breach of the fiduciary duty to act in good faith."

In a subsequent post, I addressed Footnote 112 of Disney, which reads as follows:

[W]e do not reach or otherwise address the issue of whether the fiduciary duty to act in good faith is a duty that, like the duties of care and loyalty, can serve as an independent basis for imposing liability upon corporate officers and directors. That issue is not before us on this appeal.

I argued that "footnote 112 was an afterthought designed to secure a vote for the opinion in pursuit of unanimity." I speculated privately to several colleagues that Justice Holland had demanded the footnote, though what he intended to do with it I wasn't sure.

Now I know. The triad is dead.

Yesterday, the Delaware Supreme Court issued a unanimous, en banc opinion that seems to drive a stake in the heart of "the fiduciary duty of good faith." The following comes from Stone v. Ritter:

It is important, in this context, to clarify a doctrinal issue that is critical to understanding fiduciary liability under Caremark as we construe that case. The phraseology used in Caremark and that we employ here—describing the lack of good faith as a "necessary condition to liability"—is deliberate. The purpose of that formulation is to communicate that a failure to act in good faith is not conduct that results, ipso facto, in the direct imposition of fiduciary liability. The failure to act in good faith may result in liability because the requirement to act in good faith "is a subsidiary element[,]" i.e., a condition, "of the fundamental duty of loyalty." It follows that because a showing of bad faith conduct, in the sense described in Disney and Caremark, is essential to establish director oversight liability, the fiduciary duty violated by that conduct is the duty of loyalty.

This view of a failure to act in good faith results in two additional doctrinal consequences. First, although good faith may be described colloquially as part of a "triad" of fiduciary duties that includes the duties of care and loyalty, the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. Only the latter two duties, where violated, may directly result in liability, whereas a failure to act in good faith may do so, but indirectly. The second doctrinal consequence is that the fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. As the Court of Chancery aptly put it in Guttman, "[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation's best interest."

I will have a lot to say about this at some future date, probably in a law review article, but the first question that springs to mind is this: Has the Delaware Supreme Court been acting in good faith in its development of the duty of good faith?

Over the past decade, the Court has had numerous opportunities to "clarify" this issue, and the Court has consistently muddied the waters. As noted above in my Gaylord citation above, the Court of Chancery responded to Justice Horsey's unfortunate sentence by treating the mysterious duty of good faith as a species of loyalty violation, but the Supreme Court repeatedly emphasized the distinctiveness of "the duty of good faith." I never liked the idea that good faith was part of the duty of loyalty, but if that's where the Supreme Court wanted it, did we really need over a decade to figure that out?

We are told that the duty of good faith is connected to Caremark, which the Supreme Court has cited in three other cases, though never with the complete endorsement of the Caremark standard that appears in Stone. This makes sense to me, given the notion of "good faith" articulated in the Disney cases.

Then we are told that Caremark is really a duty of loyalty case. Not duty of loyalty in the traditional sense -- you know, those cases "involving a financial or other cognizable fiduciary conflict of interest" -- but something different. More like a good faithy version of loyalty. Ok, I think I basically get good faith after Disney, but why dilute a useful and longstanding conception of loyalty with these other fact situations? Was the post-Disney triad broken and in need of repair?

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Like the Chancery Court, the Supreme Court in Disney distinguished between conduct that violated the duty of care--for which directors were not liable--and conduct that fell below corporate best practices.  And both courts agreed that Disney directors engaged in actions that failed to meet the courts' formulations of corporate best practices.  I intuitively understand the distinction between conduct that satisfies due care and conduct consistent with corporate best practices--after all, when imposing liability we cannot expect directors' and officers' conduct to be the "best" or perfect.  Given this distinction, I wonder what the point is in pinpointing these best practices.  Both courts suggest that all directors and officers should use the best practices identified in the opinions as a guide for their own behavior.  But why should anyone expect that directors and officers will follow that guide when there are apparently no sanctions for their failure to do so?  Indeed, if due care is judged according to a "we don't expect perfection/nobody's perfect" standard, then not only does breaching the standard seem virtually impossible, but also it seems that engaging in behavior that satisfies "best practices" is an option that most corporate actors are free to ignore.  Thus, I find myself asking, what is the point in pinpointing aspirational standards that have no connection to the conduct in which we realistically expect directors and officers to engage?  Or to put it differently, how do best practices standards help us determine conduct that violates the duty of care?  In this regard, I find the distinction frustrating and unhelpful, except to the extent that it suggests that all corporate conduct will satisfy the duty of care because that duty does not require directors and officers to be on their "best" behavior. 

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Larry asks some provocative questions below, and I think this post addresses the first question and the last question.  Um, where is Van Gorkom?  I searched the opinion -- no "Van Gorkom."  There's not even a "Gorkom."

So, the Supreme Court of Delaware issues an opinion in an appeal that has everyone asking "Is Van Gorkom Dead?" and does not even cite Van Gorkom?  And, in the opinion, the court notes, inter alia, that directors do not need to see documentation of transactions they are approving if someone describes those documents to them.  That characterization of the facts of the Disney case sound very similar to the facts of Van Gorkom, although those facts, twenty-one years ago, resulted in a different judicial decision.  That sounds a lot like the court is rejecting Van Gorkom without saying so.  Also telling is the fact that the court never cites Van Gorkom for anything, which is odd for a breach of duty case.  So, why doesn't the court explicity overturn Van Gorkom?  Why create a blip in the common law that must be explained?  I suspected that the court would distinguish the Disney case from Van Gorkom based on the fact that the Ovitz contract was a mere employment matter and that even though the aggregate dollar amount seemed high, the amount was still small compared to the size of the company's budget.  Van Gorkom involved the sale of the company, a fundamental change that requires more attention than an employment contract.  But the court did not distinguish the facts, but instead analogized them and implied that a different result under the same facts would be erroneous.

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Now that the Delaware Supreme Court has finally opined on Disney, maybe the old gang that has gathered in this space before would like to get back together to discuss the case. I've already posted at my home site. 

Let me suggest a few topics if anybody wants to join in, most of which are touched on in my post:

1. The future of due care and Van Gorkom. What does this case say about the nature of gross negligence?

2.  What are the case's implications for bad faith and the application of 102(b)(7)? What kinds of facts might constitute bad faith?  Given the court's view of bad faith, is there any longer a meaningful role for gross negligence? 

3. What, if anything, does the case say about how it might address the undecided questions, such as the application of the bjr to officers.

4.  What does the case imply about Roe's thesis concerning federal law's impact on Delaware?

5. What can be said now about the relation between Delaware and the federal law of corporate governance?  Has federal law taken over the Caremark business just as it has disclosure?

6.  What, if any, role do theories of "good governance" and best practices have on directors' liabilities after Disney?

7.  What are the decision's implications for the executive compensation debate?

8.  What's likely to be the single biggest effect of this decision?

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Interestingly, the Supreme Court’s decision also did not reach the merits of the appellants' claim regarding the legitimacy of the director-by-director approach vs. analyzing the board as a collective body. Certainly a lot of attention was given to this approach, particularly after Emerging Communication, which suggested that directors with specialized knowledge may receive some heightened scrutiny. Although the Chancery Court’s decision appeared to back away from this more stringent approach, that court still assessed each Disney director individually in a manner that suggested that in order to be protected from liability, there needed to be a record reflecting that each director had sufficiently informed himself or herself. At the very least this director-by-director approach suggested that all board minutes needed to provide more robust accounts of individual director’s questions and comments. On appeal, the appellants’ claimed that such an approach was improper, and instead argued that the Chancery Court should have assessed the liability of the board as a whole. The Supreme Court declined to rule on the merits of this issue, but rejected the claim in part because appellants had not proven how the Chancery Court’s analysis was prejudicial and yielded an outcome different from a collective analysis. On the one hand the appellants’ argument appears to be taking a step back from the heightened scrutiny apparently required by the individualized approach adopted by the Chancery Court. Hence one could read the Supreme Court’s decision as essentially saying that because the appellants claim did not pass muster under a more stringent standard of review, it certainly would fail under the more lax “collective board” analysis. On the other hand, the Court’s opinion can be viewed as suggesting that there may be no real distinction in the two modes of analysis. If this view is correct, perhaps directors need not be concerned about creating individualized records of their actions.

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Lots of bloggers writing about Disney ...

Larry Ribstein makes a bunch of excellent points. I will highlight two. First, he notes that fiduciary duty claims other than self-dealing will be very tough to win:

[T]he 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.

Second, Larry provocatively asserts:

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.

Hmm. I am not so sure that the Delaware Supreme Court was using this case to "denounce" the feds, but I think we can safely conclude that Delaware has fairly modest aspirations for fiduciary law. And, in my view, that is a good thing.

Steve Bainbridge doesn't like Justice Jacobs' formulation of the business judgment rule. Steve is right that the business judgment rule functions as more than a procedural "presumption," and that framing the rule using that term makes it appear as "nothing more than a restatement of the basic principle that the defendant is entitled to summary judgment whenever plaintiff fails to state a prima facie case."

But I think Steve leaves the track with this statement:

[I]n the opinion (e.g., at 66) we find reference to the idea that "gross negligence (including a failure to inform one’s self of available material facts)," violates the duty of care. The word "including" would seem to imply "but not limited to," which suggests some scope for substantive review of board decisions.

Gross negligence might be evidenced by a failure to inform oneself -- indeed, the obligation to inform oneself is the core requirement of the duty of care -- but there may be other aspects of "care" that do not go to the substantive merits of the decision. For example, in Cede v. Technicolor, Inc., 634 A.2d 345, 368 (Del. 1994), the Court stated that "a director's duty of care requires a director to take an active and direct role in the context of the sale of a company from beginning to end." In the following sentence, the Court mentions the duty to gather information as a separate requirement of the duty of care. In my view, Steve is reading the wrong thing into Justice Jacobs' use of the word "including." Besides, Justice Jacobs clearly segregated the substantive review into the section on "waste."

Steve has a separate post on the duty of good faith in which he takes on the already infamous footnote 112. Steve suggests that resolution of the issue may not matter much: "It's hard to imagine a case in which the defendants would be found to have acted in bad faith as defined by Justice Jacobs without also having violated either their care or loyalty duties somewhere along the line." I think that I agree with this, but I wonder whether "intentional violations of law" will become a viable category of good-faith litigation.

Speaking of "intentional violations of law," Steve asks in another post whether "intentional violation of law = bad faith." Steve writes in  response to my post: "I have not seen anything in the opinion squarely so stating and, upon reflection, I think Gordon ought to be wrong - at least insofar as he may be suggesting that intentional law violations per se constitute bad faith."

Responding to the first part of his statement is easy. On page 72, Justice Jacobs describes "knowing violation[s] of law" under Section 102(b)(7) of the DGCL as an example of "subjective bad faith." Justice Jacobs also quotes approvingly from Chancellor Chandler's opinion, which states, "A failure to act in good faith may be shown ... where the fiduciary acts with the intent to violate applicable positive law." So I don't think that there is much doubt about where the Delaware courts stand on this.

As to whether this ought to be the result, Steve argues that "fiduciary obligation and the duty to act lawfully make a bad fit." It's an interesting argument, but it flies in the face of a long history of treating illegality as a form of bad faith. When I was researching The Shareholder Primacy Norm, I found this doctrine used quite commonly among 19th Century courts. It's not likely to be changed now.

As you might imagine, Elizabeth Nowicki is disappointed in the opinion, which makes her flu feel all the more oppressive. Elizabeth criticizes the Court for rejecting the appellants' claim that "directors violate their duty of good faith if they are making material decisions without adequate information and without adequate deliberation." She wonders, "am I to believe that the good court is saying that such decisions *are* acts in good faith?" Whether she believes it or not, the answer is yes.

Elizabeth's indignation has some intuitive appeal. Indeed, the Court recognizes that existence of some overlap between the duty of care and the duty of good faith, but argues that the duties should remain (?) distinct: "The conduct that is the subject of due care may overlap with the conduct that comes within the rubric of good faith in a psychological sense, but from a legal standpoint those duties are and must remain quite distinct." The reason is obvious:

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).

At one time, I thought the Court might use Disney to reinvigorate Smith v. Van Gorkom, but this statement (and others like it) should put that fear to rest. Litigants will not be allowed to use the duty of good faith to outflank exculpation when the underlying behavior is nothing more than a failure to gather adequate information or a failure to act with adequate deliberation.

This new opinion has lots of little nuggets, and I will attempt to say a few more things later today. As always, your comments are most welcome.

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Darian and RR focus our attention on footnote 112:

[W]e do not reach or otherwise address the issue of whether the fiduciary duty to act in good faith is a duty that, like the duties of care and loyalty, can serve as an independent basis for imposing liability upon corporate officers and directors. That issue is not before us on this appeal.

I agree with RR that this is odd, and that we could have used an answer. This footnote is in deep tension with the text of the opinion. As I noted below, the Court took pains to distinguish the duty of good faith from the other traditional duties. Also, in January, I explained at length why the plaintiffs misunderstood the role of bad faith in rebutting the business judgment rule. In the opinion today, the Court made the same essential points, though more briefly. The bottom line: bad faith can be used for "rebutting the business judgment rule presumptions" and for "evaluating the availability of charter-authorized exculpation from monetary damage liability after liability has been established." (p. 40) But we don't know if it can be an independent basis for liability?

In addition, the Court describes actions that must be "proscribed" using the duty of good faith: "To protect the interests of the corporation and its shareholders, fiduciary conduct ... which does not involve disloyalty (as traditionally defined) but is qualitatively more culpable than gross negligence, should be proscribed." Does the duty serve as a "proscription" if it cannot be summoned as an independent basis for liability?

Finally, the Court notes that "highly significant consequences" flow from distinguishing the duty of care and the duty of good faith. The two consequences it discusses are exculpation under Section 102(b)(7) and indemnification under Section 145. Strange that the Court does not mention in this part of the opinion the possibility that the duty of care might be the basis of liability (at least, theoretically) while the duty of good faith might not.

All of this suggests to me that footnote 112 was an afterthought designed to secure a vote for the opinion in pursuit of unanimity. But as for why one or more of the justices perceived this to be necessary is not at all clear to me.

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As Gordon and our readers have pointed out, the Delaware Supreme Court declined to address issues that it decided did not need to be addressed at this point.  One interesting side issue that was raised on appeal by the appellants was whether the business judgment rule applied to officers or only directors.  The appellants argued that the BJR did not apply to decisions made by mere officers.  At the time, I blogged about this here and so did Steve Bainbridge.  It seemed like a good time for the court to clear that question mark up once and far all.

Or not.  In footnote #38, the court puts that question on ice:

These claims are asserted against the Disney defendants in their capacity as directors. The appellants also advance, as an alternative claim, an argument that Disney defendants Eisner, Litvack and Russell, are liable in their separate capacity as officers who, unlike directors, are not protected by the business judgment rule or the exculpatory provision of the Disney charter. That alternative argument is procedurally barred, because it was not fairly presented to the Court of Chancery. SUP. CT. R. 8. Indeed, the Chancellor noted in his Post-trial Opinion that the application of the business judgment to Eisner and Litvack was not contested, and that the “parties essentially treat both officers and directors as comparable fiduciaries, that is, subject to the same fiduciary duties and standards of substantive review.” Post-trial Op. at *50, n. 588. To the extent the argument is advanced against Russell, it also is not grounded in fact, because Russell was not an officer of Disney.

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In my view, the most interesting part of the new Disney opinion is the Court's discussion of the duty of good faith (pp. 60-73). Here are some thoughts on that portion of the opinion:

• The Court rejected the plaintiffs' contention that Chancellor Chandler changed the definition of "bad faith" between his 2003 opinion ("consciously and intentionally disregarded their responsibilities") and his 2005 opinion ("intentional dereliction of duty, a conscious disregard for one's responsibilities"). The Court stated, "We perceive no substantive difference" between the two, and that seems right to me.
• The Court clearly embraces the duty of good faith as a distinct duty, separate from care and loyalty. For example, "grossly negligent conduct, without more, does not and cannot constitute a breach of the fiduciary duty to act in good faith." (p. 67)
• The big question, therefore, is whether plaintiffs can find cases where the directors' conduct would constitute a breach of the duty of good faith, but not a breach of the duty of care or the duty of loyalty. The Court observes, "Cases have arisen where corporate directors have no conflicting self-interest in a decision, yet engage in misconduct that is more culpable than simple inattention or failure to be informed of all facts material to the decision." But it offers no citations. In my view, plaintiffs should be looking for one of three fact scenarios: intentional infliction of harm on the corporation, intentional violations of law, and intentional derelictions of duty.
• The Court noticed the language in Section 102(b)(7) that Elizabeth Nowicki has been touting as a new basis for liability: "acts ... not in good faith." The Court looked at that statute and found two categories of "subjective bad faith" (which it also describes as "actual intent to do harm): "intentional misconduct" and "knowing violation of law." These are the first two fact scenarios listed in the prior paragraph. The Court says that "acts ... not in good faith" are encompassed by Chancellor Chandler's definition of bad faith, i.e., intentional derelictions of duty. In short, "acts ... not in good faith" are acts of "bad faith."  

Will the duty of good faith be important in future litigation? I assume that it will be argued frequently, at least in the near future, because bad faith is not capable of exculpation under Section 102(b)(7). Nevertheless, I suspect that the number of fact scenarios in which the duty of good faith will have traction is small, with "intentional violations of law" being the largest potential category. See Enron, et al.

All in all, I think that Justice Jacobs did an excellent job with the opinion. I am surprised that the decision was unanimous, and now I am wondering: what took them so long?

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The Delaware Supreme Court unanimously affirmed the Court of Chancery's decision in the Disney case. I have uploaded Justice Jacobs' 91-page opinion here. Analysis to come ...

Thanks to Rob Saunders, Julie Hill, and Steve Haas for alerting me and sending the opinion.

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Earlier this week, I wrote, "I heard from a little birdie that the release of the Delaware Supreme Court's opinion in Disney was imminent...." We are now past the 90-day mark from the oral argument, and the opinion is still forthcoming. Should we read anything into this?

Larry Ribstein has suggested that the delay could be a sign that it's about to reverse. He could be right about reversal, but that's reading a lot into a relatively short delay. Nevertheless, I suspect that the delay may be important if it suggests that there is disagreement among the justices. As noted by former guest-blogger David Skeel, The Unanimity Norm in Delaware Corporate Law, 83 Va. L. Rev. 127 (1997), the Delaware Supreme Court has a strong unanimity norm:

Delaware's justices write separately in only three percent of the court's reported cases. The percentage is even lower when considering the court's whole docket. The minuscule number of separate opinions is particularly noteworthy given that the supreme court, unlike many state high courts, is the national arbiter of an important and often controversial area of law.

If I am right that Disney is dividing the justices, it reinforces what I have been saying for a long time: Disney is a tough case. Horrible facts for the Disney directors bumping up against legal rules that rightly show directors great deference in non-conflict transactions.

Does a split court suggest affirmance or reversal? It's not much to go on, but I keep remembering Omnicare, a recent split decision in which Justice Holland wrote a majority opinion, with then-Chief Justice Veasey and current-Chief Justice Steele dissenting.

I hope that a split court doesn't bring us another Omnicare.

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Last week, I heard from a little birdie that the release of the Delaware Supreme Court's opinion in Disney was imminent, and Chief Justice Steele told me awhile back that the opinion would be posted on the Court's website. Since Friday, that website has been inaccessible -- "Bad Gateway." Meanwhile, we wait ...

UPDATE: The Delaware Supreme Court's website is back online, but still no Disney opinion.

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Larry Ribstein thinks that the Delaware Supreme Court is taking a bit too long to decide the Disney appeal (their own rules require a decision within 90 days of the oral argument, which means that we will see something by April 25), and he is wondering whether the Court is planning to reverse. The grounds for reversal? Larry seems to favor the claim that Michael Eisner did not have authority to terminate Michael Ovitz without board oversight:

Another possible basis for reversal is that the chancellor held that Eisner had the power to terminate Ovitz on his own, and therefore that the board had no duty to act. The supreme court might hold that this was wrong -- the ceo's technical power does not limit the board's duty.

This was unquestionably the weakest part of Chancellor Chandler's opinion. If Larry is right in supposing that the Supreme Court wants to send a message to corporate directors, this would be the place to do it. As Larry observes, it would  be a "sufficiently narrow ground that the court can distinguish it in the future."

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The Appellants lead in both their brief and in the oral argument with an assertion about the Disney board of directors and the business judgment rule (BJR):

[P]laintiffs established that the presumption [of the business judgment rule] was rebutted because the Disney Board breached its fiduciary duty of care by failing to inform itself of all material information reasonably available with respect to Ovitz's employment agreement.

The Appellants are attempting to avail themselves of the enigmatic procedural system established by Emerald Partners v. Berlin, 787 A.2d 85 (Del. 2001). Is there an easy way to explain Emerald Partners? Perhaps not, but here's a go ...

To understand Emerald Partners, you need to understand how the Delaware courts approach fiduciary duty claims. They begin with the business judgment rule, which they describe as a presumption that "in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company [and its shareholders].'' If the plaintiffs cannot rebut that presumption, their case is dead in the water. Defendants win.

So the big question is: how do plaintiffs rebut the presumption?

Before Trial

Before a trial, plaintiffs rebut the presumption  of the BJR by alleging facts sufficient to support a finding that the board of directors violated the duty of care, the duty of loyalty, or the duty of good faith.

Now the tricky part.

Even if the plaintiffs successfully allege facts sufficient to support a finding that the board of directors violated its duty of care, the complaint may be dismissed if the corporation's charter contains an exculpatory provision. Under Section 102(b)(7) of the Delaware General Corporation Law, corporations can adopt a charter provision that eliminates or limits the personal liability of directors for monetary damages for breach of the duty of care (an "exculpatory provision"). In Malpiede v. Townson, 780 A.2d 1075 (Del. 2001), the Delaware Supreme Court held that where a corporation has such an exculpatory provision and the plaintiffs file a complaint that contains only a duty of care claim, the court will dismiss the compaint because the plaintiffs cannot recover monetary damages from the defendants. Or, stated another way, to survive a motion to dismiss, a complaint must allege a breach of the duty of loyalty or the duty of good faith.

How did this play out in Disney? Like most corporations today, Disney has an exculpatory provision in its charter, but in his May 2003 decision (825 A.2d 275), Chancellor Chandler concluded that the complaint alleged facts sufficient to rebut the BJR under the duty of good faith and that such claims would not be exculpated under a 102(b)(7) provision. According to Chancellor Chandler:

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 also conclude that plaintiffs' pleading is sufficient to withstand a motion to dismiss under Rule 12(b)(6). Specifically, plaintiffs' claims are based on an alleged knowing and deliberate indifference to a potential risk of harm to the corporation. Where a director consciously ignores his or her duties to the corporation, thereby causing economic injury to its stockholders, the director's actions are either "not in good faith" or "involve intentional misconduct." [Citing  8 Del. C. § 102(b)(7)(ii).] Thus, plaintiffs' allegations support claims that fall outside the liability waiver provided under Disney's certificate of incorporation.

Believe it or not, that's the easy part.

At Trial

Once past the motion to dismiss, the plaintiffs are not necessarily out of the woods. After a trial, the Court of Chancery may conclude that the plaintiffs have not proven facts that rebut the presumption of the business judgment rule. In such a case, the Court should rule in favor of the defendants. (Emerald Partners: "If a shareholder plaintiff fails to meet this evidentiary burden, the business judgment rule operates to provide substantive protection for the directors and for the decisions that they have made.") Alternatively, the Court of Chancery might conclude that the plaintiffs have rebutted the presumption of the business judgment rule. In such a case, the burden shifts to the defendants to show that the challenged transaction was entirely fair.

Now, you might think that the defendants would be spared the trouble of proving entire fairness if the plaintiff's case rested solely on a breach of the duty of care. Why not allow the defendants to invoke the exculpatory provision and be done with it? Because Emerald Partners says so:

A determination that a transaction must be subjected to an entire fairness analysis is not an implication of liability. Therefore, when entire fairness is the applicable standard of judicial review, this Court has held that injury or damages becomes a proper focus only after a transaction is determined not to be entirely fair. A fortiori, the exculpatory effect of a Section 102(b)(7) provision only becomes a proper focus of judicial scrutiny after the directors' potential personal liability for the payment of monetary damages has been established. Accordingly, although a Section 102(b)(7) charter provision may provide exculpation for directors against the payment of monetary damages that is attributed exclusively to violating the duty of care, even in a transaction that requires the entire fairness review standard ab initio, it cannot eliminate an entire fairness analysis by the Court of Chancery.

If the Court completes the entire fairness inquiry and concludes that the transaction was unfair, it must take the additional step of identifying which duty (care, loyalty, or good faith) is the basis for liability.

If the board's actions do not withstand the judicial scrutiny of an entire fairness analysis, the breach or breaches of fiduciary duty upon which substantive liability for monetary damages is based become outcome determinative when the directors seek exculpation through a charter provision enacted in accordance with Section 102(b)(7). Such a provision bars any claim for monetary damages against director defendants based solely on the board's alleged breach of its duty of care but does not provide protection against violations of the fiduciary duties of either loyalty or good faith. Consequently, we have held that "[t]he Court of Chancery must identify the breach or breaches of fiduciary duty upon which liability [for damages] will be predicated in the ratio decidendi of its determination that entire fairness has not been established." Accordingly, we hold that when entire fairness is the applicable standard of judicial review, a determination that the director defendants are exculpated from paying monetary damages can be made only after the basis for their liability has been decided.

Again, how did this play out in Disney? The analysis did not proceed through all of the stages outlined by Emerald Partners because Chancellor Chandler concluded that the plaintiffs did not rebut the presumption of the BJR. With respect to the hiring of Ovitz, Chancellor Chandler wrote:

I conclude that the only reasonable application of the law to the facts as I have found them, is that the defendants did not act in bad faith, and were at most ordinarily negligent, in connection with the hiring of Ovitz and the approval of the [Ovitz Employment Agreement.]

With respect to Ovitz's termination, Chancellor Chandler held that Eisner and Litvak (not Kate!) did not breach their duties and the remainder of the Disney board of directors had no duty to act. In short, the plaintiffs never overcame the presumption of the BJR.

The Disney Appeal

As noted above, the plaintiffs contend that Chancellor Chandler erred by "failing to make a threshold determination that the [Disney] board's gross negligence rebutted the presumption of the business judgment rule." The basis for their claim is the following language from the Chancellor's opinion:

The presumption of the business judgment rule creates a presumption that a director acted in good faith. In order to overcome that presumption, a plaintiff must prove an act of bad faith by a preponderance of the evidence. (emphasis added in plaintiff's brief)

This is a grossly misleading argument, which seems to be based on a fundamental misreading of
Emerald Partners. (That's easy enough to understand, as Emerald Partners is the most convoluted case in all of Delaware law.) According to the appellants, the notion of "good faith" is irrelevant at the initial stage of the inquiry, when the Court is attempting to determine whether the presumption of the BJR has been rebutted. In their view:

"Good faith" is only relevant to the court's analysis when the plaintiffs have met their burden on the due care claim, and defendants have failed to demonstrate the entire fairness of the transaction.

This is simply wrong. As explained above, the court in Emerald Partners identified three important and separate inquiries: (A) whether the plaintiffs rebutted the presumption of the BJR; and (B) if the plaintiffs were successul in rebutting the presumption of the BJR, whether the transaction was entirely fair; and (C) if the transaction were unfair, whether the basis for liability was a breach of the duty of care, loyalty, or good faith.

The appellants are referring to the inquiry at Stage C, but the Emerald Partners Court also noted that good faith is relevant at Stage A:

To rebut the presumptive applicability of the business judgment rule, a shareholder plaintiff has the burden of proving that the board of directors, in reaching its challenged decision, violated any one of its triad of fiduciary duties: due care, loyalty, or good faith. If a shareholder plaintiff fails to meet this evidentiary burden, the business judgment rule operates to provide substantive protection for the directors and for the decisions that they have made. If the presumption of the business judgment rule is rebutted, however, the burden shifts to the director defendants to prove to the trier of fact that the challenged transaction was "entirely fair" to the shareholder plaintiff.

In summary, appellants argue that Chancellor Chandler botched the BJR analysis because his discussion of good faith was "premature" (i.e., should have been saved for Stage C), and he wrongly placed the burden of persuasion on the plaintiffs. Both of these claims should be rejected by the Supreme Court because good faith is an appropriate part of the analysis at Stage A and the burden of persuasion at that stage rests on the plaintiffs.

P.S. I think the whole notion of the BJR as a "presumption" is silly and Emerald Partners is a nightmare. This post is not intended as a defense of these doctrines, but merely an explication.

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I just read the most unusual exhibit to an SEC filing.  Check out the Disney-Pixar merger agreement, exhibit 99.

It's titled Principles for Management of the Feature Animation Businesses, and it's in large part designed to ensure that the Pixar culture -- which accounts for a good chunk of the purchase price -- survives.  It's concise and easy to read.  How did this document arise?  Was it a last minute drafting session?  I wonder if contracts would be easier to read if we had to do them all at the last minute, and without forms. 

Note that culture, in the agreement, is in quotation marks.  The Pixar "culture".  I wonder if we'll be at the point soon when culture loses the quotation marks and becomes recognized as a corporate asset like any other.  We don't put goodwill in quotations any more.

I am a believer in the significance of institutional culture and corporate culture.  But I wonder -- can you really maintain culture with a steering committee?  Top-down force feeding of culture won't work.  Leadership by example, though, helps, and if Jobs and the other Pixar bigwigs stay the course, maybe it will all work out.

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"Not in Good Faith Means Not in Good Faith"

This statement should have been of the utmost importance yesterday in the appellants’ oral arguments before the Delaware Supreme Court in the Disney appeal. The meaning of “not in good faith” is the issue, in my view, on which the appellants’ could have gotten a reversal. But the phrase “not in good faith” was never uttered. Indeed, the point was never even made in passing that “Not in Good Faith Means Not in Good Faith.” I find that astounding.

Let me back up a step and observe three things before I go further:

1. Directors are obligated to act in good faith.

2. The business judgment rule’s protection is based in part on the rebuttable presumption that the director at issue acted in good faith.

3. DGCL 102(b)(7) does not protect a director from personal liability to his shareholders "for acts or omissions not in good faith."

Keeping the above three observations about good faith in mind, I am of the strong view that the appellants should have based their oral argument yesterday on “good faith.” The appellants should have maintained that Chancellor Chandler erred as a matter of law in analyzing issues of good faith by using the phrase “bad faith” as a substitute for “not in good faith.” Specifically, the Chancellor failed to assess whether the Disney directors’ acts were undertaken “not in good faith,” such that they were outside the protection of the business judgment rule presumption and DGCL 102(b)(7).

Some of you might be thinking that I must have skipped many of the 174 pages of Chancellor Chandler’s August 9, 2005, Disney opinion, as the Chancellor held, on page 133, that “the only reasonable application of the law to the facts as I have found them, is that the defendants did not act in bad faith.” But that is just my point (and I did read all 174 pages) – the Chancellor’s bad faith analysis is a misapplication of the law. Bad faith has nothing to do with anything in this case. It is the absence of good faith that is important. Respectfully, I suggest that Chancellor Chandler should have analyzed whether the plaintiffs proved that the complained of directorate decisions and actions reflected a lack of good faith. (In fairness, Chancellor Chandler acknowledged on page 120 that he was using “bad faith” because it is difficult to define and work with “good faith.”)

Not In Good Faith Does Not Mean "Bad Faith (Not In Good Faith Means Not In Good Faith, revisited)

Many jurists and academics do exactly what Chancellor Chandler did – equate an act “not in good faith” with a “bad faith” act. But “bad faith” and “not in good faith” mean two different things. By obligating a plaintiff to prove that a director acted in bad faith, the court is obligating the plaintiff to identify facts much worse than those that would establish the lack of good faith. That is to say, “bad faith” conduct is roughly conduct that is affirmatively against the interests of the corporation (such as fraudulent conduct). Good faith conduct is conduct that is in the best interest of and taken for the purpose of benefiting the corporation. So “not in good faith” conduct is conduct that is not taken for the purpose of benefiting the corporation- conduct that is not deliberately chosen as being in the best interest of the corporation. An act "not in good faith" does not have to be a nasty, fraudulent, selfish, etc. act. The phrase “not in good faith” does include these “bad faith” acts, but the phrase also includes acts that are not venal or otherwise ill-motivated, such as an abdication of duties due to time pressure.

For example, the failure of Sidney Poitier to ask for more specific information about Ovitz’s pay package and potential termination package was not an act intended by Poitier to harm the Walt Disney Co. (as best I can tell). It was not a “bad faith” act. But it was (in my view, not having the full record in front of me) an act or omission not taken in good faith. It was an omission that was not made for purposes of benefiting the corporation. The English is sticky, but you get the point. If Poitier was not acting for the purpose of benefiting the corporation – if he was not acting in the best interests of the corporation – then he was not acting in good faith.

Is This How the "Not-in-Good-Faith" Story Ends?

To finish this post out, allow me to note that I was a bit disappointed with the oral arguments in part because it is my sense (and I hope that I am wrong) that the Delaware Supreme Court will likely not be inclined to raise the issue of “not in good faith” in an opinion sua sponte. However, the precise issue of the definition of good faith and the meaning of the phrase “an act. . . not in good faith” does not often come before the Delaware Supreme Court in a manner that is teed up to allow the Court to address the definitional issues directly. My concern is that the opportunity presented by this case to get some guidance from the highest court in Delawaron “not in good faith” is not going to come around again any time soon. In the meanwhile, each time a lower court (in any jurisdiction) or an academic commits to writing the bastardizing of the phrase “not in good faith” into “bad faith,” without even acknowledging the shorthand, the momentum behind this inaccurate wordsmith work will grow. My fear is that, at some point, it will just be a given that “not in good faith” in the director liability world actually means “bad faith,” and the current grey area of director abdication of duties will by default move almost entirely beyond the reach of shareholder plaintiffs. It will then be too late to subvert the dominant paradigm. This troubles me.

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I had intended to post several ideas from the oral argument yesterday, but a combination of teaching, administrative, and family obligations drew me away. Today is looking to be more of the same, so my Disney posts will mostly have to wait. But I will share one quick impression.

Steven Schulman opened the argument for the appellants by reminding the Supreme Court, "We have been before you before in this matter." He was referring, of course, to the Delaware Supreme Court's decision, Brehm v. Eisner, 746 A2d 244 (Del. 2000). As noted by the others who have posted below, Schulman then proceeded to re-argue the facts of the case, giving me the sense that he preferred the facts as they appeared in Brehm to the facts contained in Chancellor Chandler's August 2005 opinion. I laughed heartily, therefore, when Gregory Williams began the Appellee's argument with this zinger: "The plaintiff's briefs and their argument today sound as if no trial occurred in this case."

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In my treatise, Corporation Law and Economics, I argued that officers should get the benefit of the BJR, opining that:

It is reasonably well-settled that officers owe a duty of care to the corporation. It is less well-settled that officers get the benefit of the business judgment rule. Under the ALI PRINCIPLES, the rule applies to both directors and officers. [ALI Principles § 4.01.]

Judicial precedents are divided, however. [Compare Galef v. Alexander, 615 F.2d 51, 57 n.13 (2d Cir. 1980) (holding that the business judgment rule “generally applies to decisions of executive officers as well as those of directors”); FDIC v. Stahl, 854 F. Supp. 1565, 1570 n.8 (S.D. Fla. 1994) (holding that the rule “applies equally to both officers and directors”) with Platt v. Richardson, 1989 WL 159584 at *2 (M.D. Pa. 1989) (holding that the rule “applies only to directors of a corporation and not to officers.”). At least one court claims that the former view is the majority position, rejecting an argument that “the business judgment rule applies only to the conduct of corporate directors and not to the conduct of corporate officers” on grounds that it was “clearly contrary to the substantial body of corporate case law which has developed on this issue.” Selcke v. Bove, 629 N.E.2d 747, 750 (Ill. App. 1994).]

Most of the theoretical justifications for the business judgment rule extend from the boardroom to corporate officers. Many corporate decisions are made by officers, for example, who are likely to be even more risk averse than directors. Accordingly, insulation from liability may be necessary to encourage optimal levels of risk-taking by officers. Just as the board of directors is properly regarded as a production team, so is the so-called top management team. Accordingly, internal team governance may be preferable to external review. In sum, the better view is that officers are eligible for the protections of the business judgment rule.

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Elizabeth Nowicki observes:

The points made by appellants’ counsel (as I recall) include: 1.  The directors had the obligation to meet together (as a group) and deliberate together on the decision to fire Ovitz.  By failing to do so, the directors breached some duty, per se.

I tend to sympathize with Larry Ribstein's point that:

I would hope that, after its mistake in Van Gorkom, the court now recognizes how wrong it would be to insist on excessive procedures, including requiring a meeting in order to satisfy due care duties.  And clearly that shouldn't matter for good faith purposes under 102(b)(7).

Yet, it is important to recognize that corporate law's insistence that boards of directors act collectively has a sound basis. Indeed, the very existence of the board of directors is predicated on the superiority of group as opposed to individual decision making. Or so I argued in my article Why a Board? Group Decisionmaking in Corporate Governance:

Abstract: The default statutory model of corporate governance contemplates not a single hierarch but rather a multi-member body that acts collegially. Why? This article reviews evidence that group decisionmaking is often preferable to that of individuals, focusing on evidence that groups are particularly likely to be more effective decisionmakers in settings analogous to those in which boards operate. Most of this evidence comes not from neo-classical economics, but from the behavioral sciences. In particular, cognitive psychology has a long-standing tradition of studying individual versus group decisionmaking. This article contends that behavioral research, taken together with various strands of new institutional economics, sheds considerable light on the role of the board of directors. In addition, the analysis has implications for several sub-regimes within corporate law. Are those sub-regimes well-designed to encourage optimal board behavior? Two such sub-regimes are surveyed here: First, the seemingly formalistic rules governing board decisionmaking processes turn out to make considerable sense in light of the experimental data on group decisionmaking. Second, the adverse consequences of judicial review for effective team functioning turns out to be a partial explanation for the business judgment rule.

Indeed, in that article, I even went so far as to venture a defense of the Van Gorkom decision:

… the Van Gorkom court arguably created a set of incentives consistent with the teaching of the literature on group decision making. The decision disfavors agenda control by senior management, penalizes boards that simply go through the motions, and encourages inquiry, deliberation, care, and process. The decision strongly encourages boards to seek outside counsel and financial advice, which is consistent with evidence groupthink can be prevented by outside expert advice and evaluations. Even the court’s criticism of the board’s willingness to take action after a single meeting is consistent with suggestions that a “second-chance meeting” also helps prevent groupthink. As such, the oft-repeated law and economics critique of Van Gorkom appears overblown. Contrary to what most law and economics scholars have asserted, there is a rational basis for the seemingly formalistic procedures mandated by that opinion.

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I agree with Elizabeth's excellent post.  I wanted to add one additional comment on her point 1.  I would hope that, after its mistake in Van Gorkom, the court now recognizes how wrong it would be to insist on excessive procedures, including requiring a meeting in order to satisfy due care duties.  And clearly that shouldn't matter for good faith purposes under 102(b)(7). In fact, this point might give the court an extra incentive to rely on good faith.

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What a show!  My M&A class watched the webcast with me this morning, and I am definitely glad to have the opportunity to share this glimpse into the world of Delaware law with my students.

As the arguments proceeded, I was somewhat hopeful for the appellants because the court only asked appellants' counsel two questions but then peppered appellees' counsel with questions.  But then I realized that the questions posed to appellees' counsel were really softballs designed to foreclose all further discussion and make appellants' arguments seem absurd.  So, I am not hopeful for the appellants.  However, several issues were raised that I think are worthy of discussion.

1.  Does the BJR apply to officers?  I think if you polled corporate law scholars and business people, the overwhelming majority would say yes.  But they might not be able to back it up with law on their fingertips.  A quick perusal of the casebooks and treatises in my offices results in the same proof that appellees' counsel offered:  myriad cases from Delaware and elsewhere that assume that the BJR applies to officers as well as directors.  These cases and treatises that I have use the terms "directors," "directors and officers," and "corporate officers" interchangeably.  The various briefs cite to Business Lawyer articles by Lyman P.Q. Johnson on the one hand and Disney guest blogger Larry Hammermesh (with A. Gilchrist Sparks, an attorney in the proceeding).  I suppose this issue rarely comes up because plaintiffs rarely go after the isolated action of an officer that was sufficiently non-extraordinary to not need approval of the board of directors.  However, in the Disney opinion, Chancellor Chandler characterized the firing of Michael Ovitz by Michael Eisner as an action Eisner took unilaterally as CEO, not as Chairman of the Board.

2.  Was the firing of Ovitz subject to board control?  Appellants said yes because of words in the charter, but Appellees claimed that Appellants were misreading the charter.  Larry Ribstein explains below that the board could have delegated that duty to Eisner, but we don't have a corporate resolution.  The Chancery Court said no, so the failure of the board to have a meeting or to order an audit or to have documentation regarding the no-fault termination package was irrelevant.  If the Supreme Court disagrees, we may have more proceedings, but I doubt that will happen.  As a rhetorical point, I liked the way Appellees' counsel (Gregory P. Williams, I think) referred to the decision to terminate Ovitz as a "question of contract administration."  That phrase makes the decision seem very ministerial and immaterial.

Also, the court pointed out that Eisner as CEO was authorized to settle disputes and lawsuits, so couldn't that authority allow him to fire Ovitz under the NFT.  If so, then the charter and bylaws don't work very well together if one gives the board the ability to fire officers but the CEO the ability to fire them to "settle disputes."

3.  Can a board commit gross negligence if acting in good faith?  When I read the August opinion, the part that struck me was Chancellor Chandler seeming to say that a director does not violate the duty of care if the director does not act in good faith.  He quotes Chancellor Allen in Caremark as saying "Indeed, one wonders on what moral basis might shareholders attack a good faith business decision of a director as "unreasonable" or "irrational."  Where a director in fact exercises a good faith effort to be informed and to exercise appropriate judgment, he or she should be deemed to satisfy fully the duty of attention."  Chandler then quotes Allen again to define lack of good faith as "sustained or systematic failure of a director to exercise reasonable oversight."  This conflation could be seen to narrow what is gross negligence (must be in bad faith) or expand what is bad faith (includes sustained inattention).  Either way, let's have some explanation!

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Larry, thank you for breaking the ice.  We agree on a few things, so I will focus more on additional observations not raised in Larry’s post.

The points made by appellants’ counsel (as I recall) include:

1.  The directors had the obligation to meet together (as a group) and deliberate together on the decision to fire Ovitz.  By failing to do so, the directors breached some duty, per se.

2.  Eisner never had the authority to fire Ovitz, and therefore. . .  (I am not sure how this sentence would end in counsel’s mind).

3.  Chancellor Chandler erred in placing the officers within the protection of the business judgment rule presumption.

I think point one above is a non-starter.  I am not aware of an absolute obligation of directors to meet together in a situation like this such that the failure to so do would be a per se . . . breach of the duty of care (I am assuming.).

Point two above is no more persuasive to me.  If what appellants’ counsel was arguing was that the board breached its duty of care by failing to follow-up to assess whether THEY (the board) needed to act with respect to Ovitz’s firing, then I am not convinced that counsel pointed to facts that would put the directors outside the BJR protection.  If the directors are not outside of the BJR presumption’s protection, then the appellants’ counsel certainly did not convince me that the directors’ failure to follow-up on the firing was irrational (std of review that would apply).

Setting aside point three and the BJR debate as it pertains to officers (and I agree with Larry that this is a big issue – my inclination is to sidestep the issue for purposes of this post, and instead point readers toward the articles written by Lyman Johnson and Larry Hammermesh), I will summarize by noting that I found it hard to identify the core of any fundamental legal (not factual) argument made by appellants' counsel.  I viewed the bulk of what the appellants’ counsel said at oral argument as factual in nature, and I consider that a hard basis on which to sway a Delaware Supreme Court panel to reverse their trial court brethren. 

Specifically, I fully expected appellants’ counsel to point to a legal definition of gross negligence that would have put the non-officer directors outside the protection of the BJR presumption on the facts as found by the Chancellor. I was disappointed not to hear (or find in a brief) any good legal argument proffered by counsel for the appellants for reversal on the gross negligence point.  I agree that the Disney directors and the Compensation Committee were sloppy.  But at no point in the oral argument did I hear counsel connect the dots to show that the facts lined up with the definition of gross negligence (“reckless indifference to or a complete disregard of the stockholders”).  (This is why I think the appeal should have focused on good faith, but that is another post for later. . . .)  To that end, I considered appellants’ statement that bad faith and gross negligence should not have been discussed at the same point in the opinion a non sequitur.

Moreover, I am astounded that counsel for the appellants did not make the point that whether or not there was good cause for termination was irrelevant - the failure of the directors to even consider the good cause issue, debate it, and see if it would inform the termination package construction was the relevant point under the BJR.

Lastly, I have to ask:  Did I correctly hear appellees' counsel observe that Ovitz "did not perform?"  Now, I am not a litigator, but I can see no good reason for that observation from that side of the courtroom.

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I was called away for a couple of minutes, but heard just about all the rest -- if I missed something, I'm sure Gordon and Elizabeth or others can fill me in. I won't try to be precise about identifying lawyers or specific questioning justices.

The appellant's main argument is that the bjr was rebutted here by gross negligence in deciding on the termination.  In answer to a court question, any ratification by the board wouldn't be enough to save that breach. 

Appellant claims that the sole power to terminate was in the board, per the charter.  (I'm not sure how this deals with the question of whether the board could delegate the decision to the ceo (Eisner) as long as it properly supervised.)

Appellant claims that the Chancellor's bad faith test was contrary to Delaware law.  As a matter of policy, his test was so subjective that it would always be met by "pure heart" testimony. (Not necessarily -- there can be circumstantial evidence of bad faith.)

Appellee responds that the Chancellor looked both at bad faith and gross negligence. There was some argument about whether the Chancellor should have accepted some of the testimony. A court question made it clear that the question comes down to whether the Chancellor applied the wrong standard -- which here would boil down to gross negligence vs. some version of bad faith.

(I wonder if the Court might hold that the Chancellor erroneously applied bad faith, even if bad faith is ultimately determinative under 102(b)(7).  In other words, the court has to go through all the hoops whether or not one of them determines the result. This would be comparable to what the Court did in Van Gorkom -- due care no matter what, even if it doesn't control liability. Then we're just back to the wheel-spinning of entire fairness in Cede, etc.)

Appellant raises what might be a big issue here:  were the non-director officers protected by the bjr? It relies on Lyman Johnson's article and some authority in other states, and emphasizes that the bjr should depend on how the extent to which the protected party was compensated.

Appellee responds that the point of the bjr is to encourage risk-taking, and doesn't rest on compensation. (This would seem to me to be the much better argument. I may discuss this further later).

There was a lot of discussion on whether the board could have terminated for cause.  How is this relevant? Even if Ovitz clearly could have been terminated for cause, the question would still be whether it appropriately did not do so.

More later. . . .

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As I noted last Friday, the Disney case will be argued before the Delaware Supreme Court today at noon (Delaware time). The argument will be webcast by Courtroom Connect. If you are interested in viewing the oral argument, contact John Shin of Courtroom Connect for details (410.300.1200 or JShin@Courtroomconnect.com).

Several of the participants in our Conglomerate Forum on Disney will be watching the webcast and blogging about the argument here today and tomorrow. Please stop back and join us for what promises to be a fascinating discussion of one of the most important corporate fiduciary duty cases in recent memory.

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The oral argument in Disney will take place before the Delaware Supreme Court next Wednesday, January 25. It will be webcast, and I will pass along the details as soon as I have them. If you are interested in preparing for the argument, here are the briefs:

Appellants' Opening Brief
Non-Ovitz Defendants' Answer
Ovitz's Answer
Appellants' Reply

We are planning a reunion of the Conglomerate Forum: Disney commentators who were here after Chancellor Chandler issued his opinion last August. See here for those posts.

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At long last, the parents of Toy Story and Toy Story2 may make it official; the WSJ today is reporting that Disney may (finally) acquire Pixar.  I can think of many reasons why this acquisition makes perfect sense and long overdue, but here are a few:

1.  The costs of market contracting between Disney and Pixar seem to be too high, so integration will save transaction costs.  In other words, since the two don't seem to be able to achieve the same synergy through contracts, they should be part of the same firm.  (Of course, the pro-Kelo crowd would just say that Disney should be able to acquire Pixar through eminent domain because Pixar is a nut-job holdout!)

2.  Quite a bit of time passes in between Pixar movies.  I sold my Pixar stock in 1996 because no one knew when the next movie was going to be released and make some money.  The stock has obviously rebounded and Pixar has overcome some of the cyclicality of its enterprise, but being part of a larger firm could also even out those cycles.

3.  Toy Story3.  I personally promise everyone at Disney that, should there be a Toy Story3, with Buzz and Woody, my family will see it three times in the theater.  We will buy the DVD the first day it is released.  We will buy every licensed piece of plastic/piece of clothing/plush toy that is manufactured that vaguely resembles something in the movie.  We will go to McDonald's three times a week until we get every Happy Meal toy from the movie.  Get the picture?

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Law.com has an article in its In-House Counsel section today on lessons from the Disney/Michael Ovitz case decided by the Delaware Court of Chancery in August.  I taught this case in BA last semester, and it was very helpful that Gordon's case book (with Cindy Williams) had the earlier opinion of the court refusing to dismiss the claim before trial.  Because we had the two opinions, we could discuss how a set of facts can win on a motion to dismiss, but still not prove at trial, without additional facts, the breaches alleged given the difference in the burden of proof.  The article today emphasizes that corporate counsel should strive to have not only provable facts to win a case brought for breach of fiduciary duty, but also have the facts to win a dismissal before trial and save the company the costs of litigation. 

Of course, I had to chuckle at the opening paragraph:  "Having now had a chance to digest the decision and review the eight-year history of messy, public litigation over Michael Ovitz's hiring. . . ."  Of course, here at the Glom, we took about 12 hours to do the same thing before launching the Disney forum!

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