October 26, 2004
The Disney Trial
Posted by Gordon Smith

The national spotlight is back on Wilmington as the Disney case is currently being tried before Chancellor William B. Chandler III of the Delaware Court of Chancery. This is a case that has been bouncing around the Delaware courts since 1997, and it has already become an important new addition to the corporate law pantheon. By the time this is over, the Delaware courts might have invented a powerful new method of reviewing director actions.

To a corporate lawyer, the most conspicuous feature of the claims in Disney is the absence of self-interest on the part of the Disney managers (other than Ovitz). Normally, absent self-interested behavior, the Delaware courts are very deferential to director action. In this instance, however, Chancellor Chandler paved the way for a stockholder win with his May 2003 ruling, denying Disney's motion to dismiss. In that opinion, the Chancellor wrote the following with regard to the latest stockholder complaint:

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.

Against that legal backdrop, the stockholders are now attempting to prove that the directors breached a fiduciary duty of good faith. The stockholders have brought three expert witnesses before the court: (1) Deborah DeMott of Duke Law School stated, "I saw no indication that the selection of Mr. Ovitz was preceded by a meeting of Disney's board of directors"; (2) John Donohue of Yale Law School testified that Ovitz "seemed to have no understanding at all" of his role and could have been fired for cause; and (3) Kevin Murphy of the University of Southern California testified, "The initial contract was one of the most generous - if not the most generous - ever offered to a non-C.E.O. in corporate America," and that Ovitz's pay was "unreasonable" and "not in the interest of shareholders."

The stockholder case against the directors looks strong, and the claim against Michael Ovitz appears to be even easier. Just last month, Chancellor Chandler denied Ovitz's attempt to dismiss one of the claims, which alleges a self-interested transaction. According to Chancellor Chandler:

Ovitz's negotiated separation from the company was an interested transaction within the meaning of section 144 because he, as a director and officer, engaged in a transaction with the corporation for which he was a fiduciary and received a benefit greater than that of Disney's stockholders, and this benefit was material to Ovitz. It was more than merely receiving what he was entitled to under his contract. Ovitz has argued that receiving his [Non-Fault Termination ("NFT")] was merely a pre-arranged contractual obligation, akin to receiving his salary. It is true that if Ovitz received a NFT, that he had a contractual right to receive the payout he did receive. But Ovitz did not have a contractual right to receive a NFT, which distinguishes this situation from the mere receipt of salary. Instead, Ovitz's receipt of a NFT was conditioned upon a one-time determination (to be made by Disney) that was not guaranteed by his contract, and Ovitz appears to have actively engaged in negotiations and decisionmaking that affected Disney's determination to grant the NFT.

This looks like a loser for Ovitz. The issue before the Court will be whether Ovitz dealt fairly with Disney, and that will be a hard case for Ovitz to make.

Over the next few weeks, I will be watching the case and offering insights. I welcome your comments on this important case.

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