August 09, 2005
Norms v. liability
Posted by Account Deleted

As Gordon points out, an important aspect of the Disney opinion, as I anticipated in paragraph 11 of my Preview, was the Chancellor’s elaborate and repeated distinction between norms of good governance and liability as mechanisms for dealing with corporate misconduct.  Throughout the opinion the chancellor says, the defendants could and should have done better, but they're not liable for their failures.

This distinction is particularly important given the change in norms since the time of defendants' conduct, as the court noted at the beginning of its opinion (p. 1-2):

Recognizing the protean nature of ideal corporate governance practices, particularly over an era that has included the Enron and WorldCom debacles, and the resulting legislative focus on corporate governance, it is perhaps worth pointing out that the actions (and the failures to act) of the Disney board that gave rise to this lawsuit took place ten years ago, and that applying 21st century notions of best practices in analyzing whether those decisions were actionable would be misplaced.

The Chancellor then laid out (at 4-5) the sensitive business considerations that underlie the Delaware approach (also discussed in paragraph 1 of my Preview) which distinguish it from the more heavy-handed federal (Sarbox) approach: 

It is easy, of course, to fault a decision that ends in a failure, once hindsight makes the result of that decision plain to see. But the essence of business is risk—the application of informed belief to contingencies whose outcomes can sometimes be predicted, but never known. . . . . Even where decision-makers act as faithful servants. . . their ability and the wisdom of their judgments will vary. The redress for failures that arise from faithful management must come from the markets, through the action of shareholders and the free flow of capital, and not from this Court. Should the Court apportion 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. The entire advantage of the risk-taking, innovative, wealth-creating engine that is the Delaware corporation would cease to exist, with disastrous results for shareholders and society alike. That is why, under our corporate law, corporate decision-makers are held strictly to their fiduciary duties, but within the boundaries of those duties are free to act as their judgment and abilities dictate, free of post hoc penalties from a reviewing court using perfect hindsight. Corporate decisions are made, risks are taken, the results become apparent, capital flows accordingly, and shareholder value is increased.

Of course there's a limit.  As I anticipated in paragraph 12 of my Preview, the Chancellor would make clear that the court "stands ready" to impose discipline for a fiduciary breach.  The court said (p. 4)

The decision-makers entrusted by shareholders must act out of loyalty to those shareholders. They must in good faith act to make informed decisions on behalf of the shareholders, untainted by self-interest. Where they fail to do so, this Court stands ready to remedy breaches of fiduciary duty.

I'll discuss in later posts where the court draws the line.


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