August 10, 2005
the other Larry heard from
Posted by Hamermesh

1. The opinion seems like a bit of an anticlimax (is anyone actually reading this, or have we moved on already?)

2. I share the skepticism I sense from Larry and Sean that the “duty of good faith,” if it ever really was or is a distinct obligation, will amount to much as a basis for director monetary liability. And I agree that this opinion itself won’t do much at all to change director behavior. It was the court’s willingness to use the good faith theory/exception to 102(b)(7) exculpation that allowed the case to go to trial, and to engender the tremendous cost to Disney and its directors in terms of fees, expenses and reputational harm. Whether this kind of discipline-by-trial has a net positive social value is hard to say – but if anything changes director behavior, it’s the prospect of putting up with the burdens of going to trial, and not the threat of personal liability, that will elicit more attentive treatment of issues like executive compensation.

2b As Larry Ribstein knows, I wholeheartedly support his suggestion that Van Gorkom is rapidly on the way to obsolescence and irrelevance. I was surprised that in going so far to distinguish Van Gorkom, the Chancellor didn’t simply point out that the intervention of 102(b)(7) and the implementing Disney charter provision made the legal issue completely different. Does anyone think that the directors in Van Gorkom would have been held liable if a 102(b)(7) provision/regime had been in force?

3. Larry R. is onto something when he notes the role of agency law in the Disney opinion. This opinion illustrates how many big decisions in big companies are made without any involvement of the board whatsoever. This fact implicates two significant legal issues. First, how should the conduct of officers be judged when they act unilaterally? Does the business judgment rule protect them? (102(b)(7) can’t). This is what Lyman Johnson has been debating with me and Gil Sparks in the last couple issues of The Business Lawyer. I won’t get into the substance of that debate, but the Disney case highlights the practical importance of the issue. The second issue may be of more interest in the current context: that issue is when the directors are obligated to step in and exercise judgment when they know a decision is being made at a lower level and could potentially affect the corporation adversely. As the Chancellor frames the legal standard (p. 123, after “long and careful consideration”), action not in good faith (the 102(b)(7) exception) involves “intentional dereliction of duty, a conscious disregard for one’s responsibilities.” How does this standard work when we’re talking about whether directors should have responded to a red flag, or a pink flag? The Chancellor partly answers this, continuing with the observation that “[d]eliberate indifference and inaction in the face of a duty to act is, in my mind, conduct that is clearly disloyal to the corporation.” This is only a partial answer, however, because it doesn’t define when there is a “duty to act.” The Chancellor softens his formulation a bit later (p. 125) when he says that bad faith exists in a failure to respond in the case of a “known duty to act.” So it’s not clear which standard applies: do directors have to know they have a duty, before they can be held liable for failing to respond, or can a duty to act arise where the flag is red enough that a director should have known of a responsibility to act but chose not to investigate or take action? Perhaps it’s the former standard, because maybe you can’t deliberately fail to act unless you know that action is required. If this is where we come out, there is little substance indeed to the “duty of good faith.”

4. In any event, the Chancellor concludes that the New Board wasn’t obligated to act on the NFT determination, despite awareness on the part of some or all of them that Eisner and Litvack were handling it. The Chancellor’s conclusion seems to rest heavily on authority concepts: even though the Board had concurrent power to act on the matter, he says, Eisner had the power as well, so the Board had no duty to act. (p. 168). This reasoning alone surely can’t be sufficient in and of itself: directors can’t be universally relieved of responsibility to investigate and act on a red flag simply because the matter is within the CEO’s concurrent authority. What else does the Chancellor rely on to exonerate the New Board in respect of the NFT determination? Two things: (i) a finding that this determination was not material to Disney (n. 577) (he’s clearly correct in focusing on materiality, since a director’s duty to step in ought to depend on the significance of the matter to the corporation); and (ii) a tantalizingly enigmatic footnote 580. Here the Chancellor says implies that the New Board was unaware that Disney had grounds to terminate Ovitz for cause. Had the directors been aware of such grounds, he suggests, “the calculus would be much different.” This is intriguing. What kind of awareness would have changed the calculus? Knowledge of the circumstances that might have constituted cause for removal? I doubt it. More likely the Chancellor had in mind not only knowledge of such circumstances, but also knowledge that they constituted cause for removal.

Disney, Forum: Disney | Bookmark

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