June 08, 2006
Whither Good Faith?
Posted by Gordon Smith

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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Disney Affirmed!
Posted by Gordon Smith

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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April 28, 2006
Where is Disney?
Posted by Gordon Smith

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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April 24, 2006
Disney Today?
Posted by Gordon Smith

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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April 08, 2006
Disney: Will the Supreme Court Reverse?
Posted by Gordon Smith

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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January 28, 2006
The Core Issue in Disney: Rebutting the BJR
Posted by Gordon Smith

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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January 27, 2006
Steering Culture
Posted by Victor Fleischer

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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January 26, 2006
Not in Good Faith Means Not in Good Faith
Posted by Elizabeth Nowicki

"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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The Disney Argument: An Impression
Posted by Gordon Smith

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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January 25, 2006
BJR and Officers
Posted by Steve Bainbridge

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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Group Decision Making
Posted by Steve Bainbridge

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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Individual vs group board decisionmaking
Posted by Account Deleted

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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Disney, BJR and Good Faith
Posted by Christine Hurt

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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Additional Initial Thoughts
Posted by Elizabeth Nowicki

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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Initial thoughts on the Disney argument
Posted by Account Deleted

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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