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 [email protected]).

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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I had noticed earlier that one of the pieces on Hofstra Law Review new Ideas page is a short article by Jonathan Macey on the August 2005 opinion in the Disney derivative litigation.  (Remember the Conglomerate Disney Forum?)  The article, Delaware:  Home of the Most Expensive Raincoat, uses the Disney opinion to opine on the dominance of Delaware corporate law and public choice theory.  (Tip:  Matt Bodie).  Coincidentally, my BA class is reading the Disney opinion for discussion tomorrow.

The posting of this article on the Ideas page is a great example of how the Internet can revolutionize legal scholarship.  The opinion was released on August 9, 2005.  In the normal course of events, an eager scholar could begin an article on that opinion in Fall 2005 and send it out in March 2006.  (Prof. Macey could probably send it to someone mid-cycle, but the average law prof seems to send out in one of two windows.)  In a best case scenario, a law review would accept it in Spring 2006 for publication at the earliest of Fall/Winter 2006, over a year after the date of decision.  Through the magic of the Internet, the article has appeared mere three months after the decision.  Of course, ssrn also creates the same possibility, but not with the signalling ability of a law review-sponsored website.  And, of course, the Disney Forum allowed for opinions to be given almost simultaneously in a more interactive, but less formal, environment.

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I am back from a very enjoyable conference at the University of Iowa, where I spoke with Justices Holland and Jacobs of the Delaware Supreme Court. They told me that the plaintiffs had appealed the Disney decision and that the oral argument would be held in December or January. The Court will issue its opinion within 60 days of the oral argument, so we should know something definitive on Disney early next year. Of course, the Justices would not discuss the merits of the case (and I didn't ask), but the consensus among academic participants of the conference was that the Delaware Supreme Court would affirm.

By the way, the Delware Supreme Court abandoned its en banc experiment, which I described here. Unless there is a disagreement on the initial panel of three justices, therefore, the Court will not sit en banc, even though it is an important case.

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Several people have inquired about this W$J editorial on the Disney case, so I thought I would take the opportunity to explain more fully here. Here is the last paragraph of the editorial, if you are having trouble with access:

A director's job is to decide what's best for investors, not what's most risk-averse. Disney's shareholders had proper recourse, says Gordon Smith, a professor of securities law at the University of Wisconsin Law School who has followed the case, "but it's not ex post in suing directors for bad decisions. It's ex ante in getting good directors to make the decisions." We're glad Judge Chandler agrees.

Chancellor Chandler expressed the same sentiment in this way: "The redress for failures that arise from faithful management must come from the markets … and not from this Court." In corporate governance circles, the word "markets" traditionally has been limited to the buying and selling of shares, including via hostile takeovers. Over the past decade, however, increasing activism by pension funds and other institutional investors has expanded the menu of market mechanisms.

In my view, one lesson of Disney and similar corporate governance failures is that shareholders should be more focused on board composition than they are now. The SEC's failed director nomination rule was a ham-handed effort at facilitating shareholder participation in board composition, but even without any rule changes, much can be done. Perhaps the Disney case will serve as a reminder that fixing problems after they have occurred is no substitute for electing competent directors.

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Hi, Everyone:  I managed to miss the excitement due to travel on Wed and technical incompetence on Thurs, but the exchange was terrific.  On the offchance folks aren't weary of mulling over the case, I thought  I'd post a distilled version of a couple of things I was intending to chime in on.

Generally, I thought Chancellor Chandler's opinion was extremely powerful and almost persuasive -- I say "almost" b/c I still am uncomfortable with the dearth of board involvement etc.

Reading the opinion, I had a much different impression than much of the news coverage, which tended to suggest that the opinion had strongly criticised the directors' performance.  Although there are a few lines of that sort, it seemed to me that the opinion had surprisingly little "shaming" language.  It was much less critical of the Disney board than I would have expected; the Chancellor emphasized the difference between the standard of conduct and the standard of review (in Mel Eisenberg's terms), but wasn't especially critical of the conduct.

Somewhat related, I was surprized that there wasn't more discussion of the legal standards.  Many of us are hoping that Disney will clarify Delaware's good faith standard, but the Chancellor didn't delve into this in any detail.  The decision was much, much more about the facts. Perhaps this is in part b/c the principal audience is the Del SCt; I suspect it isn't lost on Chancellor Chandler that the Van Gorkom decision overruled a chancery court decision that had held that the directors didn't breach their duty of care.

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Michael Madison thinks that the Disney decision encourages innovation.  Because directors are free to screw up without being second-guessed, they will take more risks.

I'm not so sure.  Extreme managerial slack allows risk-taking, but it also allows silly decisions by unconstrained CEOs.  Whatever else can be said about the hiring of Ovitz, the hiring process was not executed smoothly or sensibly.  If Disney had been owned by a private equity firm with firmer controls on management, I doubt we would have seen the disaster that we saw.  They may have hired Ovitz, but I suspect his pay package would have more tightly tied pay to performance, and his integration into the firm would likely have been more carefully thought through.

The extreme managerial slack that Madison and Chancellor Chandler praise exists mostly at public companies; it is less common, as a practical matter, among companies owned by VC firms or private equity firms.  And I suspect that more innovation takes place within those privately-held firms than at public companies. 

One possible counterargument:  the substantial freedom enjoyed by public company CEOs is a prize that founders may aspire to when they create companies in the first place.  So to the extent that the Disney decision makes becoming a public company executive look alluring, it may encourage innovation.

Madison is surely right that some sort of business judgment rule is necessary to encourage risk-taking.  But without getting too deep into merits review of business decisions, some sort of process review may be necessary on occasion. 

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The past two days have been very enlightening for me, and I have received many emails from readers who appreciate the efforts of the participants in the Conglomerate Forum on Disney. Thanks to all who participated.

Obviously, we did not determine the timing of the release of the opinion, and a few of our participants were traveling or otherwise unavailable this week. We may yet hear from some of them, but if we are not able to read their reactions to Chancellor Chandler's opinion, perhaps we will hear from them after the Delaware Supreme Court has had its turn.

If you are interested in reading the collected posts from the Conglomerate Forum on Disney, you can find them all here. Including this one.

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I find this discussion fascinating, as I am currently working on two “duty of care” papers. Below is my response to the suggestion that the duty of care and Van Gorkom are dead or dying. I agree with Steve Bainbridge's earlier post, but I get to the same result (I think) with a different formula.

Here is the generic duty of care analysis as I have gleaned from the Delaware courts. I break the analysis down into numbered steps to make it easier to work with, because I think that shorthand analysis is one of the ways that Delaware’s judiciary muddles some of their case law in this area:

1. Directors are afforded significant deference from the judiciary. If a director is sued for an alleged breach of his duty of care, he will automatically be afforded the protection of the Business Judgment Rule Presumption.

2. If, however, the plaintiff can show that one of the factual prerequisites to the business judgment rule does not exist, the director will be stripped of the protection of the presumption, and his actions will be more closely scrutinized.

3. The four factual prerequisites to the BJR are: a decision made, in good faith, absent conflicts, after the director has become reasonably informed (and the director must not be GROSSLY NEGLIGENT with respect to this “informed” point).

4. If one of these four factual prerequisites is missing, the action at issue will be reviewed using a reasonableness and fairness standard.

5. However, a director can also be protected statutorily with a charter provision similar to that authorized by DGCL 102(b)(7).

6. If a director defendant shows that such a charter provision exists, he is again presumptively protected unless a plaintiff can show that the alleged duty of care breach is based on or revolves around or is predicated on an act taken “not in good faith.” (Let us please ignore the duty of loyalty for now -- Lyman Johnson does incredible work with that in his recent article.)

Conclusion:

Van Gorkom lives on as indicated in point 3 above. The duty of care lives on, assuming a DGCL 102(b)(7) provision, in point 6 above.

As the above analysis applies to Disney:

In the Disney case, I seems that we all agree that there is a sticky point with respect to my point 6 above. The plaintiffs’ need to show that the defendant directors acted “not in good faith.” If we agree that the definition proffered on p.123 of the Disney opinion is a useful way to assess “not in good faith,” then, interestingly, we move a bit away from fraud and closer to gross negligence with “not in good faith.”

The Chancellor said on p.123:

“Upon long and careful consideration, I am of the opinion that the concept of intentional dereliction of duty, a conscious disregard for one’s responsibilities, is an appropriate (although not the only) standard for determining whether fiduciaries have acted in good faith. Deliberate indifference and inaction in the face of a duty to act is, in my mind, conduct that is clearly disloyal to the corporation. It is the epitome of faithless conduct....”

This language – “in the face of a duty to act,” for example, and “intentional dereliction of duty” – leads us back to a basic duty of care analysis. Did the directors breach their duty of care in a way that falls within the Chancellor's definition of "good faith"? Well, if we remove the directors from the BJR protection b/c we view their “informed” efforts as grossly negligent, then we are working with a reasonable and fair standard for purposes of assessing whether they breached their duty of care. And they would be hard-pressed to satisfy that standard. So it seems that we could find that the duty of care had been breached. And then we would circle back and query whether, having so found, the breach was based on inaction or deliberate indifference or intentional dereliction, such that the conduct was now within the reach of the Chancellor’s “good faith” definition.

The above should give a sense of why I am troubled by the opinion. Moreover, hopefully it is easy to see why the compensation committee’s actions give me pause. (A poster named Roger Hipp broke down the facts nicely in a response to my earlier “Respectful Reservations” post.) Either the actions at issue were taken “not in good faith,” such that both the BJR protection AND the statutory protection are stripped from the get-go, or the actions are “grossly negligent” with respect to the “informed” obligation, which triggers the 102(b)(7) “good faith” analysis as noted above.

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Am I to understand that most, if not all, of you believe that yesterday’s Disney opinion represents … well… a 100% correct interpretation and application of the law that will be adopted and sustained across the board?  I say this with the utmost respect for Chancellor Chandler, as I am of the view that he is obviously a brilliant jurist.  But I have some concerns about the opinion, and I am not sure that it represents the final word on the duty of care and good faith.

Specifically, although the opinion was obviously thoughtfully and painstakingly written, there are points in the opinion where I respectfully disagree with the recitation of the law.  Further, taking the findings of fact in the opinion as a given, there are instances where the application of the law to the facts troubles me.  I am actually a bit surprised to have this reaction, because I fully expected that, either way this case was decided, there would be little room to question the opinion and ultimate holding.  (Basically I agree with what I think Profs. Bainbridge and Smith said – this case could have gone either way.)

In addition, plaintiffs’ counsel has indicated that the decision will be appealed, so this opinion might not be the final word in this case. Five years from now, yesterday’s opinion might be but a fuzzy memory, with the responsive Supreme Court opinion instead taking its place in our Corporations textbooks. (I am not suggesting that this will (or should) happen. I am only noting that it might be a bit early for Wachtell, Lipton (for whom I also worked) and other firms to take too much away from yesterday’s Disney directors’ Delaware triumph. To wit, many of us might have a difficult time recalling exactly what valuable information we gleaned initially from the lower courts in the Unocal, Van Gorkom, and Emerald Partners cases.)

In any event, am I alone in my reluctance to wholeheartedly embrace yesterday’s opinion at this juncture?  And am I alone in suggesting that Delaware jurisprudence in this area is a bit… inconsistent, such that I would not bet the farm on any one iteration of the current state of the common law in this area?

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One important justification for judicial deference towards directors relates to the desire to promote risk-taking. I am interested in exploring a simple question: would imposing liability on Disney's directors dampen the enthusiasm of other directors for risk?

Corporate lawyers are fond of distinguishing between the substance of a decision and the process by which a decision is made. In the Disney case, for example, the plaintiffs challenged both the substance of the board's decisions to hire and fire Michael Ovitz under the terms of his employment agreement (arguing that he was paid too much for his services) and the process by which those decisions were made (arguing that the directors did not adequately consider their decisions). The substantive claims fall under the heading of "waste" and the procedural claims fall under the headings of "due care" and "good faith" (and, with respect to Ovitz, "loyalty").

The risk-taking rationale for the business judgment rule appears to focus on the substance of board decisions. Courts refrain from second-guessing board decisions, even when they turn out badly, because courts want to encourage directors to consider risky strategies without worrying about personal liability if the strategies fail. At the same time, courts do not want to encourage sloppy procedures! As a result, application of the business judgment rule is premised on fulfilling minimum procedural requirments. Consider Chancellor Allen's canonical description of the risk-taking rationale for the business judgment rule, which Chancellor Chandler quoted in fn 407 of the Disney opinion:

Corporate directors of public companies typically have a very small proportionate ownership interest in their corporations and little or no incentive compensation. Thus, they enjoy (as residual owners) only a very small proportion of any “upside” gains earned by the corporation on risky investment projects. If, however, corporate directors were to be found liable for a corporate loss from a risky project on the ground that the investment was too risky (foolishly risky! stupidly risky! egregiously risky!—you supply the adverb), their liability would be joint and several for the whole loss (with I suppose a right of contribution). Given the scale of operation of modern public corporations, this stupefying disjunction between risk and reward for corporate directors threatens undesirable effects. Given this disjunction, only a very small probability of director liability based on “negligence”, “inattention”, “waste”, etc. could induce a board to avoid authorizing risky investment projects to any extent! Obviously, it is in the shareholders’ economic interest to offer sufficient protection to directors from liability for negligence, etc., to allow directors to conclude that, as a practical matter, there is no risk that, if they act in good faith and meet minimalist proceduralist standards of attention, they can face liability as a result of a business loss.

Gagliardi v. TriFoods Int’l Inc., 683 A.2d 1049, 1052 (Del. Ch. 1996).

Notice that Chancellor Allen presumes that the directors "act in good faith and meet minimalist proceduralist standards of attention." In other words, if the process is adequate, the court will not second-guess the substance. Of course, the main point of the Disney case was to determine whether the process used by Disney's directors was adequate to justify the protections of the business judgment rule. Now we are getting to the crux of the matter: does the desire not to second-guess substance require judicial restraint in second-guessing process?

In a word, yes.

Remember that courts are asked to review a board's decision-making process only when a decision has turned out badly. Under such circumstances, plaintiffs inevitably find procedural infirmities, and the temptation to engage in hindsight reasoning is enormous. Surely the directors should have anticipated the events that ultimately led to this disaster!

If courts are serious about encouraging risk taking by directors, such reasoning must be confined to a limited range of cases, and Delaware has done just that. After Smith v. Van Gorkom, the Delaware legislature essentially took the duty of care off the table, and the Disney decision limits the duty of good faith to an exceedingly small set of cases. Generally speaking, therefore, the Delaware courts will intervene with board decisions only when directors are subject to a conflict of interest. This was the point recently made by Larry Ribstein. If the Delaware courts attempted to be more aggressive, Chancellor Chandler warned of dire consequences: "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."

This brings us back to the question that started this post: would imposing liability on Disney's directors dampen the enthusiasm of other directors for risk? In my view, this would happen only if the actions of Disney's directors were viewed as falling within the range of ordinary director behavior. If the Disney directors were portrayed as having abdicated their directorial responsibilities -- and the facts on this are quite close -- then imposing liability would not have the ripple effects described by Chancellor Chandler.

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In a memorandum discussing the Disney opinion, my former law firm, Wachtell, Lipton, proclaims that “the Business Judgment Rule is Alive and Well” (and, presumably, living in Delaware). I’m guessing other top firms will soon make similar announcements to their clients, creating a chorus of defense firm triumphalism. And they’ll be right.

The bottom line issue concerning good faith is this: will it give plaintiffs’ lawyers a new means of surviving the motion to dismiss? The answer, as Wachtell and other firms have figured out, is: not really.

Chancellor Chandler makes clear that good faith is presumed as a part of the business judgment rule—“Delaware law presumes that directors act in good faith when making business judgments” (120). So, in order to sustain a good faith claim, plaintiffs will have to overcome the business judgment rule (124). As all of us know, that is not easily done, and the Chancellor did nothing to lighten the plaintiffs’ load when proceeding under a claim of bad faith as opposed to, say, negligence.

Still, to be fair, the Chancellor’s opinion does create another argument that plaintiffs can make in seeking to rebut the business judgment rule. Plaintiffs’ lawyers can now claim that the board’s decision-making process stems from a motive other than the best interests of the corporation. How can they do this, short of the evidence of smoldering lust I suggested in my first post? They might try to show a total absence of deliberation, but I imagine most corporations will be able to construct an adequate paper trail (primarily in board minutes) to rebut this suggestion. So when will good faith really provide any kind of life raft to a plaintiffs’ firm looking to survive the motion to dismiss?

Only, Chandler suggests, where there is “an imperial CEO or controlling shareholder with a supine or passive board” (footnote 487). The best chance for a bad faith claim, in other words, involves (1) a board stacked with the CEO’s cronies, and (2) an act that the CEO wants the board to accept for personal rather than professional reasons.

Disney fulfilled condition (1) but not condition (2).

The single most important thing the defense did at trial was to show that Eisner and Ovitz didn’t really have a friendship, but rather a business relationship. Remember Ovitz on the stand (the richest man I have ever pitied) saying that Eisner was his best friend? Remember Eisner shrewdly responding a few days later that Ovitz was “a guy who had a hundred best friends”? That was not only a Hollywood moment in little Delaware. It was also, I believe, a turning point in the trial. Once it was plainly established that friendship was not a motive for the mistakes the board made, the good faith claim went away. As I note in my article, the 2003 opinion repeats some variant of the word “friend” fifteen times. The first thing I did when I got this opinion last night was search for “friend.” It appears only eight times. Once I saw that I knew the board had won. As long as the motive is business, not friendship, there’s little else the plaintiffs can say.

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Larry, obviously you were asking difficult questions with no easy answers in the post below, but I wanted to respond to some of your questions because (a) they are thought-provoking and (b) I suspect I might be outside the bell curve with some of my responses. My numbers below mirror your numbers.

1. Yes, I am still reading. I found the opinion to be a fascinating work; kudos to Gordon for putting this responsive forum together.

2. Ditto.

2b. Yes and no. If the Van Gorkom case arose in today's 102(b)(7) world, the directors should still be liable under a correct interpretation and application of 102(b)(7). Do I think the majority of Delaware courts would ever reach that same conclusion? No.

3. Most (many?) of the officers implicated in the situations I assume you are envisioning would have been directors, right? (e.g. CEO, COO, who also sat on the Board) If those folks acted unilaterally when they held both titles, would you still be asking your question? (Your question being “First, how should the conduct of officers be judged when they act unilaterally?”)

4. Did anyone else take pause with the portion of the opinion to which Larry refers when he says “The Chancellor’s conclusion [re New Board] 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)”?

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