August 10, 2005
Issues with Christine and Sean
Posted by Hamermesh

Christine: What I think your post misses is what I referred to in my earlier post, namely the enormous costs to the directors in defending the case, even though they won (so far). OK, I know Disney probably paid for their lawyers, and they’re not out of pocket in dollar terms, but they spent a lot of time in depositions and in Georgetown, Delaware, of all places, and haven’t exactly enjoyed warm publicity. So I disagree with your advice to directors not to do anything differently. This might have been an avoidable mess, had the OEA been developed with better process and greater comp committee study and involvement and documentation.

Sean: I’m sympathetic to your singling out executive comp for special treatment. But how far do boards have to be involved? Was the NFT determination a matter of “executive compensation” that the Disney board should have been involved in? How many officers’ pay packages do boards have to function on? All of them? Just the CEO? Where’s the line? Can’t a board draw the line itself? If not, who draws it for them?

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The Tax and Financial Engineering Angle
Posted by Victor Fleischer

I will leave the Delaware fiduciary duty stuff to the experts, but I thought I would talk a bit about the role that the tax law and financial engineering played in the story.  The comp committee wanted to give Ovitz "downside protection," by which they apparently meant a guaranteed salary.  To preserve the appearance of pay-for-performance, they offered some of this guaranteed salary in the form of options, but if the options failed to appreciate to at least $50 million, Disney would make up the difference. 

This guarantee ran into a 162(m) problem: 

To that end, Santaniello concluded that the $50 million guarantee presented negative tax implications for the Company, as it might not have been deductible.  Concluding  that the provision must be eliminated, Russell initiated discussions on how to  compensate Ovitz for this change—from this, an amalgamation of amendments to certain terms of the OEA arose in order to replace the back-end guarantee. 

(Opinion pp. 26-27.)

Section 162(m) of the Code provides that corporations may not deduct compensation in excess of $1 million unless it is qualified performance-based compensation.  A guarantee means that the compensation is no longer performance-based.  I find it telling (but not at all unusual) that Disney's response was not to renegotiate for stronger performance-based incentives, but instead to seek a financial engineering solution that allows as little economic downside risk as possible without running afoul of 162(m).  Disney accomplished this by, among other things, lowering the strike price of some of Ovitz's options to at-the-money and increasing the severance package.  Long-dated at-the-money options are almost as good as receiving cash or stock, but produce better tax consequences for the executive.  I have written extensively about how the tax code distorts financial incentives in the private equity context.   The public company context is, sadly, even more distorted.  When it comes to corporate governance, tax only hurts.  It never helps.

Among other problems, the Code encourages the sort of financial engineering that makes meaningful review by a board of directors more difficult.  If Ovitz were simply offered $150 million in straight cash, guaranteed, the board might have asked more questions.  Instead, to ensure that the compensation was deductible, Ovitz received a package that was economically similar to cash, but more complicated and confusing.  The desire to camouflage the compensation is not primarily tax-related, but the tax Code's bias against cash salaries doesn't help.

The end result was a nonsensical compensation design that, as Professor Murphy testified, provided perverse incentives for Ovitz to perform badly and get fired.  The Board gets a free pass on this silly compensation design, apparently, because of the "type of person" Ovitz is.  The Chancellor, seemingly dismissing the relevance of incentives, explains: 

First, based upon my personal observations of Ovitz, he possesses such an ego, and enjoyed such a towering reputation before his employment at the Company, that he is not the type of person that would intentionally perform poorly. Ovitz did not build Hollywood’s premier talent agency by performing poorly. Second, nothing in the trial record indicates to me that Ovitz intended to bring anything less than his best efforts to the Company.

(Opinion p. 132.)  It should not be enough to point to an executive's reputation as a stand-up guy.  Incentives matter, and contracts should be designed with financial incentives in mind.  (Otherwise we should just drop the pay-for-performance charade and give cash.)  I don't think it's unreasonable to expect compensation committee members to understand a bit about incentives and conduct some meaningful review of the contracts. 

Whether meaningful review of the compensation design is a matter for Delaware law or "best practices" I do not have the expertise to say.  But I will suggest that if Delaware doesn't get its act together with respect to executive comp, we may soon see federal intervention, for better or for worse, perhaps through the tax Code.  And that's not likely to help anyone.

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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.

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Is Executive Compensation Special?
Posted by S_Griffith

It is. After all, Elkins and Disney, both good faith cases, are also executive compensation cases. What’s special about it?

First, executive compensation is a unique context where ordinary (that is, large) deference to board decision-making is not appropriate. Ordinarily, the question of how much to deliberate—the key indicator, by proxy, of bad faith (see my previous posts)—is a matter, like the decision whether to manufacture bottles or bricks, up to the board to decide and therefore protected by the business judgment rule. At the limits, this means a board can decide not to deliberate on most matters—that is, it can delegate the decision to management or a specialist. The rare exception to this principle is for those matters (like mergers, see the Chancellor’s discussion at page 150) that the DGCL says must be determined by the board. Executive compensation, although not carved out as unique by the statute, is another exception to the board’s ability to decide (by delegating) not to deliberate. As the court in Elkins stated:

While there may be instances in which a board may act with deference to corporate officers' judgments, executive compensation is not one of those instances. The board must exercise its own business judgment in approving an executive compensation transaction.

Why is executive compensation different? Why is board deference appropriate in other matters but not here? The answer, obviously, is that management has an overwhelming interest in setting its own compensation as high as it possibly can and cannot be trusted to act in the best interests of the corporation. Because of this conflict of interest, the board cannot blandly defer to management’s judgment.

Executive compensation, in other words, is a special case where management’s loyalty cannot be trusted. If the board does not exercise its own judgment to constrain management, we cannot be confident that the resulting decision is not the product of self-interest. Here again, the traditional duties of care and loyalty overlap (see Disney, footnote 402).

Second, executive compensation has recently become a hotly contested issue where the laxity of Delaware courts has been publicly criticized and calls have been made for federal intervention into corporate governance. Note, for example, that the very first footnote in the opinion cites these issues, in the context of a recent Bebchuk-Bainbridge exchange. Chancellor Chandler has previously shown himself to be highly sensitive to these matters, writing in an academic article with Vice Chancellor Strine that:

[I]t can be argued fairly that Delaware's common law did not react quickly or aggressively enough to changes in compensation practices during the last two decades, changes that were so substantial quantitatively that they required a qualitatively more intense form of judicial review…. In the past, the Delaware courts had generally taken a hands-off approach to executive compensation based on the assumption that this was a matter of business judgment, which could also be factored into the electorate's voting decisions.

William B. Chandler & Leo E. Strine, Jr., The New Federalism of the American Corporate Governance System: Preliminary Reflections of Two Residents of One Small State, 152 U. Pa. L. Rev. 953, 1001 (2003).

Going forward, however, Chandler and Strine wrote that state law policymakers “including judges shaping the common law” will be responsive to the concerns raised by the recent federal intervention and “reflect more deeply on whether their own policies need adaptation to better protect stockholders.” Id.

What Disney does, as I have argued elsewhere ( is to make a pre-emptive strike against the possibility that the federal government will further usurp Delaware’s role as the fundamental corporate law-maker. Good faith is a rhetorical device to permit greater judicial intrusion into a specific area of concern—executive compensation. What today’s opinion does is to confine the further judicial intervention to that specific area. Whether this will stem the threat of further federal intervention is a debatable question, and it is distinct from the question of whether it will actually do anything to fix the problem of executive compensation (if indeed it is a problem).

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What is deliberate indifference?
Posted by S_Griffith

An interesting aspect of good faith/ bad faith analysis is how to do it by proxy. That is, if you can’t see into the hearts of the board, how can you decide whether they acted with deliberate indifference? One way is to look at how long they thought about their decision. This method was employed most explicitly in the Elkins case, where the court was plainly wary of the way such analyses of process can slide into analyses of substance:

[Plaintiffs’] Counsel took the following position: “Now we're not saying if it was 20 minutes, it would have been okay or if it was 5 minutes, it wouldn't have been okay. Perhaps 5 or 10 minutes would have been sufficient if there had been some other involvement or discussion with the expert other than that very brief meeting.”

The Elkins court ultimately rejected this degree of parsing and chose instead to dismiss bad faith allegations where it found any evidence of deliberation, allowing them to proceed only where it found none. This binary analysis, sustaining bad faith claims only if there is zero deliberation, is necessary to avoid the situation where courts start establishing precedents for how much time boards must spend on each type of decision. Fundamentally, the decision about how much to deliberate is, like the decision to make bottles or bricks, a business decision protected by the business judgment rule.

All of this comes up again in today’s Disney opinion when the Chancellor, comparing the Disney board with the Trans Union board, addresses the amount of time the compensation committee spent on the Ovitz contract, deciding ultimately that it is “not insignificant” (153). In other words, only a truly insignificant amount of time will be evidence of deliberate indifference sufficient to support a bad faith claim. Otherwise, the decision of how much time to spend is up to the board and protected by the business judgment rule.

As rare as zero deliberation may be, a bottom line lesson of the opinion for practitioners is to pay close attention to board minutes. Footnote 539 will remind defense lawyers to make sure that board minutes are always robust and reflective of a careful and deliberative process. Equally, it will remind plaintiffs' lawyers where to look for evidence of a true lack of deliberation.

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Bad Faith
Posted by S_Griffith

When does a director act in bad faith? When the director acts “for some purpose other than a genuine attempt to advance corporate welfare” (120) or for some reason “unrelated to a pursuit of the corporation’s best interests” (121). We then get a handful of hypothetical situations in which directors might not act in good faith—i.e., directors making decisions on the basis of greed, hatred, lust, envy, revenge, shame, pride, and (maybe) persistent sloth. Some of these are plain violations of more basic loyalty principles—most obviously greed, but maybe also envy and sloth. The others could only come up in dime store novels. Try to imagine a director who makes corporate decision on the basis of lust or revenge… The legal professoriate, at least, might be able to imagine this, but outside of the context of a law school hypothetical, I doubt such situations will ever arise. How would a litigant go about establishing that a decision was or was not motivated by lust? By introducing love letters into evidence? “Dear Honey, To show you how much I love you I am going to do something at the board meeting today that really sticks it to the man. Don’t ever leave me. Love, Snuggles.”

Without evidence like that, who can say what is in the hearts of men? So litigants will try to establish a breach of fiduciary duty by pointing to what actually happened. That is: process and outcomes. But that is how you establish traditional breaches like care and waste. So, my prediction (which I also made in the paper the Chancellor cites in footnote 402) is that despite all of the talk about good faith, at the end of the day, it won’t mean much. Litigants will go on fighting about care and loyalty and resort to good faith only in those situations where the traditional arguments (because of a 102b7 provision, for example) are unavailable, but even then, the good faith arguments will have the same form as the traditional arguments about care and loyalty.

In other words, this opinion, in spite of sketching the contours of something called “good faith” is a conservative opinion. The Chancellor even refrains from calling the allegations a good faith complaint—instead he says the claim states “a non-exulpated breach of fiduciary duty claim” (122). Try saying that five times fast. This might not have been the case—if, for example, the Chancellor had set the standard for establishing a breach of good faith much lower than the standard for establishing a breach of the BJR-shielded duty of care—but the opinion doesn’t do that. It slides the scale back in the direction of board authority and away from judicial accountability. And while it is true, as Charles Elson said in the NY Times, that “[i]t means that you can't just make a decision with a devil-may-care attitude,” it probably has not, as he went on to say, “altered director behavior forever.”

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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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Agency law
Posted by Account Deleted

There was an interesting little discussion of agency law in the Disney opinion. The question is whether the board should have gotten more involved in Ovitz’s termination. The court said it didn’t have to act at all – the CEO had the agency power to terminate Ovitz on his own, even without the board.  See p. 165, n. 570. 

This brings to mind the casebook chestnut, in my book and others, Lee v. Jenkins Bros, 268 F.2d 357 (2d Cir. 1959), which involved hiring of an executive rather than firing.

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Repeat After Me ...
Posted by Gordon Smith

"Unlike ideals of corporate governance, a fiduciary's duties do not change over time." (2)

"Times may change, but fiduciary duties do not." (3)

These statements seem to have been intended to highlight the fact that Delaware is not going to create new avenues of liability to satisfy the post-Enron reformist impulse. Nevertheless, the notion that fiduciary duties are constant seems wildly out of place in this case, when all of us were wondering what to make of the duty of good faith and Chancellor Chandler is writing sentences like this: "The Delaware Supreme Court has been clear that outside the recognized fiduciary duties of care and loyalty (and perhaps good faith), there are no other fiduciary duties."

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Good faith
Posted by Account Deleted

In paragraph 4 of my Preview I stressed the importance of whether the defendants acted in bad faith in the sense of “knowing or deliberate indifference.”  As Gordon points out, this was, in fact, a key to the case. The court laid out its view of bad faith at the beginning of its analysis, pp. 120-24.  It made clear that bad faith amounted to acting intentionally with a purpose other than to further the corporation’s interest. 

Throughout its analysis of the defendants’ conduct the court emphasized the difference between an absence of due care and intentional disregard of duty.

I found most interesting the court’s analysis of the function of a good faith duty in filling in the gaps in the duty of loyalty.  Noting that Eisner had stocked the Disney board with supine sycophants, the court said (p. 135, n. 487):

It is precisely in this context—an imperial CEO or controlling shareholder with a supine or passive board—that the concept of good faith may prove highly meaningful. The fiduciary duties of care and loyalty, as traditionally defined, may not be aggressive enough to protect shareholder interests when the board is well advised, is not legally beholden to the management or a controlling shareholder and when the board does not suffer from other disabling conflicts of interest, such as a patently self-dealing transaction. Good faith may serve to fill this gap and ensure that the persons entrusted by shareholders to govern Delaware corporations do so with an honesty of purpose and with an understanding of whose interests they are there to protect. In a thoughtful article, Professor Lyman Johnson has written about the richer historical and literary understanding of loyalty and care, beyond their more narrow “non-betrayal” and “process” uses in contemporary jurisprudence. Professor Johnson’s description of a more expansive duty of loyalty to encompass affirmative attention and devotion may, in my opinion, fit comfortably within the concept of good faith (or vice versa) as a constituent element of the overarching concept of faithfulness. See Lyman P. Q. Johnson, After Enron: Remembering Loyalty Discourse in Corporate Law, 28 DEL. J. CORP. LAW 27 (2003).

Nevertheless, one wonders how much of a gap-filler the good faith duty will prove to be. Again, intentional disregard is necessary for liability.  Thus, despite many lapses of good governance, Eisner is not liable because he didn’t “short-circuit” the board’s decision-making processes (136), act with improper motive (p. 139, n. 485), and had a subjective belief that his actions were in the corporation’s best interests (141). Russell, the compensation committee chair, probably should have done more investigation, but he did not act in bad faith (144).  Watson was not “ostrich-like” and did not act with intentional disregard of the corporation’s interests, just as Poitier and Lozano did not “bury their heads in the sand” (p. 158).

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Van Gorkom
Posted by Account Deleted

Interestingly, the Chancellor found it necessary to distinguish this case from Van Gorkom (150-54).  He observed that the Ovitz contract, though large, was still smaller in relation to the corporation than that in Van Gorkom, and therefore did not require as much board-level procedure (he notes, at 533, that a sub-executive could have spent as much money on a movie as Eisner spent on Ovitz). 

Moreover, as I anticipated, the Chancellor found that, even without formal procedure, there was at least informal discussion, and consideration of the important factors justifying hiring Ovitz and compensating him handsomely. See 153-54, 157-58, and compare paragraph 8 of my Preview.

Despite all these distinctions from Van Gorkom I wonder about that case's continued relevance.  Suppose the procedures are far worse than those in Van Gorkom, even taking into account the differing circumstances.  Wouldn’t defendants nevertheless be exonerated if there was no intentional disregard amounting to bad faith? Or is some compliance with Van Gorkom-like procedures still necessary for good faith?

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Welcome to the Conglomerate Forum on Disney!
Posted by Gordon Smith

Thank you for joining us here at Conglomerate for a discussion of the Disney opinion, the full text of which has been posted by the Wall Street Journal. Over the next few days, we will hear from many leading experts on the Disney case, and we encourage you to engage us in the comments. Participants in the Conglomerate Forum include the following (with links to some of the stories in which they have been quoted in connection with the Disney case):

Steve Bainbridge of the UCLA School of Law
Victor Fleischer of the UCLA School of Law
Sean Griffith of the University of Connecticut School of Law (Slate)
Larry Hamermesh of the Widener University School of Law (W$J, News Journal)
Christine Hurt of Marquette University Law School
Lyman Johnson of Washington & Lee University School of Law
Elizabeth Nowicki of the University of Richmond School of Law
Larry Ribstein of the University of Illinois College of Law (NYT, Today, LA Daily News)
David Skeel of the University of Pennsylvania Law School (Marketplace)
Gordon Smith of the University of Wisconin Law School (Orlando Sentinel, Marketplace, W$J)

If you would like some background on the case, keep reading. Otherwise, I recommend that you dive into our participant's posts, which will appear immediately below this entry.

By now you certainly know that the directors of Disney prevailed on all of the claims. Chancellor Chandler composed a lengthy opinion (174 pages and 591 footnotes, and he describes the opinion as going into "painful detail"), about half of which describes the underlying facts, and the remainder of which contains his legal discussion and analysis. Of course, this opinion is not the last word on the Disney case, as the plaintiffs have promised to appeal the ruling to the Delaware Supreme Court. Nevertheless, Chancellor Chandler's views carry tremendous weight, as his 2003 Disney opinion gave us the most thorough judicial discussion to date of the role of good faith in fiduciary law.

If you have been reading the news reports, you will be familiar with the basic facts of the case. Michael Ovitz was hired by Disney in August 1995 and terminated in December 1996. Under the terms of his employment agreement, his "non-fault termination" resulted in several important benefits to Ovitz: the balance of his contract salary, an imputed amount of bonuses, a $10 million termination fee, and immediate vesting of 3 million stock options. In the end, Ovitz received approximately $140 million in compensation for his 15 or so months of employment.

The legal claims focused on whether Disney's directors fulfilled their fiduciary obligations in connection with the hiring and termination of Ovitz. According to Chancellor Chandler, "The fiduciary duties owed by directors of a Delaware corporation are the duties of due care and loyalty," but the reason all of us are paying such close attention to this case is that we are wondering about the third duty in Delaware's triad: the duty of good faith. With regard to this duty, Chancellor Chandler observes, "Decisions from the Delaware Supreme Court and the Court of Chancery are far from clear with respect to whether there is a separate fiduciary duty of good faith." In this case, Chancellor Chandler comes down firmly in favor of such a duty, though that duty is closely related to the traditional duties of care and loyalty:

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....

To create a definitive and categorical definition of the universe of acts that would constitute bad faith would be difficult, if not impossible. And it would misconceive how, in my judgment, the concept of good faith operates in our common law of corporations. Fundamentally, the duties traditionally analyzed as belonging to corporate fiduciaries, loyalty and care, are but constituent elements of the overarching concepts of allegiance, devotion and faithfulness that must guide the conduct of every fiduciary. The good faith required of a corporate fiduciary includes not simply the duties of care and loyalty, in the narrow sense that I have discussed them above, but all actions required by a true faithfulness and devotion to the interests of the corporation and its shareholders. A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. There may be other examples of bad faith yet to be proven or alleged, but these three are the most salient.

The duty of good faith is at the heart of this case because the plaintiffs could not make out a claim based on the duty of loyalty (although they attempted to make that claim against Michael Ovitz) and claims based on the duty of care are largely ineffectual in Delaware because of an important statutory provision adopted almost 20 years ago. In 1985, the Delaware Supreme Court famously held in Smith v. Van Gorkom that the directors of Trans Union Corporation breached their duty of care in approving a merger agreement. In the wake of that decision, the Delaware legislature added Section 102(b)(7) to the Delaware code, which allows shareholders (via charter provision) to "exculpate" directors from liability for monetary damages for breach of the duty of care. Almost every Delaware corporation, including Disney, now includes such an exculpatory provision in its corporate charter, thus ensuring that the duty of care will not lead to director liability. Interestingly, Section 102(b)(7) expressly provides that that corporate charters may not eliminate or limit director liability for "acts or omissions not in good faith." Thus, the plaintiffs in the Disney case could not obtain money damages by proving that the Disney directors breached their duty of care, but the shareholders might have obtained money damages by proving that the Disney directors acted in bad faith.

Unfortunately for those plaintiffs, Chancellor Chandler held that the conduct in this case did not constitute bad faith. The Chancellor made three references to "ideals" -- (1) "ideals of corporate governance"; (2) "ideals of corporate best practices"; and (3) "aspirational ideals" -- and noted that the Disney directors fell well short of these ideals. But the standard of liability ("bad faith") does not require directors to achieve their ideals. In a moment of comparative institutional analysis, Chancellor Chandler meaningfully concluded, "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."

In my view, this was a close case, and like Steve Bainbridge, I would not have been shocked to see this come out the other way, even though I found Larry Ribstein's prediction very persuasive. Some are not happy about the result. However you feel about it, I am certain that this Conglomerate Forum will offer new insights into the import and implications of the case. Welcome!

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Disney Directors Win!
Posted by Gordon Smith

The Disney opinion is out, and Disney's directors have prevailed. The result is not a huge surprise, but at 180 pages, the opinion contains a lot to chew on. I will post a brief later today, and look here for commentary starting on Wednesday morning.

UPDATE: I just did a quick take on the opinion for Marketplace. It is scheduled to be part of the 6:00 pm  (Eastern) show, if you have access to a radio. The archive link is here.

UPDATE 2: David Skeel, who will be blogging in our Conglomerate Forum, appears on the same Marketplace program.

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August 08, 2005
Disney Opinion Imminent?
Posted by Gordon Smith

Rumor has it that today is the day. In it's story, Market Watch mentions the Conglomerate Forum:

Law professors have already made plans for an online symposium to discuss what Chandler has to say in the Disney case, particularly about how much attention boards of directors need to pay to the hiring, and firing, of top executives. The morning-after Web session will be held at, a blog hosted by University of Wisconsin Law School Professor D. Gordon Smith and other academics. Larry Ribstein of the University of Illinois College of Law has already predicted victory for Disney's directors on his Ideoblog.

If the opinion is released today, I will post a notice and a "brief" of the case in the late afternoon or evening. We will hold our analyses until Wednesday morning, however, so that we have adequate time to gather our thoughts. After all, this is harder than constitutional law.

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August 04, 2005
The Disney Opinion ... One More Week
Posted by Gordon Smith

For those of you who are anxiously awaiting our Conglomerate Forum on the Disney opinion, it appears that the opinion will not be issued until next week. Truth be told, I am relieved, as I am still in Utah struggling to get internet access.

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