Lots of bloggers writing about Disney ...

Larry Ribstein makes a bunch of excellent points. I will highlight two. First, he notes that fiduciary duty claims other than self-dealing will be very tough to win:

[T]he only way a board is going to be held liable for breach of fiduciary duty when it it isn't self-dealing is to (1) really not have any idea what it is doing; and (2) not have a 102(b)(7) clause in the charter; or (3) have such a clause but proceed in conscious disregard of the board's responsibility, which would be truly puzzling in the absence of self-dealing. In other words, the board will be liable for non-self-dealing conduct on a cold day in August in Miami under a blue moon.

Second, Larry provocatively asserts:

The opinion resoundingly denounces the federal approach to corporate governance in SOX. The opinion says that the court is going to trust the board's judgment as long as the board shows any sign of actually exercising this judgment.

Hmm. I am not so sure that the Delaware Supreme Court was using this case to "denounce" the feds, but I think we can safely conclude that Delaware has fairly modest aspirations for fiduciary law. And, in my view, that is a good thing.

Steve Bainbridge doesn't like Justice Jacobs' formulation of the business judgment rule. Steve is right that the business judgment rule functions as more than a procedural "presumption," and that framing the rule using that term makes it appear as "nothing more than a restatement of the basic principle that the defendant is entitled to summary judgment whenever plaintiff fails to state a prima facie case."

But I think Steve leaves the track with this statement:

[I]n the opinion (e.g., at 66) we find reference to the idea that "gross negligence (including a failure to inform one’s self of available material facts)," violates the duty of care. The word "including" would seem to imply "but not limited to," which suggests some scope for substantive review of board decisions.

Gross negligence might be evidenced by a failure to inform oneself -- indeed, the obligation to inform oneself is the core requirement of the duty of care -- but there may be other aspects of "care" that do not go to the substantive merits of the decision. For example, in Cede v. Technicolor, Inc., 634 A.2d 345, 368 (Del. 1994), the Court stated that "a director's duty of care requires a director to take an active and direct role in the context of the sale of a company from beginning to end." In the following sentence, the Court mentions the duty to gather information as a separate requirement of the duty of care. In my view, Steve is reading the wrong thing into Justice Jacobs' use of the word "including." Besides, Justice Jacobs clearly segregated the substantive review into the section on "waste."

Steve has a separate post on the duty of good faith in which he takes on the already infamous footnote 112. Steve suggests that resolution of the issue may not matter much: "It's hard to imagine a case in which the defendants would be found to have acted in bad faith as defined by Justice Jacobs without also having violated either their care or loyalty duties somewhere along the line." I think that I agree with this, but I wonder whether "intentional violations of law" will become a viable category of good-faith litigation.

Speaking of "intentional violations of law," Steve asks in another post whether "intentional violation of law = bad faith." Steve writes in  response to my post: "I have not seen anything in the opinion squarely so stating and, upon reflection, I think Gordon ought to be wrong - at least insofar as he may be suggesting that intentional law violations per se constitute bad faith."

Responding to the first part of his statement is easy. On page 72, Justice Jacobs describes "knowing violation[s] of law" under Section 102(b)(7) of the DGCL as an example of "subjective bad faith." Justice Jacobs also quotes approvingly from Chancellor Chandler's opinion, which states, "A failure to act in good faith may be shown ... where the fiduciary acts with the intent to violate applicable positive law." So I don't think that there is much doubt about where the Delaware courts stand on this.

As to whether this ought to be the result, Steve argues that "fiduciary obligation and the duty to act lawfully make a bad fit." It's an interesting argument, but it flies in the face of a long history of treating illegality as a form of bad faith. When I was researching The Shareholder Primacy Norm, I found this doctrine used quite commonly among 19th Century courts. It's not likely to be changed now.

As you might imagine, Elizabeth Nowicki is disappointed in the opinion, which makes her flu feel all the more oppressive. Elizabeth criticizes the Court for rejecting the appellants' claim that "directors violate their duty of good faith if they are making material decisions without adequate information and without adequate deliberation." She wonders, "am I to believe that the good court is saying that such decisions *are* acts in good faith?" Whether she believes it or not, the answer is yes.

Elizabeth's indignation has some intuitive appeal. Indeed, the Court recognizes that existence of some overlap between the duty of care and the duty of good faith, but argues that the duties should remain (?) distinct: "The conduct that is the subject of due care may overlap with the conduct that comes within the rubric of good faith in a psychological sense, but from a legal standpoint those duties are and must remain quite distinct." The reason is obvious:

To adopt a definition of bad faith that would cause a violation of the duty of care automatically to become an act or omission “not in good faith,” would eviscerate the protections accorded to directors by the General Assembly’s adoption of Section 102(b)(7).

At one time, I thought the Court might use Disney to reinvigorate Smith v. Van Gorkom, but this statement (and others like it) should put that fear to rest. Litigants will not be allowed to use the duty of good faith to outflank exculpation when the underlying behavior is nothing more than a failure to gather adequate information or a failure to act with adequate deliberation.

This new opinion has lots of little nuggets, and I will attempt to say a few more things later today. As always, your comments are most welcome.

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Darian and RR focus our attention on footnote 112:

[W]e do not reach or otherwise address the issue of whether the fiduciary duty to act in good faith is a duty that, like the duties of care and loyalty, can serve as an independent basis for imposing liability upon corporate officers and directors. That issue is not before us on this appeal.

I agree with RR that this is odd, and that we could have used an answer. This footnote is in deep tension with the text of the opinion. As I noted below, the Court took pains to distinguish the duty of good faith from the other traditional duties. Also, in January, I explained at length why the plaintiffs misunderstood the role of bad faith in rebutting the business judgment rule. In the opinion today, the Court made the same essential points, though more briefly. The bottom line: bad faith can be used for "rebutting the business judgment rule presumptions" and for "evaluating the availability of charter-authorized exculpation from monetary damage liability after liability has been established." (p. 40) But we don't know if it can be an independent basis for liability?

In addition, the Court describes actions that must be "proscribed" using the duty of good faith: "To protect the interests of the corporation and its shareholders, fiduciary conduct ... which does not involve disloyalty (as traditionally defined) but is qualitatively more culpable than gross negligence, should be proscribed." Does the duty serve as a "proscription" if it cannot be summoned as an independent basis for liability?

Finally, the Court notes that "highly significant consequences" flow from distinguishing the duty of care and the duty of good faith. The two consequences it discusses are exculpation under Section 102(b)(7) and indemnification under Section 145. Strange that the Court does not mention in this part of the opinion the possibility that the duty of care might be the basis of liability (at least, theoretically) while the duty of good faith might not.

All of this suggests to me that footnote 112 was an afterthought designed to secure a vote for the opinion in pursuit of unanimity. But as for why one or more of the justices perceived this to be necessary is not at all clear to me.

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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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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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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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"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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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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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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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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Yesterday's New York Times links to our Conglomerate Forum on Disney.

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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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