The much awaited Disney decision1 released on August 9, 2005 is good news for corporate directors in many respects. Chancellor Chandler of the Delaware Court rejected the shareholder complaint that the directors and certain officers of Disney had breached their fiduciary duty in the way in which they had handled the hiring and ultimate termination of Michael Ovitz as President of The Walt Disney Company ("Disney"). Mr. Ovitz had joined Disney as President in 1995, signing an employment contract worth over $23 million a year. Little more than a year later, he was terminated, receiving a termination package with a reported value of over $140 million. Although Chancellor Chandler found much to criticize in the way in which the Disney board conducted itself, its actions (or inaction) were not sufficient for a finding of liability. He did however state that a board which demonstrated deliberate indifference and inaction in the face of a duty to act could be found to have breached their fiduciary duty. This is new ground for directors' liability in the United States – as it would be in Canada.
Why the Decision is Significant
For corporate directors, among the most troubling aspects of the allegations in Disney was that they were framed as a breach of the duty of loyalty and good faith. Had the plaintiffs been successful in arguing that the failure of the board to be more engaged in Disney's employment relationship with Mr. Ovitz was a breach of this aspect of their fiduciary duty, the directors and officers would have had no recourse to their insurance, indemnities or the exculpation provisions (discussed below) in the corporation's governing documents. In 2003, the Disney directors sought to have the suit against them dismissed, arguing in part that Disney's very dominant CEO, Michael Eisner, had been responsible for the process of both hiring and firing Mr. Ovitz, and that he had not brought these matters to the board for approval before announcing them publicly. Chancellor Chandler refused their request to have their names struck from the action, saying that the matter should proceed to trial. This left open for several years the possibility that an action of this nature, framed as a breach of the duty of loyalty and good faith, could succeed against the members of the board of directors. The failure of the plaintiffs to prove their case has resolved this issue for the time being (on facts similar to Disney), in favour of corporate directors. However, Chancellor Chandler went to some length to set out the circumstances in which a director could be found to have breached his or her fiduciary duty – circumstances that include one "where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties".
The Disney decision comes 20 years after the decision in Smith v. Van Gorkom, the decision that sent a chill through boardrooms across the United States. In that case, the directors were sued successfully for having breached their duty of care to shareholders in approving a merger between Trans Union and a company in the Marmon Group of companies. The deal paid shareholders $55 a share at a time when the shares were trading at $38 and the transaction was approved by the shareholders. In spite of this, the Court found that the directors had breached their duty of care (which is similar to the duty of care in Canada) because of the failure in the process the directors had followed in approving the transaction. Although Mr. Van Gorkom, the Chairman of the Board, had put the deal in front of the board with no advance warning, and the directors were given no information to review in advance of the meeting, the board approved the transaction in two hours. The fact that the shareholders received a significant premium for their shares was irrelevant, because the directors did not know what Trans Union's value was and were therefore not in a position to assess the adequacy of the premium. The Court found that the directors were grossly negligent in approving the sale of Trans Union upon two hours' consideration, without prior notice and without the exigency of a crisis or emergency. It was not enough that there was no fraud or bad faith on the part of the Trans Union board. The Court stated that directors have a duty to inform themselves prior to making a business decision of all material information reasonably available to them, and to assess such information with a critical eye.
Chancellor Chandler referred extensively to the decision in Smith v. Van Gorkom but found that the nature of the decision being made by the Disney board and the information it had before it made the circumstances much different. The employment contract and termination arrangements for a President did not rise to the same level as the sale of the company. While the arrangements with Mr. Ovitz were largely controlled by Disney CEO Michael Eisner, the board was aware of the discussions and some of the directors participated actively in the negotiation process.
Criticism by the Court
Although Chancellor Chandler found that the actions of the directors and officers of Disney did not rise to the level of a breach of fiduciary duty, he could not condone the process they had followed. Much of his criticism was levelled at Mr. Eisner, to whom he referred as having "enthroned himself as the omnipotent and infallible monarch of his personal Magic Kingdom". The decision cautions that Mr. Eisner's actions should not serve as a model for fellow executives and fiduciaries to follow and included among his many "lapses", the following:
- he failed to keep the board informed as he should have
- he stretched the outer boundaries of his authority as CEO by acting without specific board direction or involvement
- he prematurely issued a press release that placed significant pressure on the board to accept Mr. Ovitz and approve his compensation package in accordance with the press release
- "To my mind, these actions fall short of what shareholders expect and demand from those entrusted with a fiduciary position. Eisner's failure to better involve the board in the process of Ovitz's hiring, usurping that role for himself, though not in violation of law, does not comport with how fiduciaries of Delaware corporations are expected to act."
Chancellor Chandler was also critical of the board, noting the contrast between ideal corporate governance practices and "the unwholesome boardroom culture at Disney". He described how "ornamental, passive directors contribute to sycophantic tendencies among directors and how imperial CEOs can exploit this condition for their own benefit, especially in the executive compensation and severance area."
Words of Comfort for Directors and Officers
Throughout the decision, Chancellor Chandler made a number of observations that should provide comfort to corporate directors and officers who are wondering how much the world has changed for them in the post-Enron era. Among these:
- The actions being complained of took place more than ten years ago - applying 21st century notions of best practices in analyzing whether those decisions were actionable would be misplaced.
- The standard to which directors and officers are held as fiduciaries of a corporation may not be the same as that contemplated by ideal corporate governance – in fact, Chancellor Chandler stated that a failure to adhere to ideals of good governance that are not otherwise required by law may not lead to liability: Aspirational ideals of good corporate governance practices for boards of directors that go beyond the minimal legal requirements of the corporation law are highly desirable, often tend to benefit stockholders, sometimes reduce litigation and can usually help directors avoid liability. But they are not required by the corporation law and do not define standards of liability
- The only logical way for a corporation of Disney's size and scope to operate is for everyday governance to be "under the direction of" the board of directors, not "by" the board. "As a general rule, a CEO has no obligation to continuously inform the board of his actions as CEO, or to receive prior authorization for those actions."
What Guidance Does the Disney Decision Offer for Canadian Directors
Because Canadian corporate law, jurisprudence and accepted standards of governance are so similar to those in the United States, the Disney decision will be of interest to directors of Canadian corporations. However, there are substantive differences between Canadian and U.S. law that must be kept in mind in applying the Disney decision in a Canadian context:
- Under U.S. corporate law, the duty of care is part of the fiduciary duty. Canadian corporate law imposes two duties on directors and officers – the fiduciary duty (the duty to act honestly and in good faith, with a view to the best interests of the corporation) and the duty of care (the duty to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances). It is in part this difference in approach that has led the U.S. courts to the view that directors may have a fiduciary duty to creditors when the corporation is "in the vicinity of insolvency", while Canadian law (as recently articulated by the Supreme Court of Canada in the Peoples decision) takes the position that no such duty is owed by Canadian directors to the corporation's creditors.
- Disney, like many other Delaware corporations, had in its articles an "exculpation clause" for its directors and officers. The Delaware corporate statute was amended in response to the Smith v. Van Gorkom decision to allow corporations to limit the liability of their directors and officers in situations which in Canada would essentially amount to a breach of the duty of care. It may not extend to breaches of loyalty or good faith or to transactions from which the director derived a personal benefit. Most Canadian corporate statutes specifically prohibit such exculpation clauses in a corporation's articles.
- The Canadian business judgment rule is different from the American business judgment rule discussed in the decision. In the United States, there is a presumption that directors' decisions have been made on an informed basis, in good faith and with the honest belief that the action taken was in the best interests of the company. To overcome this presumption, a plaintiff must show not only that the director failed to exercise his or her fiduciary duty (including the duty of care), but that the director was "grossly negligent" in failing to do so. In other words, the onus is on the plaintiff to rebut the presumption that the directors acted properly. This is different from the approach taken by Canadian courts, which do not assume that the directors behaved appropriately, but instead review the processes followed by the directors in reaching their decision to determine whether those processes were in fact appropriate. An interesting contrast can be drawn between the Disney decision and the 2002 decision in UPM-Kymmene Corp. v. UPM-Kymmene Miramichi Inc. often referred to as the "Repap" decision. In that decision an Ontario court found that the compensation committee of Repap Enterprises Ltd. had completely abandoned its oversight responsibilities in connection with an employment contract with Repap. The Court held that the directors had breached their duty of care, but not their fiduciary duty. Whether a Canadian court would be prepared to consider an action in a situation similar to Disney or Repap as a breach of fiduciary duty remains an open question.
Notwithstanding the differences in Canadian law, the decision in Disney is a milestone in the development of U.S. law dealing with directors' duties that will be considered and referred to both in Canadian courtrooms and in Canadian boardrooms.
1 In re The Walt Disney Company, 2005 Del. Ch. Lexis 113.