Canada: The Disney Decision

Last Updated: August 24 2005
Article by Michael Disney, Alan Golden, Bill Gula and Guy Lander

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Michael Disney
 
In association with
Related Video
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
Accounting and Audit
Anti-trust/Competition Law
Consumer Protection
Corporate/Commercial Law
Criminal Law
Employment and HR
Energy and Natural Resources
Environment
Family and Matrimonial
Finance and Banking
Food, Drugs, Healthcare, Life Sciences
Government, Public Sector
Immigration
Insolvency/Bankruptcy, Re-structuring
Insurance
Intellectual Property
International Law
Litigation, Mediation & Arbitration
Media, Telecoms, IT, Entertainment
Privacy
Real Estate and Construction
Strategy
Tax
Transport
Wealth Management
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.