Published in Above Board @ Gowlings, April 2006.
In August 2005, a Delaware Court issued the widely anticipated Disney decision, dismissing an action brought by shareholders against the directors of the Walt Disney Company.
After all the corporate scandals, class actions and prison sentences, the Disney decision comes to the rescue of directors.
Pursuant to the business judgment rule, directors are protected from personal liability against someone challenging their decisions taken in good faith, on an informed basis, in the best interests of the corporation. Consequently, the courts should not impose their decision on the business and affairs of a corporation.
The essential facts:
- Disney's shareholders alleged various breaches of fiduciary duty by Disney's directors in connection with the hiring and termination of Michael Ovitz as President of the Walt Disney Company.
- Mr. Ovitz was hired as President of Disney in 1995 with a salary of $23 million a year.
- Mr. Ovitz had been personally selected by Michael Eisner, the CEO of Disney. Mr. Ovitz had been a personal friend of Mr. Eisner for nearly twenty-five years. These men were very well acquainted, both socially and professionally. Mr. Eisner had been trying to hire him for years. When Ovitz joined Disney, he had put in place "Creative Artist Agency" (CAA), a corporation with over 550 employees and about 1,400 of Hollywood's top actors, directors, writers and musicians — a roster that earned CAA approximately $150 million in annual revenues and an annual income of $20 million for Ovitz who was regarded as one of the most powerful figures in Hollywood.
- Mr. Ovitz's Disney employment contract also provided him with a non-fault termination clause, pursuant to which Mr. Ovitz stood substantial compensation.
- He was terminated 14 months later on a without cause basis and with a termination package of over $140 million in cash and vested stock options.
The Delaware Court noted that:
- There were many aspects of the directors' conduct that fell significantly short of the best practices of ideal corporate governance.
- Disney's board had virtually no role in the decision to hire Ovitz, and minimal input into his employment agreements: this material decision was taken in the course of one Compensation Committee meeting that lasted one hour and was based only on a term sheet.
- The board had almost no choice in approving the decision to terminate Ovitz without cause: once it was determined by CEO Michael Eisner that he was unable to work well with Ovitz, the only alternative was Ovitz's termination.
The Court on Corporate Governance
The Court emphasized the distinction between compliance with fiduciary duties, which are legal obligations, and corporate governance best practices. It stated that:
Corporate governance best practices can be nothing more than an aspirational ideal as opposed to a template for a legal standard of care.
The Court also noted that the events in the Disney case took place in 1995-1996, before the corporate scandals and subsequent legislative focus on corporate governance, and therefore applying twenty-first century notions of best practices in analyzing the decisions of Disney's directors would be misplaced.
A guide to Board decision-making
In its decision, although the Court found that Eisner and the board had met the legal requirement, it definitely criticized the process followed. The Court also made it fairly apparent that the actions of both Eisner and the board would be unlikely to withstand scrutiny in the current corporate context.
A new mantra: process, process, process
Following the Disney decision, the courts will, more than ever, scrutinize the process by which the board reaches a decision.
Directors should therefore follow the next ten best practice rules:
a) Material / Information
- Directors shall receive the material well in advance of board meetings;
- Directors have to read and understand all the material received before the meeting — they must be prepared;
- Directors shall attend and participate at all meetings.
b) Time and number of meetings
In the Disney decision, the Court emphasized the importance of board and committees meeting minutes in determining what was discussed and not discussed at meetings, and whether questions were asked, and the nature of those questions.
The evidentiary value of meeting minutes strongly militates in favour of comprehensive minutes being prepared in order to demonstrate informed and good faith board participation, and consideration of actions of material importance to the corporation.
Therefore directors should:
- Not get caught in the rush of time; directors must take time to think;
- Not be afraid to ask the tough questions;
- Ask an expert's advice, if necessary;
- Have more than one meeting on material issues, if necessary;
- Insist on receiving and reviewing minutes of meetings.
c) Liability on a director-by-director basis
The Court stressed that liability determinations must be made on a director-by-director basis. Accordingly, the Court conducted a separate review of the actions of each of Disney's directors at each critical stage of the Ovitz employment and termination process.
Therefore directors should:
- Be proactive and diligent in providing oversight of management — they cannot just defer to the CEO;
- Always have a comprehensive understanding of the business and goals of the corporation.
In conclusion — The nature of business is risk and risk assessment
The Disney decision confirms the business judgment rule and the fact that courts should not discourage risk taking by second-guessing decisions of directors taken in good faith and on an informed basis.
If the courts start assessing liability based on ultimate outcome — directors may start taking decisions that minimize risk rather than maximize value; an outcome antithetical to a corporation's economic growth.
So yes, directors are protected by the business judgment rule against courts' scrutiny but provided the decision is taken in good faith, in the best interests of the corporation and on an informed basis.
Thereforemake sure you follow process and remember Gowlings can guide you through this process.
Note: The Disney decision is currently under appeal before the Supreme Court of Delaware, where oral arguments were heard on January 25, 2006; a decision is now expected in about three months. Once it is known, we will update you on the impact it may have on your rights and responsibilities.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.