In Re the Walt Disney Co. Derivative Litigation

Court of Chancery of Delaware
825 A.2d 275, 30 Employee Benefits Cas. (BNA) 2288, 2003 Del. Ch. LEXIS 52 (2003)

ELI5:

Rule of Law:

Directors may be held liable for a breach of the duty of good faith if they consciously and intentionally disregard their responsibilities, failing to exercise any business judgment or deliberation in approving a material corporate transaction. Such conduct is not protected by the business judgment rule or a § 102(b)(7) exculpatory charter provision.

Facts:

Walt Disney Company CEO Michael Eisner, a close personal friend of Michael Ovitz for over 25 years, unilaterally decided to hire Ovitz as the company's president.
Despite internal documents warning of the compensation's excessive size, Eisner moved forward with the hiring process.
The Disney compensation committee met for less than an hour, received only a brief oral summary of the employment agreement's terms, did not review the draft agreement, and failed to consult a compensation expert before approving the hire.
The full board also spent minimal time discussing the matter, did not review the draft agreement, and delegated authority for negotiating the final terms to Eisner.
The final employment agreement, which the board never reviewed, contained a non-fault termination clause that was significantly more favorable to Ovitz than the version summarized to the committee.
After approximately one year of poor performance, Ovitz sought to leave Disney.
Eisner, without consulting the board or any committee, granted Ovitz a non-fault termination.
Ovitz's severance package was valued at over $140 million, including a cash payment of more than $38 million and the immediate vesting of three million stock options.

Procedural Posture:

Shareholders filed a derivative lawsuit on behalf of the Walt Disney Company against its directors and Michael Ovitz in the Delaware Court of Chancery.
After the plaintiffs' first amended complaint was dismissed, the Delaware Supreme Court affirmed in part but remanded to allow the plaintiffs to amend their complaint again.
Plaintiffs conducted a books and records inspection under 8 Del. C. § 220 to gather additional facts.
Plaintiffs filed a second amended complaint, which is the subject of this opinion.
Defendants filed motions to dismiss the second amended complaint for failure to state a claim (Rule 12(b)(6)) and for failure to make a pre-suit demand on the board (Rule 23.1).

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Issue:

Do allegations that a board of directors failed to review draft agreements, consult with experts, or meaningfully deliberate before approving a nine-figure executive employment contract and a subsequent non-fault termination create a reasonable doubt that the board's actions were the product of a valid exercise of business judgment, thereby excusing pre-suit demand?

Opinions:

Majority - Chancellor Chandler

Yes. The allegations create a reasonable doubt that the board's actions were the product of a valid exercise of business judgment, thus excusing pre-suit demand. The pleaded facts suggest the directors consciously and intentionally disregarded their responsibilities, which constitutes a potential breach of the duty of good faith. The court reasoned that the directors' alleged behavior went beyond mere negligence; it suggested a complete abdication of their fiduciary duties. The board's failure to review the draft agreement, obtain expert advice, or engage in any meaningful deliberation over a transaction of material importance indicated they failed to exercise any business judgment. This 'ostrich-like approach' and 'we don’t care about the risks' attitude, if true, constitutes a knowing and deliberate indifference that falls outside the protections of the business judgment rule and a § 102(b)(7) exculpatory clause, which does not shield directors from liability for acts 'not in good faith.'

Analysis:

This decision significantly developed the concept of the duty of good faith under Delaware law, clarifying that it can be breached by a conscious disregard of directorial responsibilities. By characterizing the board's alleged inaction as a potential good faith violation rather than merely a breach of the duty of care, the court opened a path for plaintiffs to overcome powerful defenses like the business judgment rule and § 102(b)(7) exculpatory provisions. This case serves as a strong warning to corporate boards that while courts will not second-guess substantive business decisions, they will rigorously scrutinize the deliberative process. A complete failure to engage in such a process for a material transaction can lead to personal liability for directors.

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