In many previous issues of A Potpourri, we have discussed the protection provided to corporate directors under the business judgment rule. According to the rule, courts will not override business decisions that were made by fully informed directors who have deliberately reviewed all reasonably available information and have acted in good faith and without conflict of interest. Even in the absence of a personal gain derived from a conflict of interest, however, directors may be held accountable to a corporation and its shareholders if they fail to seek information required to evaluate a transaction or if they disregard available information in making a decision. In these situations, they may be deemed to have acted in bad faith, thereby violating their fiduciary duties as directors. In a recent decision involving The Walt Disney Company (“Disney”), the Delaware Court of Chancery analyzed the scope of the business judgment rule.
The Disney decision involved a claim filed by 17 shareholders who challenged the compensation and severance packages awarded to Disney’s President, Michael Ovitz (“Ovitz”). According to the shareholders’ claim, Chief Executive Officer Michael Eisner (“Eisner”) unilaterally anointed his successor when he picked his close friend Ovitz as Chief Executive Officer after Eisner underwent quadruple-bypass surgery. Disney retained Ovitz under an employment agreement that provided, among other things, an annual base salary of $1 million, a discretionary bonus of up to $10 million per year and options for up to 5 million Disney shares. In addition, if he died, became disabled or was wrongfully terminated during the term of his employment, he would receive the current value of his remaining salary, annual bonuses of $7.5 million, a lump sum payment of $10 million and immediate vesting of options for 3 million Disney shares. After a short stint, Ovitz was terminated and received a severance package worth an estimated $140,000,000.
The shareholders alleged that the directors breached their fiduciary duties and acted in bad faith because, among other things:
· The compensation committee, and the full board, failed to review the complete employment agreement offered to Ovitz, relying only upon summaries in approving Ovitz’s employment.
· They failed to consult experts to determine the reasonableness of compensation and severance packages.
· The compensation committee spent less than one hour considering employment terms.
. The board delegated final negotiation of employment terms to Ovitz’s close friend, Eisner.
By denying the directors’ motion to dismiss the shareholders’ claims, the court rejected the directors’ argument that they acted in good faith under the protection of the business judgment rule. Accordingly, the shareholders have the opportunity to prove their claims. The court stated that the rule would not protect the directors if the shareholders could prove that they “consciously and intentionally disregarded their responsibilities, adopting a ‘we don’t care about the risks’ attitude.” According to the court, “[w]here a director consciously ignores his or her duties to the corporation, thereby causing injury to its stockholders, the director’s actions are either ‘not in good faith’ or ‘involve intentional misconduct,’” resulting in loss of protection of the business judgment rule.
The Disney decision is a reminder to directors of their duties to solicit and carefully review available information in evaluating and taking corporate actions. (We reported in the July/August 2003 issue of A Potpourri that similar reasoning was applied by the Seventh Circuit Court of Appeals in Chicago in evaluating a recent claim against Abbott Laboratories.) Please let us know if we may assist you or your board in reviewing proposed transactions or implementing corporate governance guidelines.