Court: Delaware Chancery Court (2005)
Citation: 907 A.2d 693 (2005)
Appeal Court: Delaware Supreme Court (2006)
Citation: 906 A.2d 27 (2006)
Judges: Chancellor William Chandler (Chancery Court)
Supreme Court Justice: Justice Jack B. Jacobs
The In re Walt Disney Co. Derivative Litigation is one of the most significant cases in U.S. corporate law, especially in the realm of fiduciary duties and executive compensation. The case primarily concerns the scope of the duty of care under Delaware law and the business judgment rule.
It gained widespread attention due to the controversy surrounding the enormous executive compensation package awarded to Michael Ovitz, a former Hollywood agent, who was hired by Disney in 1995 as its executive president. Ovitz’s appointment, along with his subsequent firing, led to a derivative suit filed by Disney shareholders alleging that the board of directors had breached their fiduciary duties.
This case is crucial in understanding corporate governance, executive compensation, and the balance between directors’ discretion in managing a corporation and their responsibility to act in the best interests of shareholders. The case not only provided valuable insight into the application of Delaware’s corporate law but also highlighted the tension between board autonomy and the need for effective oversight of executive decisions.
Facts of In re Walt Disney Co. Derivative Litigation
The In re Walt Disney Co. Derivative Litigation revolves around the appointment of Michael Ovitz as the Executive President and Director of The Walt Disney Company in 1995. Ovitz was a former Hollywood agent who had founded Creative Artists Agency (CAA), a leading talent agency. Disney’s then-CEO Michael Eisner was keen to bring Ovitz on board to strengthen the company’s management, and they negotiated a highly lucrative compensation package.
Ovitz’s compensation package included a base salary of $3 million, plus bonuses, stock options, and a generous exit package should things not go as planned. The deal amounted to around $24 million per year, a sum significantly higher than what would be considered reasonable for an executive of his position. Despite concerns raised by Disney’s compensation committee and external compensation expert Graef Crystal, the deal was pushed forward without proper scrutiny.
One of the most controversial aspects of the arrangement was the inclusion of a termination package that would guarantee Ovitz a substantial payout in case of non-fault termination. After only a year at Disney, Ovitz was dismissed, reportedly due to a personality clash with other executives. However, he walked away with $140 million in severance, despite his brief and largely unsuccessful tenure. This termination package, along with the hiring process itself, formed the basis of the shareholder derivative suit filed in January 1997.
The plaintiffs in this case were Disney shareholders who argued that the Disney board of directors, including Eisner, had breached their fiduciary duties by approving Ovitz’s excessive compensation package and his costly severance agreement. The suit primarily focused on two issues: (1) the hiring of Ovitz, and (2) his firing. The plaintiffs claimed that the Disney board had acted in bad faith and grossly neglected their duties, which resulted in significant financial waste for the company.
Court of Chancery Decision (2005)
The case eventually came to trial in 2004, where the Delaware Chancery Court, under Chancellor William Chandler, ruled in favor of Disney’s board of directors. The court applied the business judgment rule, a principle in corporate law that presumes that directors act in good faith, with reasonable care, and in the best interest of the company, unless proven otherwise.
Chancellor Chandler noted that the case centered on the fiduciary duties that Disney’s directors owed to shareholders. Specifically, the issue was whether the board had committed “waste” or had acted with gross negligence or bad faith in hiring and firing Ovitz. Under Delaware law, directors are granted broad discretion in their decisions, and the business judgment rule provides them with a presumption of acting in the company’s best interests. In this case, the plaintiffs had to prove that the directors had acted in bad faith or with gross negligence, which was not proven by the evidence presented.
Chandler was critical of the conduct of Disney’s executives, particularly CEO Michael Eisner. He described Eisner as “enthroned” as the “omnipotent and infallible monarch of his personal Magic Kingdom.” However, despite the numerous flaws in the process, including the lack of sufficient documentation and the rush to appoint Ovitz, the court ruled that the board had acted with a subjective belief that it was acting in good faith and in the company’s best interests. The court’s decision was driven by the finding that the board had been adequately informed about the material facts, even if they did not adhere to “best practices” in terms of process.
The court concluded that Ovitz’s hiring was neither grossly negligent nor in bad faith. Furthermore, his firing, although it involved significant financial waste, was not done with gross negligence or bad faith. Despite the obvious problems with Disney’s corporate governance in this case, the court found that the directors had met the minimum threshold for the business judgment rule.
In re Walt Disney Co. Derivative Litigation Supreme Court of Delaware Decision (2006)
The plaintiffs appealed the Chancery Court’s decision to the Delaware Supreme Court. In its 2006 ruling, the Delaware Supreme Court, led by Justice Jack B. Jacobs, affirmed the lower court’s decision. The Supreme Court held that the Chancery Court had correctly applied the business judgment rule and had not made any errors of law or fact. The plaintiffs had argued that Disney’s board had failed to exercise due care in approving Ovitz’s compensation package, but the Supreme Court found that the board had been adequately informed of the potential costs and risks associated with the agreement.
Justice Jacobs emphasized that, while the board’s actions may not have followed the best corporate governance practices, the directors were not required to adhere to a “best case” scenario. The Supreme Court affirmed that Delaware law does not mandate that directors must always follow best practices as long as they act in good faith and with due care. The Court noted that the compensation committee had considered the material facts, including Ovitz’s demands for protection against the risk of leaving a lucrative position at CAA and the compensation package’s structure.
The Court also highlighted the importance of the business judgment rule in protecting directors’ decisions. Directors are presumed to act in the best interest of the company unless proven otherwise. The Court reiterated that a decision may be criticized as poor or imprudent but still fall within the scope of the business judgment rule if it was made in good faith.
Conclusion
The In re Walt Disney Co. Derivative Litigation case stands as a pivotal decision in Delaware corporate law. It underscores the importance of the business judgment rule and provides clarity on the scope of directors’ fiduciary duties, particularly in the context of executive compensation. While the case involved substantial financial waste, the court ruled in favor of Disney’s board of directors, concluding that they had acted within the bounds of their fiduciary duties. The decision reaffirms the discretion granted to directors under Delaware law and sets an important precedent for future cases involving corporate governance and executive compensation.
Through this case, the Delaware courts provided guidance on the standards for evaluating corporate decisions, emphasizing the balance between shareholder rights and director discretion in running a corporation.