Of Mice and Men

Part One of a Two-Part Article

“The best laid schemes o' mice an' men / oft go awry.” From “To a Mouse,” by Robert Burns.

On Aug. 9, 2005, the Delaware Court of Chancery issued its decision in In re The Walt Disney Co. Derivative Litigation, 2005 WL 2056651 (Del. Ch. Aug. 9, 2005), a case that had drawn intense media attention to a relationship that definitely had gone awry despite the best laid schemes of The Walt Disney Company and its former President, Michael Ovitz. (The case currently is on appeal to the Delaware Supreme Court.) As the court noted, the case became something of a “public spectacle … commencing as it did with the spectacular hiring of one of the entertainment industry's best known personalities to help run one of its iconic businesses, and ending with a spectacular failure of that union, with breathtaking amounts of severance pay the consequence.” The severance package amounted to approximately $140 million in cash and vested stock options, which was paid to Ovitz upon the termination of his employment under a “no-fault” termination provision in his employment agreement. (The court found that the $140 million severance payment, while “breathtaking,” was not economically material to Disney.)

Now that the dust has settled and that breathtaking $140,000,000 severance payment is history, the question is: what has been learned? The Court of Chancery's decision — that no Disney board member was liable for violating his or her fiduciary duties with respect to the hiring, and then the firing after a little more than 1 year, of Michael Ovitz — did not dramatically alter the landscape of Delaware law with respect to the business judgment rule or the fiduciary duties of board members of a Delaware corporation. Although the court criticized the Disney board members, and in particular Chairman of the Board and Chief Executive Officer Michael Eisner, for lax corporate governance practices, it nevertheless held that the board's actions were protected by the presumption of the business judgment rule that “in making a business decision the directors of a corporation [act] on an informed basis … and in the honest belief that the action taken [is] in the best interests of the company [and its shareholders].” Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).

The court distinguished between the post-Enron and WorldCom legislative focus on tightening and improving corporate governance standards, and traditional legal standards for the fiduciary duties of directors, noting that “Delaware law does not  – indeed, the common law cannot — hold fiduciaries liable for a failure to comply with the aspirational ideal of best practices … ”

Delaware Corporations

Of particular importance to directors of Delaware corporations is the court's lengthy description of what it perceived as inappropriate and likely negligent behavior of the Disney board members. The court noted that “[f]or the future, many lessons of what not to do can be learned from defendants' conduct here,” and went on to discuss the contours of the duty of good faith and the types of processes and procedures boards of directors should consider if they are to satisfy their fiduciary duties and avail themselves of protection of the presumption of the business judgment rule and the safe harbor from personal monetary liability of Delaware General Corporation Law Section 102(b)(7).

Boards of directors of Delaware corporations can take comfort in the reaffirmation of the policy that the Delaware courts will not engage in post hoc substantive judicial evaluation of informed, good-faith business decisions. As a long-term guide, however, the Disney decision may prove to be less satisfactory, as ultimately the courts, as in Disney, must evaluate each director's conduct by weighing the specific processes and procedures (or lack thereof) undertaken by the directors against traditional legal standards and concepts such as “good faith,” which the Disney court at one point described as “hazy jurisprudence.” Given that haze, the Disney decision does not provide a well-lit path to guide directors of a Delaware corporation.

Ovitz and Disney: A Failed Relationship

In October 1995, Ovitz was hired as the president of Disney. The hiring of Ovitz, then the senior partner of Creative Artist Agency, the “premier Hollywood talent agency,” and a long-time friend of Eisner, was precipitated by two events: the 1994 death in a helicopter crash of Frank Wells, the long-time president and Chief Operating Officer of Disney, followed 3 months later by Eisner, who has assumed Wells' duties, undergoing quadruple bypass surgery. A third event, Disney's announcement of the acquisition of CapCities/ABC (which doubled the size the Disney), placed even greater demands on Eisner and magnified the need for someone to help shoulder the load.

Eisner and two of the four members of the compensation committee, with the assistance of an executive compensation consultant, Graef Crystal, negotiated the basic terms of Ovitz's employment agreement. The court noted that “outside his small circle of confidants, it appears that Eisner made no effort to inform the board of his discussions with Ovitz until after they were essentially completed and an agreement in principle had been reached.”

On Aug. 14, 1995, Ovitz executed a letter of intent. That same day, Disney made the hiring public in a press release setting forth the basic terms of the employment agreement — even though it was still subject to approval by Disney's compensation committee and board. The news caused the Disney stock price to increase 4.4% in a single day, increasing Disney's market capitalization by over $1 billion.

Under those circumstances, the court found that Ovitz's hiring was presented for consideration by the compensation committee and board largely as a fait accompli. It wasn't until Sept. 26, 1995, when the compensation committee met for 1 hour in which numerous other matters were discussed, that the terms of the Ovitz employment agreement were considered. The full compensation committee reviewed only a term sheet before unanimously approving the terms of the Ovitz employment agreement. Immediately thereafter, the terms of Ovitz's employment agreement were submitted to the Disney board, which elected him as president. Neither the compensation committee nor the board had the benefit of the presence at their meetings of Graef Crystal, or copies of his comprehensive executive compensation database or his report on the basic terms of Ovitz' employment agreement, which had been submitted only to Eisner and the two members of the committee who negotiated the terms.

Short-lived Term

Ovitz's tenure at Disney was short-lived. The court attributed the rapid deterioration of the Ovitz-Disney relationship to a “mismatch of cultures and styles.” Whatever the reasons, by the fall of 1996, members of the board had begun openly discussing the termination of Ovitz because of the perception of an irreparable disconnect between Ovitz and the Company. On Dec. 12, 1996, Ovitz was terminated without cause, triggering an approximately $140 million cash and stock severance payment.

The action to terminate Ovitz, and to do so without cause, was taken without a vote, or even a discussion at a full session of the board. Eisner did, however, consult with and seek the advice of Sanford Litvack, Disney's General Counsel and board member. Litvack advised Eisner that: 1) he believed Eisner had the power to fire Ovitz on his own accord without convening a board meeting; and 2) no grounds existed to terminate Ovitz for cause (and thereby avoid the costly severance payment). Litvack also cautioned against trying to “bluff Ovitz” by taking a position that sufficient grounds existed to terminate the employment agreement for cause, as this had the potential to harm Disney's reputation and “make it difficult for Disney to do business and be viewed as an honest business partner.”

Next month, we discuss the court's decision — and offer a primer on the standards governing fiduciary conduct.

Part One of a Two-Part Article

“The best laid schemes o' mice an' men / oft go awry.” From “To a Mouse,” by Robert Burns.

On Aug. 9, 2005, the Delaware Court of Chancery issued its decision in In re The Walt Disney Co. Derivative Litigation, 2005 WL 2056651 (Del. Ch. Aug. 9, 2005), a case that had drawn intense media attention to a relationship that definitely had gone awry despite the best laid schemes of The Walt Disney Company and its former President, Michael Ovitz. (The case currently is on appeal to the Delaware Supreme Court.) As the court noted, the case became something of a “public spectacle … commencing as it did with the spectacular hiring of one of the entertainment industry's best known personalities to help run one of its iconic businesses, and ending with a spectacular failure of that union, with breathtaking amounts of severance pay the consequence.” The severance package amounted to approximately $140 million in cash and vested stock options, which was paid to Ovitz upon the termination of his employment under a “no-fault” termination provision in his employment agreement. (The court found that the $140 million severance payment, while “breathtaking,” was not economically material to Disney.)

Now that the dust has settled and that breathtaking $140,000,000 severance payment is history, the question is: what has been learned? The Court of Chancery's decision — that no Disney board member was liable for violating his or her fiduciary duties with respect to the hiring, and then the firing after a little more than 1 year, of Michael Ovitz — did not dramatically alter the landscape of Delaware law with respect to the business judgment rule or the fiduciary duties of board members of a Delaware corporation. Although the court criticized the Disney board members, and in particular Chairman of the Board and Chief Executive Officer Michael Eisner, for lax corporate governance practices, it nevertheless held that the board's actions were protected by the presumption of the business judgment rule that “in making a business decision the directors of a corporation [act] on an informed basis … and in the honest belief that the action taken [is] in the best interests of the company [and its shareholders].” Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).

The court distinguished between the post-Enron and WorldCom legislative focus on tightening and improving corporate governance standards, and traditional legal standards for the fiduciary duties of directors, noting that “Delaware law does not  – indeed, the common law cannot — hold fiduciaries liable for a failure to comply with the aspirational ideal of best practices … ”

Delaware Corporations

Of particular importance to directors of Delaware corporations is the court's lengthy description of what it perceived as inappropriate and likely negligent behavior of the Disney board members. The court noted that “[f]or the future, many lessons of what not to do can be learned from defendants' conduct here,” and went on to discuss the contours of the duty of good faith and the types of processes and procedures boards of directors should consider if they are to satisfy their fiduciary duties and avail themselves of protection of the presumption of the business judgment rule and the safe harbor from personal monetary liability of Delaware General Corporation Law Section 102(b)(7).

Boards of directors of Delaware corporations can take comfort in the reaffirmation of the policy that the Delaware courts will not engage in post hoc substantive judicial evaluation of informed, good-faith business decisions. As a long-term guide, however, the Disney decision may prove to be less satisfactory, as ultimately the courts, as in Disney, must evaluate each director's conduct by weighing the specific processes and procedures (or lack thereof) undertaken by the directors against traditional legal standards and concepts such as “good faith,” which the Disney court at one point described as “hazy jurisprudence.” Given that haze, the Disney decision does not provide a well-lit path to guide directors of a Delaware corporation.

Ovitz and Disney: A Failed Relationship

In October 1995, Ovitz was hired as the president of Disney. The hiring of Ovitz, then the senior partner of Creative Artist Agency, the “premier Hollywood talent agency,” and a long-time friend of Eisner, was precipitated by two events: the 1994 death in a helicopter crash of Frank Wells, the long-time president and Chief Operating Officer of Disney, followed 3 months later by Eisner, who has assumed Wells' duties, undergoing quadruple bypass surgery. A third event, Disney's announcement of the acquisition of CapCities/ABC (which doubled the size the Disney), placed even greater demands on Eisner and magnified the need for someone to help shoulder the load.

Eisner and two of the four members of the compensation committee, with the assistance of an executive compensation consultant, Graef Crystal, negotiated the basic terms of Ovitz's employment agreement. The court noted that “outside his small circle of confidants, it appears that Eisner made no effort to inform the board of his discussions with Ovitz until after they were essentially completed and an agreement in principle had been reached.”

On Aug. 14, 1995, Ovitz executed a letter of intent. That same day, Disney made the hiring public in a press release setting forth the basic terms of the employment agreement — even though it was still subject to approval by Disney's compensation committee and board. The news caused the Disney stock price to increase 4.4% in a single day, increasing Disney's market capitalization by over $1 billion.

Under those circumstances, the court found that Ovitz's hiring was presented for consideration by the compensation committee and board largely as a fait accompli. It wasn't until Sept. 26, 1995, when the compensation committee met for 1 hour in which numerous other matters were discussed, that the terms of the Ovitz employment agreement were considered. The full compensation committee reviewed only a term sheet before unanimously approving the terms of the Ovitz employment agreement. Immediately thereafter, the terms of Ovitz's employment agreement were submitted to the Disney board, which elected him as president. Neither the compensation committee nor the board had the benefit of the presence at their meetings of Graef Crystal, or copies of his comprehensive executive compensation database or his report on the basic terms of Ovitz' employment agreement, which had been submitted only to Eisner and the two members of the committee who negotiated the terms.

Short-lived Term

Ovitz's tenure at Disney was short-lived. The court attributed the rapid deterioration of the Ovitz-Disney relationship to a “mismatch of cultures and styles.” Whatever the reasons, by the fall of 1996, members of the board had begun openly discussing the termination of Ovitz because of the perception of an irreparable disconnect between Ovitz and the Company. On Dec. 12, 1996, Ovitz was terminated without cause, triggering an approximately $140 million cash and stock severance payment.

The action to terminate Ovitz, and to do so without cause, was taken without a vote, or even a discussion at a full session of the board. Eisner did, however, consult with and seek the advice of Sanford Litvack, Disney's General Counsel and board member. Litvack advised Eisner that: 1) he believed Eisner had the power to fire Ovitz on his own accord without convening a board meeting; and 2) no grounds existed to terminate Ovitz for cause (and thereby avoid the costly severance payment). Litvack also cautioned against trying to “bluff Ovitz” by taking a position that sufficient grounds existed to terminate the employment agreement for cause, as this had the potential to harm Disney's reputation and “make it difficult for Disney to do business and be viewed as an honest business partner.”

Next month, we discuss the court's decision — and offer a primer on the standards governing fiduciary conduct.