DELAWARE SUPREME COURT AFFIRMS DISNEY, CONTINUING VITALITY OF BUSINESS JUDGMENT RULE
Michael W. Peregrine, Esquire
McDermott Will & Emery LLP, Chicago, Illinois
James R. Schwartz, Esquire
Manatt Phelps & Phillips LLP, Los Angeles, California
William W. Horton, Esquire
Haskell Slaughter Young & Rediker LLC, Birmingham, Alabama
In a major validation of the business judgment rule,1 the Delaware Supreme
Court has affirmed that the directors of the Walt Disney Company did not violate their
fiduciary duty in connection with the hiring and subsequent termination of Michael Ovitz
as Disney’s chief operating officer.2 In so doing, the court affirmed the much-scrutinized
August 2005 decision of Chancellor William B. Chandler III, holding that aspirational
best practices, while a worthwhile goal, do not constitute the legal standard under which
director liability is to be judged. In that earlier decision, Chancellor Chandler found that
the Disney directors had acted in good faith and in a manner consistent with their duty
of loyalty, that the full board had made a proper delegation of authority to the
1
The business judgment rule is a common law rule (often incorporated into statute) that presumes that in making a business decision, the directors of a corporation have acted on an informed basis, in good faith, and in the honest belief that the action was taken in the best interests of the corporation, absent evidence of fraud, bad faith, or self-dealing. Essentially, the rule—a linchpin of Delaware corporate law in particular —provides that so long as directors have not violated their fiduciary duties to the corporation and have engaged in an appropriate deliberative process, a court will not second-guess their decisions even if those decisions ultimately prove to have been unwise.
2
In re Walt Disney Derivative Litigation, Case No. 411, 2005 (Del. June 8, 2006).
August 2006
EXECUTIVE SUMMARY
compensation committee and that, as a result, the directors were protected from
personal liability under the business judgment rule.
The supreme court’s decision should be welcome news to corporate directors,
especially given the highly publicized criticism of the actions of the Disney directors in
connection with the Ovitz matter and the attempt by plaintiffs in that matter to establish
a rule that would equate a lack of due care with “bad faith.” This article will briefly review
and analyze the underlying facts and the supreme court’s decision, and will identify
specific lessons therefrom for nonprofit corporate boards.
I. BRIEF OVERVIEW OF CASE
The case came to the supreme court on appeal from Chancellor Chandler’s
175-page decision, which followed a thirty-seven-day bench trial. The litigation was brought
as a derivative action, with claims based on alleged breaches of individual directors’
duties of care, loyalty, and good faith and alleged waste of corporate assets in
connection with Disney’s short employment relationship with Mr. Ovitz. The directors
were alleged to have breached their fiduciary duty and acted in bad faith in connection
with both their approval of the employment and compensation of Mr. Ovitz and of his
subsequent “no fault” termination after only fourteen months of employment, which
triggered payment of a controversial $130 million severance package. Specifically, the
plaintiffs argued that those breaches of fiduciary duty deprived the Disney defendants of
the protection of the business judgment rule and required them to establish the fairness
of their actions to the corporation (a burden which plaintiffs alleged they failed to meet).3
While critical of many of the board’s related practices and actions, Chancellor Chandler
nevertheless concluded that they were “protected business decisions,” and found no
liability on behalf of any defendant.4
3
In the alternative, the plaintiffs argued that even if the business judgment rule applied, the defendants’ conduct constituted corporate waste.
4
For a more detailed discussion of the facts and Chancellor Chandler’s decision, see Peregrine and Schwartz, “Disney’s Message to Healthcare Governance: Process Counts” AHLA Sarbanes-Oxley Task Force Executive Summary, September 2005, available at
A unanimous supreme court, in an eighty-nine-page decision written by Justice
Jacobs, ratified Chancellor Chandler’s analysis and affirmed his ruling that personal
liability should not be imposed on the individual directors. In doing so, the court reached
significant conclusions about the board’s actions and processes in a variety of areas:
1. Exercise of Due Care. Under Delaware law, the “duty of care” refers to
directors’ duties to appropriately inform themselves of relevant facts and to act only after
due consideration of such facts. On appeal, the principal duty of care issues revolved
around the extent to which board and committee members adequately informed
themselves before reaching employment- and compensation-related decisions, based
largely on the board’s delegation of those issues to its compensation committee and on
the form in which relevant information was communicated to the compensation
committee and the board. The court affirmed the Chancellor’s decision that the board’s
delegation of authority to the compensation committee was indeed appropriate under
state law, and that committee members had adequately informed themselves of the
material facts, even though those facts could have been presented in a more
comprehensive and user-friendly fashion. In so doing, it agreed with the Chancellor’s
decision that, while the committee process fell short of “best practices,” the process did
not fall below the level required for a proper exercise of due care.5 As noted above, key
to this portion of the decision was the court’s view that aspirational best practices, while
a valuable goal, do not define the legal standard by which director conduct is to be
measured.
Moreover, the court’s holding provided strong support for the rights of boards of
directors to delegate responsibility to appropriate committees of the board and to
reasonably rely on outside consultants in reaching its decisions.
2. Exercise of Good Faith. On appeal, the plaintiffs argued that the
Chancellor applied an incorrect definition of “bad faith” in analyzing the actions of
directors, at both the full board and committee levels. This is an important consideration,
because a demonstration of bad faith can be used to rebut the presumption of the
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business judgment rule. In upholding the Chancellor’s decision that the directors did not
breach their duty to act in good faith, the court confirmed that gross negligence
(including a failure to inform oneself of available material facts) does not, without more
(e.g., malevolence or an intentional and conscious disregard for one’s fiduciary
obligations), constitute bad faith. In this regard, the court strongly distinguished between
simple “gross negligence” constituting a breach of the duty of care, and the type of
actions necessary to establish what the court believed was a very different concept of
lack of good faith. According to the court, a breach of the duty of good faith must involve
either subjective bad faith—“fiduciary conduct motivated by an actual intent to do harm,”
which was not alleged in the case—or an intentional and conscious (as distinguished
from negligent or grossly negligent) dereliction of duty.
3. Waste of Assets. The third principal claim on appeal was that (the
business judgment rule aside) the amount required to be paid to Mr. Ovitz in the event
of a “no fault” termination constituted corporate waste. The court again affirmed the
extremely high standard of abuse required to implicate the corporate waste doctrine,
holding that “[a] claim of waste will arise only in the rare, ‘unconscionable case where
directors irrationally squander or give away corporate assets.’” The court held that
Disney’s clear obligations under the terms of Mr. Ovitz’s contract, the absence of any
basis for “for-cause” termination and the presence of credible testimony that the
company would be better off without Mr. Ovitz disposed of this claim, because they
provided a rational basis for the no-fault termination decision.
II. GENERAL RELEVANCE OF DELAWARE DECISIONS
Delaware cases are worthy of note by nonprofit corporations because of the
number of businesses incorporated in Delaware, the volume of business controversies
litigated in Delaware courts, the strength of its judiciary (including a specialized court,
the Chancery Court, that has jurisdiction over cases arising under its corporate laws),
and the fact that it has a unified corporation code applicable to for-profit and nonprofit
corporations alike. Furthermore, Delaware decisions often address alleged violations of
fiduciary duty that closely resemble those duties owed by directors of nonprofit
be particularly informative to nonprofit organizations—and those who regulate them—
even where those organizations are not governed by Delaware law.
III. ANALYSIS
1. The case confirms the vitality of the business judgment rule, even under
fact patterns that may be less than ideal. Despite the “imperfections” in the Disney
board’s decision-making process, its exercise of good faith and due care was sufficient
to sustain the presumption of business judgment rule protection.
2. In the court’s words, “Aspirational ideals of corporate good governance
practices . . . can usually help directors avoid liability. But they are not required by
corporation law and do not define the standards of liability.” In other words, corporate
law does not require adherence to supposed “best practices” to satisfy fiduciary
obligations. There is no basis to suggest (as some have) that the case would have been
decided differently had the subject conduct occurred in the present (i.e., post-Sarbanes
Oxley). However, as noted in the Chancery Court decision, corporate directors
considering similar circumstances on a going-forward basis would be well advised to
consider the criticisms leveled at the Disney board and attempt to avoid the more
obvious pitfalls, at a minimum.
3. Along those lines, application of evolving perceptions of best practices is
nevertheless an admirable aspiration and can constitute evidence of good faith. “The
conscientious pursuit by directors of principles of best practices is the best prophylactic
against liability.”6 That the Disney directors were able to avoid liability under these facts
does not obviate the fact that they had to go through extraordinarily expensive litigation
to achieve that result.
4. Gross negligence is not the same as bad faith. A finding of bad faith—
which requires evidence beyond that necessary to show gross negligence—may serve
to rebut the presumption of the business judgment rule (which is why the use of
allegations of “bad faith” is a growing pleading practice in fiduciary duty litigation). “Bad
faith” allegations can also be used to vitiate indemnification and insurance protection.
6
5. While the business judgment rule (in varying forms) is recognized as
generally applicable to nonprofit corporations in most jurisdictions, it should not be
assumed that a state charity official or a court reviewing the actions of a nonprofit board
under similar circumstances would reach the same conclusions as the Disney court.
This is particularly the case given the absence of a “market remedy” in the nonprofit
context.
6. Accordingly, nonprofit organizations and their counsel are well advised to
do whatever they reasonably can—including effective education and documentation—to
position themselves to render informed decisions in good faith. The authors recommend
that nonprofit boards take the following steps to support “good faith” decision-making:
i. Confirming the applicability of the business judgment rule in the
relevant jurisdiction.
ii. Adopting and maintaining recognized governance “best practices,”
taking into account the particular circumstances of the organization.
iii. Promoting active board discussions and emphasizing “process”
protections as a key element in board decision-making.
iv. Maintaining an awareness of the financial posture and related
competitive strategy of the enterprise.
v. Confirming board access to information and advisors necessary to
making an informed decision.
vi. Monitoring the board agenda and reviewing all board and
committee meeting minutes to ensure an accurate record of deliberations.
vii. Assuring a functioning and effective conflict of interest disclosure
and review process.
viii. Having a coherent understanding of any business transactions
brought to the board for approval, including the relationship of the transaction to
the mission of the organization.
ix. Confirming the appropriateness of any delegation of principal board
responsibility to a board committee.
x. Application of vigorous conflict of interest procedures to particular
These recommendations are designed to emphasize “good faith” and position the
board’s action for the protection of the business judgment rule.
DELAWARE SUPREME COURT AFFIRMS DISNEY, CONTINUING VITALITY OF BUSINESS
JUDGMENT RULE © 2006 is published by the American Health Lawyers Association. All rights reserved. No part of this publication may be reproduced in any form except by prior written permission from the publisher. Printed in the United State of America.
Any views or advice offered in this publication are those of its authors and should not be construed as the position of the American Health Lawyers Association.
