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CASE:

In re The Walt Disney Co. Derivative Litigation

907 A.2d 693 (Del. Ch. 2005)

JACOBS, Justice:

[The Walt Disney Company hired Ovitz as its executive presidentand as a board member for five years after lengthy compensationnegotiations. The negotiations regarding Ovitz’s compensation wereconducted predominantly by Eisner and two of the members of thecompensation committee (a four-member panel). The terms of Ovitz’scompensation were then presented to the full board. In a meetinglasting around one hour, where a variety of topics were discussed,the board approved Ovitz’s compensation after reviewing only a termsheet rather than the full contract. Ovitz’s time at Disney wastumultuous and short-lived.]…In December 1996, only fourteen monthsafter he commenced employment, Ovitz was terminated without cause,resulting in a severance payout to Ovitz valued at approximately $130 million. [Disney shareholders then filed derivative actions onbehalf of Disney against Ovitz and the directors of Disney at thetime of the events complained of (the “Disney defendants”),claiming that the $130 million severance payout was the product offiduciary duty and contractual breaches by Ovitz and of breaches offiduciary duty by the Disney defendants and a waste of assets. TheChancellor found in favor of the defendants. The plaintiffappealed.]

We next turn to the claims of error that relate to the Disneydefendants. Those claims are subdivisible into two groups: (A)claims arising out of the approval of the OEA [Ovitz employmentagreement] and of Ovitz’s election as President; and (B) claimsarising out of the NFT [nonfault termination] severance payment toOvitz upon his termination. We address separately those twocategories and the issues that they generate.…

…[The due care] argument is best understood against the backdropof the presumptions that cloak director action being reviewed underthe business judgment standard. Our law presumes that “in making abusiness decision the directors of a corporation acted on aninformed basis, in good faith, and in the honest belief that theaction taken was in the best interests of the company.” Thosepresumptions can be rebutted if the plaintiff shows that thedirectors breached their fiduciary duty of care or of loyalty oracted in bad faith. If that is shown, the burden then shifts to thedirector defendants to demonstrate that the challenged act ortransaction was entirely fair to the corporation and itsshareholders.…

The appellants’ first claim is that the Chancellor erroneously(i) failed to make a “threshold determination” of gross negligence,and (ii) “conflated” the appellants’ burden to rebut the businessjudgment presumptions, with an analysis of whether the directors’conduct fell within the 8 Del. C. § 102(b)(7) provisionthat precludes exculpation of directors from monetary liability“for acts or omissions not in good faith.” The argument runs asfollows: Emerald Partners v. Berlin required theChancellor first to determine whether the business judgment rulepresumptions were rebutted based upon a showing that the boardviolated its duty of care, i.e., acted with grossnegligence. If gross negligence were established, the burden wouldshift to the directors to establish that the OEA was entirely fair.Only if the directors failed to meet that burden could the trialcourt then address the directors’ Section 102(b)(7) exculpationdefense, including the statutory exception for acts not in goodfaith.

This argument lacks merit. To make the argument the appellantsmust ignore the distinction between (i) a determination of badfaith for the threshold purpose of rebutting the business judgmentrule presumptions, and (ii) a bad faith determination for purposesof evaluating the availability of charter-authorized exculpationfrom monetary damage liability after liability has beenestablished. Our law clearly permits a judicial assessment ofdirector good faith for that former purpose. Nothing in EmeraldPartners requires the Court of Chancery to consider onlyevidence of lack of due care (i.e. gross negligence) indetermining whether the business judgment rule presumptions havebeen rebutted.…

The appellants argue that the Disney directors breached theirduty of care by failing to inform themselves of all materialinformation reasonably available with respect to Ovitz’s employmentagreement.…[but the] only properly reviewable action of the entireboard was its decision to elect Ovitz as Disney’s President. Inthat context the sole issue, as the Chancellor properly held, is“whether [the remaining members of the old board] properlyexercised their business judgment and acted in accordance withtheir fiduciary duties when they elected Ovitz to the Company’spresidency.” The Chancellor determined that in electing Ovitz, thedirectors were informed of all information reasonably availableand, thus, were not grossly negligent. We agree.

…[The court turns to good faith.] The Court of Chancery heldthat the business judgment rule presumptions protected thedecisions of the compensation committee and the remaining Disneydirectors, not only because they had acted with due care but alsobecause they had not acted in bad faith. That latter ruling, theappellants claim, was reversible error because the Chancellorformulated and then applied an incorrect definition of badfaith.

…Their argument runs as follows: under the Chancellor’s 2003definition of bad faith, the directors must have “consciouslyand intentionally disregarded their responsibilities, adoptinga ‘we don’t care about the risks’ attitude concerning a materialcorporate decision.” Under the 2003 formulation, appellants say,“directors violate their duty of good faith if they are makingmaterial decisions without adequate information and withoutadequate deliberation[,]” but under the 2005 post-trial definition,bad faith requires proof of a subjective bad motive or intent. Thisdefinitional change, it is claimed, was procedurally prejudicialbecause appellants relied on the 2003 definition in presentingtheir evidence of bad faith at the trial.…

Second, the appellants claim that the Chancellor’s post-trialdefinition of bad faith is erroneous substantively. They argue thatthe 2003 formulation was (and is) the correct definition, becauseit is “logically tied to board decision-making under the duty ofcare.” The post-trial formulation, on the other hand, “wronglyincorporated substantive elements regarding the rationality of thedecisions under review rather than being constrained, as in a duecare analysis, to strictly procedural criteria.” We conclude thatboth arguments must fail.

The appellants’ first argument—that there is a real, significantdifference between the Chancellor’s pre-trial and post-trialdefinitions of bad faith—is plainly wrong. We perceive nosubstantive difference between the Court of Chancery’s 2003definition of bad faith—a “conscious and intentional disregard [of]responsibilities, adopting a we don’t care about the risks’attitude…”—and its 2005 post-trial definition—an “intentionaldereliction of duty, a conscious disregard for one’sresponsibilities.” Both formulations express the same concept,although in slightly different language.

The most telling evidence that there is no substantivedifference between the two formulations is that the appellants areforced to contrive a difference. Appellants assert that under the2003 formulation, “directors violate their duty of good faith ifthey are making material decisions without adequate information andwithout adequate deliberation.” For that ipse dixit theycite no legal authority. That comes as no surprise because theirverbal effort to collapse the duty to act in good faith into theduty to act with due care, is not unlike putting a rabbit into theproverbial hat and then blaming the trial judge for making theinsertion.

…The precise question is whether the Chancellor’s articulatedstandard for bad faith corporate fiduciary conduct—intentionaldereliction of duty, a conscious disregard for one’sresponsibilities—is legally correct. In approaching that question,we note that the Chancellor characterized that definition as“an appropriate (although not the only) standardfor determining whether fiduciaries have acted in good faith.” Thatobservation is accurate and helpful, because as a matter of simplelogic, at least three different categories of fiduciary behaviorare candidates for the “bad faith” pejorative label.

The first category involves so-called “subjective bad faith,”that is, fiduciary conduct motivated by an actual intent to doharm. That such conduct constitutes classic, quintessential badfaith is a proposition so well accepted in the liturgy of fiduciarylaw that it borders on axiomatic.…The second category of conduct,which is at the opposite end of the spectrum, involves lack of duecare—that is, fiduciary action taken solely by reason of grossnegligence and without any malevolent intent. In this case,appellants assert claims of gross negligence to establish breachesnot only of director due care but also of the directors’ duty toact in good faith. Although the Chancellor found, and we agree,that the appellants failed to establish gross negligence, to affordguidance we address the issue of whether gross negligence(including a failure to inform one’s self of available materialfacts), without more, can also constitute bad faith. The answer isclearly no.

…”issues of good faith are (to a certain degree) inseparably andnecessarily intertwined with the duties of care and loyalty.…” But,in the pragmatic, conduct-regulating legal realm which calls formore precise conceptual line drawing, the answer is that grosslynegligent conduct, without more, does not and cannot constitute abreach of the fiduciary duty to act in good faith. The conduct thatis the subject of due care may overlap with the conduct that comeswithin the rubric of good faith in a psychological sense, but froma legal standpoint those duties are and must remain quitedistinct.…

The Delaware General Assembly has addressed the distinctionbetween bad faith and a failure to exercise due care(i.e., gross negligence) in two separate contexts. Thefirst is Section 102(b)(7) of the DGCL, which authorizes Delawarecorporations, by a provision in the certificate of incorporation,to exculpate their directors from monetary damage liability for abreach of the duty of care. That exculpatory provision affordssignificant protection to directors of Delaware corporations. Thestatute carves out several exceptions, however, including mostrelevantly, “for acts or omissions not in good faith.…” Thus, acorporation can exculpate its directors from monetary liability fora breach of the duty of care, but not for conduct that is not ingood faith. To adopt a definition of bad faith that would cause aviolation of the duty of care automatically to become an act oromission “not in good faith,” would eviscerate the protectionsaccorded to directors by the General Assembly’s adoption of Section102(b)(7).

A second legislative recognition of the distinction betweenfiduciary conduct that is grossly negligent and conduct that is notin good faith, is Delaware’s indemnification statute, found at 8Del. C. § 145. To oversimplify, subsections (a) and (b) ofthat statute permit a corporation to indemnify (interalia) any person who is or was a director, officer, employeeor agent of the corporation against expenses…where (among otherthings): (i) that person is, was, or is threatened to be made aparty to that action, suit or proceeding, and (ii) that person“acted in good faith and in a manner the person reasonably believedto be in or not opposed to the best interests of the corporation.…”Thus, under Delaware statutory law a director or officer of acorporation can be indemnified for liability (and litigationexpenses) incurred by reason of a violation of the duty of care,but not for a violation of the duty to act in good faith.

QUESTION:   
i. How did the court view the plaintiff’s argument that theChancellor had developed two different types of bad faith?Why?
ii. What two statutory provisions has the Delaware General Assemblypassed that address the distinction between bad faith and a failureto exercise due care (i.e., gross negligence)? Why are theyimportant?