Disney Decision Upheld: DE Supreme Court Offers Guidance on Breach of Fiduciary Duty Claims

In an 89-page opinion involving the highly publicized hiring and firing of former Walt Disney Company president Michael Ovitz, the Delaware Supreme Court, sitting en banc, affirmed the Court of Chancery’s decision denying shareholder plaintiffs’ claims for breaches of fiduciary duties.

The central issue in the case, a source of much debate among legal scholars during the 10-year history of the litigation, was the definition of the fiduciary duty of good faith within the corporate context – specifically whether a $130 million severance payment to Ovitz, who was terminated after serving as Disney’s president for only 14 months, resulted from bad faith conduct by the Disney board. Justice Jacobs, writing for the court, observed that the case “is one in which the duty to act in good faith has played a prominent role, yet to date is not a well-developed area of our corporate fiduciary law.”

The court discussed three circumstances in which bad faith might exist: (1) directorial conduct motivated by an actual intent to do harm, (2) gross negligence without malevolent intent, and (3) conscious disregard of a director’s responsibilities. According to the court, the first category – subjective intent to do harm – is quintessential bad faith.

Addressing whether only gross negligence could constitute bad faith, the court held that “[t]he answer is clearly no.” The court explained that from a philosophical standpoint, gross negligence and bad faith are to a certain degree inseparably and necessarily intertwined. However, “from a legal standpoint, those duties are and must remain quite distinct,” because the Delaware General Corporation Law treats good faith and due care differently in two contexts – section 102(b)(7) and section 145.

Section 102(b)(7) allows a Delaware corporation, through a provision in its certificate of incorporation, to immunize directors against monetary liability for duty of care breaches but not for “acts or omissions not in good faith.” Section 145 permits a corporation to advance litigation expenses to a director or officer if that person did not act with due care, but not if the person failed to act in good faith. The court reasoned that a holding that duty of care breaches are automatically breaches of good faith would nullify the distinction made by the legislature.

“Intentional dereliction of duty” or “a conscious disregard for one’s responsibilities,” the third category of fiduciary conduct, falls between the first two categories. The Supreme Court explained that such conduct is properly treated as a non-exculpable, non-indemnifiable violation of the fiduciary duty to act in good faith. The court recognized the need for a vehicle to address circumstances where a director has not breached his duty of loyalty, yet engaged in conduct more culpable than gross negligence.

The court upheld the finding that Ovitz himself was not liable. He owed no fiduciary duty to the company while he was negotiating his employment agreement, because he did not formally assume office until after the essential terms of the agreement had been negotiated. Nor did Ovitz breach any fiduciary duties owed to Disney upon his departure by accepting the severance package, because the Disney board terminated him without cause and he played no role in the board’s determination to do so.

The court also rejected the plaintiffs’ arguments that the Disney directors acted in bad faith and with gross negligence in hiring Ovitz and granting him a lucrative contract, in part because Ovitz had left his prior job, which paid him a very substantial income, and the board and compensation committee had been informed of the material facts related to the hiring. The board also discharged its fiduciary duties while deciding to terminate Ovitz’s employment without cause (as opposed to with cause, which would have resulted in a smaller compensation package) only 14 months after he was hired.

The opinion’s principal significance to Delaware corporate law is twofold. First, the court offered meaningful guidance on the scope of good faith, a relatively uncharted area of law within the corporate fiduciary context. Second, the ruling establishes that a claim for bad faith in which directors consciously disregard their responsibilities but do so without self interest is a viable standalone cause of action in Delaware.