Brehm v. Eisner 906 A. 2d 27 (Del. S. Ct. 2006)
From the mid-1980s to the mid-1990s, The Walt Disney Company enjoyed remarkable success under the guidance of Chairman and CEO Michael Eisner and President and Chief Operating Officer Frank Wells. In 1994, Wells died in a helicopter crash, prematurely forcing the company to consider his replacement. Eisner promoted the candidacy of his long-time friend, Michael Ovitz. Ovitz was the head of Creative Artists Agency (CAA), which he and four others had founded in 1974. By 1995, CAA had grown to be the premier Hollywood talent agency. CAA had 550 employees and an impressive roster of about 1,400 of Hollywood’s top actors, directors, writers, and musicians, clients that generated $150 million in annual revenues for CAA. Ovitz drew an annual income of $20 million from CAA. He was regarded as one of the most powerful figures in Hollywood. To leave CAA and join Disney as its president, Ovitz insisted on an employment agreement that would provide him downside risk protection if he was terminated by Disney or if he was interfered with in his performance of his duties as president. After protracted negotiations, Ovitz accepted an employment package that would provide him $23.6 million per year for the first five years of the deal, plus bonuses and stock options. The agreement guaranteed that the stock options would appreciate at least $50 million in five years or Disney would make up the difference. The Ovitz employment agreement (OEA) also provided that if Disney fi red Ovitz for any reason other than gross negligence or malfeasance, Ovitz would be entitled to a Non-Fault Termination payment (NFT), which consisted of his remaining salary, $7.5 million a year for any unaccrued bonuses, the immediate vesting of some stock options, and a $10 million cash out payment for other stock options. While there was some opposition to the employment agreement among directors and upper management at Disney, Ovitz was hired in October 1995 largely due to Eisner’s insistence.
At the end of 1995, Eisner’s attitude with respect to Ovitz was positive. Eisner wrote, “1996 is going to be a great year—We are going to be a great team—We every day are working better together—Time will be on our side—We will be strong, smart, and unstoppable!!!” Eisner also wrote that Ovitz performed well during 1995, notwithstanding the difficulties Ovitz was experiencing assimilating to Disney’s culture.
Unfortunately, such optimism did not last long. In January 1996, a corporate retreat was held at Walt Disney World in
Orlando. At that retreat, Ovitz failed to integrate himself in the group of executives by declining to participate in group activities, insisting on a limousine when the other executives—including Eisner—were taking a bus, and making inappropriate demands of the park employees. In short, Ovitz was a little elitist for the egalitarian Disney and a poor fi t with his fellow executives.
By the summer of 1996, Eisner had spoken with several directors about Ovitz’s failure to adapt to the company’s culture. In the fall of 1996, directors began discussing that the disconnect between Ovitz and Disney was likely irreparable, and that Ovitz would have to be terminated. In December 1996, Ovitz was officially terminated by action of Eisner alone. Eisner concluded that Ovitz was terminated without cause, requiring Disney to make the costly NFT payment.
Shareholders of Disney brought a derivative action on behalf of Disney against Eisner and other Disney directors. The shareholders alleged breaches of fiduciary duty in the hiring and fi ring of Ovitz. Eisner and the other directors defended on the grounds that they had complied with the business judgment rule. Because Disney was incorporated in Delaware, the case was brought in the Delaware Court of Chancery. The chancery court found that Eisner and the other directors had complied with the business judgment rule. The Disney shareholders appealed to the Delaware Supreme Court.
The shareholders’ claims are subdivisible into two groups: (A) claims arising out of the approval of the OEA and of Ovitz’s election as President; and (B) claims arising out of the NFT severance payment to Ovitz upon his termination.
A. Claims Arising from the Approval of the OEA and Ovitz’s Election as President
The shareholders’ core argument in the trial court was that the Disney directors’ approval of the OEA and election of Ovitz as President were not entitled to business judgment rule protection, because those actions were either grossly negligent or not performed in good faith. The Court of Chancery rejected these arguments, and held that the shareholders had failed to prove that the Disney defendants had breached any fiduciary duty.
Our law presumes that in making a business decision the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company. Those presumptions can be rebutted if the shareholder shows that the directors breached their fiduciary duty of care or of loyalty or acted in bad faith. If that is shown, the burden then shifts to the director defendants to demonstrate that the challenged act or transaction was entirely fair to the corporation and its shareholders.
Because no duty of loyalty claim was asserted against the Disney defendants, the only way to rebut the business judgment rule presumptions would be to show that the Disney defendants had either breached their duty of care or had not acted in good faith. The Chancellor determined that the shareholders had failed to prove either. [The Delaware Supreme Court affirmed the Chancellor’s finding.]
The shareholders next challenge the Court of Chancery’s determination that the full Disney board was not required to consider and approve the OEA, because the Company’s governing instruments allocated that decision to the compensation committee. This challenge also cannot survive scrutiny.
Under the Company’s governing documents the board of directors was responsible for selecting the corporation’s officers, but under the compensation committee charter, the committee was responsible for establishing and approving the salaries, together with benefits and stock options, of the Company’s CEO and President. The compensation committee also had the charter-imposed duty to “approve employment contracts, or contracts at will” for “all corporate officers who are members of the Board of Directors regardless of salary.” That is exactly what occurred here. The full board ultimately selected Ovitz as President, and the compensation committee considered and ultimately approved the OEA, which embodied the terms of Ovitz’s employment, including his compensation.
The Delaware General Corporation Law (DGCL) expressly empowers a board of directors to appoint committees and to delegate to them a broad range of responsibilities, which may include setting executive compensation. Nothing in the DGCL mandates that the entire board must make those decisions. At Disney, the responsibility to consider and approve executive compensation was allocated to the compensation committee, as distinguished from the full board. The Chancellor’s ruling—that executive compensation was to be fixed by the compensation committee—is legally correct.
In the Court of Chancery the shareholders argued that theboard had failed to exercise due care, using a director-by-director, rather than a collective analysis. In this Court, however, the shareholders argue that the Chancellor erred in following that very approach. An about-face, the shareholders now claim that in determining whether the board breached its duty of care, the Chancellor was legally required to evaluate the actions of the old board collectively.
We reject this argument, without reaching its merits, for two separate reasons. To begin with, the argument is precluded by Rule 8 of this Court, which provides that arguments not fairly presented to the trial court will not be considered by this Court. The argument also fails because nowhere do shareholders identify how this supposed error caused them any prejudice. The Chancellor viewed the conduct of each director individually, and found that no director had breached his or her fiduciary duty of care (as members of the full board) in electing Ovitz as President or (as members of the compensation committee) in determining Ovitz’s compensation. If, as shareholders now argue, a due care analysis of the board’s conduct must be made collectively, it is incumbent upon them to show how such a collective analysis would yield a different result. The shareholders’ failure to do that dooms their argument on this basis as well.
The shareholders next challenge the Chancellor’s determination that although the compensation committee’s decision making process fell far short of corporate governance “best practices,” the committee members breached no duty of care in considering and approving the NFT terms of the OEA. That conclusion is reversible error, the shareholders claim, because the record establishes that the compensation committee members did not properly inform themselves of the material facts and, hence, were grossly negligent in approving the NFT provisions of the OEA.
In our view, a helpful approach is to compare what actually happened here to what would have occurred had the committee followed a “best practices” (or “best case”) scenario, from a process standpoint. In a “best case” scenario, all committee members would have received, before or at the committee’s first meeting on September 26, 1995, a spreadsheet or similar document prepared by (or with the assistance of) a compensation expert (in this case, Graef Crystal). Making different, alternative assumptions, the spreadsheet would disclose the amounts that
Ovitz could receive under the OEA in each circumstance that might foreseeably arise. One variable in that matrix of possibilities would be the cost to Disney of a non-fault termination for each of the five years of the initial term of the OEA. The contents of the spreadsheet would be explained to the committee members, either by the expert who prepared it or by a fellow committee member similarly knowledgeable about the subject. That spreadsheet, which ultimately would become an exhibit to the minutes of the compensation committee meeting, would form the basis of the committee’s deliberations and decision.
Regrettably, the committee’s informational and decision making process used here was not so tidy. That is one reason why the Chancellor found that although the committee’s process did not fall below the level required for a proper exercise of due care, it did fall short of what best practices would have counseled.
The Disney compensation committee met twice: on September 26 and October 16, 1995. The minutes of the September 26 meeting reflect that the committee approved the terms of the OEA (at that time embodied in the form of a letter agreement), except for the option grants, which were not approved until October 16—after the Disney stock incentive plan had been amended to provide for those options. At the September 26 meeting, the compensation committee considered a “term sheet” which, in summarizing the material terms of the OEA, relevantly disclosed that in the event of a non-fault termination, Ovitz would receive: (i) the present value of his salary ($1 million per year) for the balance of the contract term, (ii) the present value of his annual bonus payments (computed at $7.5 million) for the balance of the contract term, (iii) a $10 million termination fee, and (iv) the acceleration of his options for 3 million shares, which would become immediately exercisable at market price.
Thus, the compensation committee knew that in the event of an NFT, Ovitz’s severance payment alone could be in the range of $40 million cash, plus the value of the accelerated options. Because the actual payout to Ovitz was approximately $130 million, of which roughly $38.5 million was cash, the value of the options at the time of the NFT payout would have been about $91.5 million. Thus, the issue may be framed as whether the compensation committee members knew, at the time they approved the OEA, that the value of the option component of the severance package could reach the $92 million order of magnitude if they terminated Ovitz without cause after one year. The evidentiary record shows that the committee members were so informed.
On this question the documentation is far less than what best practices would have dictated. There is no exhibit to the minutes that discloses, in a single document, the estimated value of the accelerated options in the event of an NFT termination after one year. The information imparted to the committee members on that subject is, however, supported by other evidence, most notably the trial testimony of various witnesses about spreadsheets that were prepared for the compensation committee meetings.
The compensation committee members derived their information about the potential magnitude of an NFT payout fromtwo sources. The first was the value of the “benchmark” options previously granted to Eisner and Wells and the valuations by Raymond Watson [a Disney director, member of Disney’s compensation committee, and past Disney board chairman who had helped structure Wells’s and Eisner’s compensation packages] of the proposed Ovitz options. Ovitz’s options were set at 75% of parity with the options previously granted to Eisner and to Frank Wells. Because the compensation committee had established those earlier benchmark option grants to Eisner and Wells and were aware of their value, a simple mathematical calculation would have informed them of the potential value range of Ovitz’s options. Also, in August and September 1995, Watson and Irwin Russell [a Disney director and chairman of the compensation committee] met with Crystal to determine (among other things) the value of the potential Ovitz options, assuming different scenarios. Crystal valued the options under the Black-Scholes method, while Watson used a different valuation metric. Watson recorded his calculations and the resulting values on a set of spreadsheets that reflected what option profit Ovitz might receive, based upon a range of different assumptionsabout stock market price increases. Those spreadsheets were shared with, and explained to, the committee members at the September meeting.
The committee’s second source of information was the amount of “downside protection” that Ovitz was demanding. Ovitz required financial protection from the risk of leaving a very lucrative and secure position at CAA, of which he was a controlling partner, to join a publicly held corporation to which Ovitz was a stranger, and that had a very different culture and an environment which prevented him from completely controlling his destiny. The committee members knew that by leaving CAA and coming to Disney, Ovitz would be sacrificing “booked” CAA commissions of $150 to $200 million—an amount that Ovitz demanded as protection against the risk that his employment relationship with Disney might not work out. Ovitz wanted at least $50 million of that compensation to take the form of an “up-front” signing bonus. Had the $50 million bonus been paid, the size of the option grant would have been lower. Because it was contrary to Disney policy, the compensation committee rejected the up-front signing bonus demand, and elected instead to compensate Ovitz at the “back end,” by awarding him options that would be phased in over the five-year term of the OEA.
It is on this record that the Chancellor found that the compensation committee was informed of the material facts relating to an NFT payout. If measured in terms of the documentation that would have been generated if “best practices” had been followed, that record leaves much to be desired. The Chancellor acknowledged that, and so do we. But, the Chancellor also found that despite its imperfections, the evidentiary record was sufficient to support the conclusion that the compensation committee had adequately informed itself of the potential magnitude of the entire severance package, including the options, that Ovitz would receive in the event of an early NFT.
The OEA was specifically structured to compensate Ovitz for walking away from $150 million to $200 million of anticipated commissions from CAA over the five-year OEA contract term. This meant that if Ovitz was terminated without cause, the earlier in the contract term the termination occurred the larger the severance amount would be to replace the lost commissions. Indeed, because Ovitz was terminated after only one year, the total amount of his severance payment (about $130 million) closely approximated the lower end of the range of Ovitz’s forfeited commissions ($150 million), less the compensation Ovitz received during his first and only year as Disney’s President. Accordingly, the Court of Chancery had a sufficient evidentiary basis in the record from which to find that, at the time they approvedthe OEA, the compensation committee members were adequately informed of the potential magnitude of an early NFT severance payout.
The shareholders’ final claim in this category is that the Court of Chancery erroneously held that the remaining members of the old Disney board had not breached their duty of care in electing Ovitz as President of Disney. This claim lacks merit, because the arguments shareholders advance in this context relate to a different subject—the approval of the OEA, which was the responsibility delegated to the compensation committee, not the full board.
The Chancellor found and the record shows the following: well in advance of the September 26, 1995 board meeting the directors were fully aware that the Company needed—especially in light of Wells’ death and Eisner’s medical problems—to hire a “number two” executive and potential successor to Eisner. There had been many discussions about that need and about potential candidates who could fill that role even before Eisner decided to try to recruit Ovitz. Before the September 26 board meeting Eisner had individually discussed with each director the possibility of hiring Ovitz, and Ovitz’s background and qualifications. The directors thus knew of Ovitz’s skills, reputation and experience, all of which they believed would be highly valuable to the Company. The directors also knew that to accept a position at Disney, Ovitz would have to walk away from a very successful business—a reality that would lead a reasonable person to believe that Ovitz would likely succeed in similar pursuits elsewhere in the industry. The directors also knew of the public’s highly positive reaction to the Ovitz announcement, and that Eisner and senior management had supported the Ovitz hiring. Indeed, Eisner, who had long desired to bring Ovitz within the Disney fold, consistently vouched for Ovitz’s qualifications and told the directors that he could work well with Ovitz.
The board was also informed of the key terms of the OEA (including Ovitz’s salary, bonus, and options). Russell reported this information to them at the September 26, 1995 executive session, which was attended by Eisner and all non-executive directors. Russell also reported on the compensation committee meeting that had immediately preceded the executive session. And, both Russell and Watson responded to questions from the board. Relying upon the compensation committee’s approval of the OEA and the other information furnished to them, the Disney directors, after further deliberating, unanimously elected Ovitas President.
Based upon this record, we uphold the Chancellor’s conclusion that, when electing Ovitz to the Disney presidency the remaining Disney directors were fully informed of all material facts, and that the shareholders failed to establish any lack of due care on the directors’ part.
B. Claims Arising from the Payment of the NFT Severance Payout to Ovitz
The shareholders contend that: (1) only the full Disney board with the concurrence of the compensation committee—but not Eisner alone—was authorized to terminate Ovitz; (2) because Ovitz could have been terminated for cause, Sanford Litvack [Disney’s general counsel and member of the Disney board] and Eisner acted without due care and in bad faith in reaching the contrary conclusion; and (3) the business judgment rule presumptions did not protect the new Disney board’s acquiescence in the NFT payout, because the new board was not entitled to rely upon Eisner’s and Litvack’s contrary advice.
The Chancellor determined that although the board as constituted upon Ovitz’s termination (the “new board”) had the authority to terminate Ovitz, neither that board nor the compensation committee was required to act, because Eisner also had, and properly exercised, that authority. The new board, the Chancellor found, was not required to terminate Ovitz under the company’s internal documents. Without such a duty to act, the new board’s failure to vote on the termination could not give rise to a breach of the duty of care or the duty to act in good faith.
Article Tenth of the Company’s certificate of incorporation in effect at the termination plainly states that:
The officers of the Corporation shall be chosen in such a manner, shall hold their offices for such terms and shall carry out such duties as are determined solely by the Board of Directors, subject to the right of the Board of Directors to remove any officer or officers at any time with or without cause.
Article IV of Disney’s bylaws provided that the Board Chairman/CEO “shall, subject to the provisions of the Bylaws and the control of the Board of Directors, have general and active management, direction, and supervision over the business of the Corporation and over its officers. . . .”
Read together, the governing instruments do not yield a single, indisputably clear answer, and could reasonably be interpreted either way. For that reason, with respect to this specific issue, the governing instruments are ambiguous.
Here, the extrinsic evidence clearly supports the conclusion that the board and Eisner understood that Eisner, as Board Chairman/CEO had concurrent power with the board to terminate Ovitz as President. Because Eisner possessed, and exercised, the power to terminate Ovitz unilaterally, we find that the Chancellor correctly concluded that the new board was not required to act in connection with that termination, and, therefore, the board did not violate any fiduciary duty to act with due care or in good faith.
As the Chancellor correctly held, the same conclusion is equally applicable to the compensation committee. The only role delegated to the compensation committee was “to establish and approve compensation for Eisner, Ovitz and other applicable Company executives and high paid employees.” The committee’s September 26, 1995 approval of Ovitz’s compensation arrangements “included approval for the termination provisions of the OEA, obviating any need to meet and approve the payment of the NFT upon Ovitz’s termination.”
Because neither the new board nor the compensation committee was required to take any action that was subject to fiduciary standards, that leaves only the actions of Eisner and Litvack for our consideration. The shareholders claim that in concluding that Ovitz could not be terminated “for cause,” these defendants did not act with due care or in good faith. We next address that claim.
After considering the OEA and Ovitz’s conduct, Litvack concluded, and advised Eisner, that Disney had no basis to terminate Ovitz for cause and that Disney should comply with its contractual obligations. Even though Litvack personally did not want to grant a NFT to Ovitz, he concluded that for Disney to assert falsely that there was cause would be both unethical and harmful to Disney’s reputation. In conclusion, Litvack gave the proper advice and came to the proper conclusions when it was necessary. He was adequately informed in his decisions, and he acted in good faith for what he believed were the best interests of the Company.
With respect to Eisner, the Chancellor found that faced with a situation where he was unable to work well with Ovitz, who required close and constant supervision, Eisner had three options: (1) keep Ovitz as President and continue trying to make things work; (2) keep Ovitz at Disney, but in a role other thanas President; or (3) terminate Ovitz. The first option was unacceptable and the second would have entitled Ovitz to the NFT, or at the very least would have resulted in a costly lawsuit to determine whether Ovitz was so entitled. After an unsuccessfuleffort to “trade” Ovitz to Sony, that left only the third option, which was to terminate Ovitz and pay the NFT. The Chancellor found that in choosing this alternative, Eisner had breached no duty and had exercised his business judgment:
. . . I conclude that Eisner’s actions in connection with the termination are, for the most part, consistent with what is expected of a faithful fiduciary. Eisner unexpectedly found himself confronted with a situation that did not have an easy solution. He weighed the alternatives, received advice from counsel and then exercised his business judgment in the manner he thought best for the corporation. Eisner knew all the material information reasonably available when making the decision, he did not neglect an affirmative duty to act (or fail to cause the board to act) and he acted in what he believed were the best interests of the Company, taking into account the cost to the Company of the decision and the potential alternatives. Eisner was not personally interested in the transaction in any way that would make him incapable of exercising business judgment, and I conclude that the shareholders have not demonstrated by a preponderance of the evidence that Eisner breached his fiduciary duties or acted in bad faith in connection with Ovitz’s termination and receipt of the NFT.
These determinations rest squarely on factual findings that, in turn, are based upon the Chancellor’s assessment of the credibility of Eisner and other witnesses. Even though the Chancellor found much to criticize in Eisner’s “imperial CEO” style ofgovernance, nothing has been shown to overturn the factual basis for the Court’s conclusion that, in the end, Eisner’s conduct satisfyed the standards required of him as a fiduciary.
The shareholders’ third claim of error challenges the Chancellor’s conclusion that the remaining new board members could rely upon Litvack’s and Eisner’s advice that Ovitz could be terminated only without cause. The short answer to that challenge is that, for the reasons previously discussed, the advice the remaining directors received and relied upon was accurate. Moreover, the directors’ reliance on that advice was found to be in good faith. Although formal board action was not necessary, the remaining directors all supported the decision to terminate Ovitz based on the information given by Eisner and Litvack. The Chancellor found credible the directors’ testimony that they believedthat Disney would be better off without Ovitz, and theshareholders offer no basis to overturn that finding.
To summarize, the Court of Chancery correctly determined that the decisions of the Disney defendants to approve the OEA, to hire Ovitz as President, and then to terminate him on an NFT basis, were protected business judgments, made without any violations of fiduciary duty. Having so concluded, it is unnecessary for the Court to reach the shareholders’ contention that the Disney defendants were required to prove that the payment of the NFT severance to Ovitz was entirely fair.
Judgment for Eisner and the other directors affirmed.
To brief cases, case problems and questions, use the following “IRAC” format:
What is the question presented to the court? Usually, only one issue will be discussed, but sometimes there will be more. What are the parties fighting about, and what are they asking the court to decide? For example, in the case of the assaulted customer, the issue for a trial court to decide might be whether the business had a duty to the customer to provide security patrols. The answer to the question will help to ultimately determinewhether the business is liable for negligently failing to provide security patrols: whether the defendant owed plaintiff a duty of care, and what that duty of care is, are key issues in negligence claims.
Determine what the relevant rules of law are that the court uses to make its decision. These rules will be identified and discussed by the court. For example, in the case of the assaulted customer, the relevant rule of law is that a property owner’s duty to prevent harm to invitees is determined by balancing the foreseeability of the harm against the burden of preventive measures. There may be more than one relevant rule of law to a case: for example, in a negligence case in which the defendant argues that the plaintiff assumed the risk of harm, the relevant rules of law could be the elements of negligence, and the definition of “assumption of risk” as a defense. Don’t just simply list the cause of action, such as “negligence” as a rule of law: What rule must the court apply to the facts to determine the outcome?
This may be the most important portion of the brief. The court will have examined the facts in light of the rule, and probably considered all “sides” and arguments presented to it. How courts apply the rule to the facts and analyze the case must be understood in order to properly predict outcomes in future cases involving the same issue. What does the court consider to be a relevant fact given the rule of law? How does the court interpret the rule: for example, does the court consider monetary costs of providing security patrols in weighing the burden of preventive measures? Does the court imply that if a business is in a dangerous area, then it should be willing to bear a higher cost for security? Resist the temptation to merely repeat what the court said in analyzing the facts: what does it mean to you? Summarize the court’s rationale in your own words. If you encounter a word that you do not know, use a dictionary to find its meaning.
What was the final outcome of the case? In one or two sentences, state the court’s ultimate finding. For example, the business did not owe the assaulted customer a duty to provide security patrols.