Williаm BREHM and Geraldine Brehm, as Trustees and Custodians; Michael Grening; Richard Kaplan and David Kaplan, as Trustees; Thomas M. Malloy; Richard J. Kager and Carol R. Kager, as Joint Tenants; Michael Caesar, as Trustee for Howard Gunty, Inc., Profit Sharing Plan; Robert S. Goldberg, I.R.A.; Michael Shore; Michele De Bendictis; Peter Lawrence, I.R.A.; Melvin Zupnick; Judith B. Wohl, I.R.A.; James C. Hays; and Barnett Stepak, Plaintiffs Below, Appellants, v. Michael D. EISNER, Michael S. Ovitz, Stephen F. Bollenbach, Reveta F, Bowers, Roy E. Disney, Stanley P. Gold, Sanford M. Litvack, Ignacio E. Lozano, Jr., George J. Mitchell, Thomas S. Murphy, Richard A. Nunis, Leo J. O‘Donovan, Sidney Poitier, Irwin E. Russell, Robert A.M. Stern, E. Cardon Walker, Raymond L. Watson and Gary L. Wilson, Defendants Below, Appellees. and The Walt Disney Company, Nominal Defendant Below, Appellee.
No. 469, 1998.
Supreme Court of Delaware.
Submitted: Sept. 14, 1999. Decided: Feb. 9, 2000.
746 A.2d 244
R. Franklin Balotti (argued), Anne C. Foster, Srinivas M. Raju, Peter B. Ladig, Richards, Layton and Finger, Wilmington, Delaware, for director appellees.
David C. McBride, Young, Conaway, Stargatt & Taylor, Wilmington, Delaware; Ronald L. Olson, George M. Garvey, Mark H. Epstein (argued) Munger, Tolles & Olson, Los Angeles, California, for appellee Ovitz.
Andre G. Bouchard, Joel Friedlander, Bouchard, Friedlander & MaloneyHuss, Wilmington, Delaware; Edward J. Nowak, Jay S. Handlin, Burbank, California; David S. McLeod, John P. Flynn, Dewey
Stuart M. Grant, Jay W. Eisenhofer, Megan D. McIntyre, Grant & Eisenhofer, Wilmington, Delaware, for Amicus Curiae Council of Institutional Investors.
Before VEASEY, C.J., WALSH, HOLLAND, HARTNETT and BERGER, JJ., constituting the Court en Banc.
VEASEY, Chief Justice:
In this appeal from the Court of Chancery, we agree with the holding of the Court of Chancery that the stockholder derivative Complaint1 was subject to dismissal for failure to set forth particularized facts creating a reasonable doubt that the director defendants were disinterested and independent or that their conduct was protected by the business judgment rule.2
Our affirmance, however, is in part based on a somewhat different analysis than that of the Court below or the parties. Accordingly, in the interests of justice, we reverse only to the extent of providing that one aspect of the dismissal shall be without prejudice, and we remand to the Court of Chancery to provide plaintiffs a reasonable opportunity to file a further amended complaint consistent with this opinion.
The claims before us are that: (a) the board of directors of The Walt Disney Company (“Disney“) as it was constituted in 1995 (the “Old Board“) breached its fiduciary duty in approving an extravagant and wasteful Employment Agreement of Michael S. Ovitz as president of Disney; (b) the Disney board of directors as it was constituted in 1996 (the “New Board“) breached its fiduciary duty in agreeing to a “non-fault” termination of the Ovitz Employment Agreement, a decision that was
The Complaint, consisting of 88 pages and 285 paragraphs, is a pastiche of prolix invective. It is permeated with conclusory allegations of the pleader and quotations from the media, mostly of an editorial nature (even including a cartoon). A pleader may rely on factual statements in the media as some of the “tools аt hand”4 from which the pleader intends to derive the particularized facts necessary to comply with Chancery Rule 11(b)(3) and
This is potentially a very troubling case on the merits. On the one hand, it appears from the Complaint that: (a) the compensation and termination payout for Ovitz were exceedingly lucrative, if not luxurious, compared to Ovitz’ value to the Company; and (b) the processes of the boards of directors in dealing with the approval and termination of the Ovitz Employment Agreement were casual, if not sloppy and perfunctory. On the other hand, the Complaint is so inartfully drafted that it was properly dismissed under our pleading standards for derivative suits. From what we can ferret out of this deficient pleading, the processes of the Old Board and the New Board were hardly paradigms of good corporate governance practices. Moreover, the sheer size of the payout to Ovitz, as alleged, pushes the envelope of judicial respect for the business judgment of directors in making compensation decisions. Therefore, both as to the processes of the two Boards and the waste test, this is a close case.
But our concerns about lavish executive compensation and our institutional aspirations that boards of directоrs of Delaware corporations live up to the highest standards of good corporate practices do not translate into a holding that these plaintiffs have set forth particularized facts excusing a pre-suit demand under our law and our pleading requirements.
This appeal presents several important issues, including: (1) the scope of review that this Court applies to an appeal from the dismissal of a derivative suit; (2) the extent to which the pleading standards required by
Facts
This statement of facts is taken from the Complaint. We have attempted to summarize here the essence of Plaintiffs’ factual allegations on the key issues before us, disregarding the many conclusions that are not supported by factual allegations.
A. The 1995 Ovitz Employment Agreement
By an agreement dated October 1, 1995, Disney hired Ovitz as its president. He was a long-time friend of Disney Chairman and CEO Michael Eisner. At the time, Ovitz was an important talent broker in Hollywood. Although he lacked experience managing a diversified public company, other companies with entertainment operations had been interested in hiring him for high-level executive positions.
Ovitz’ Employment Agreement had an initial term of five years and required that Ovitz “devote his full time and best efforts exclusively to the Company,” with exceptions for volunteer work, service on the board of another company, and managing his passive investments.5 In return, Disney agreed to give Ovitz a base salary of $1 million per year, a discretionary bonus, and two sets of stock options (the “A” options and the “B” options) that collectively would enable Ovitz to purchase 5 million shares of Disney common stock.
The “A” options were scheduled to vest in three annual increments of 1 million shares each, beginning on September 30, 1998 (i.e., at the end of the third full year of employment) and continuing for the following two years (through September 30, 2000). The agreement specifically provided that the “A” options would vest immediately if Disney granted Ovitz a non-fault termination of the Employment Agreement. The “B” options, consisting of 2 million shares, differed in two important respects. Although scheduled to vest annually starting in September 2001 (i.e., the year after the last “A” option would vest), the “B” options were conditioned on Ovitz and Disney first having agreed to extend his employment beyond the five-year term of the Employment Agreement. Furthermore, Ovitz would forfeit the right to qualify for the “B” options if his initial employment term of five years ended prematurely for any reason, even if from a non-fault termination.
The Employment Agreement provided for three ways by which Ovitz’ employment might end. He might serve his five years and Disney might decide against offering him a new contract. If so, Disney would owe Ovitz a $10 million termination payment. Before the end of the initial term, Disney could terminate Ovitz for “good cause” only if Ovitz committed gross negligence or malfeasance, or if Ovitz resigned voluntarily. Disney would owe Ovitz no additional compensation if it terminated him for “good cause.” Termination without cause (non-fault termination) would entitle Ovitz to the present value of his remaining salary payments through September 30, 2000, a $10 million severance payment, an additional $7.5 million for each fiscal year remaining under the agreement, and the immediate vesting of the first 3 million stock options (the “A” Options).6
Plaintiffs allege that the Old Board knew that Disney needed a strong second-in-command. Disney had recently made several acquisitions, and questions lingered about Eisner‘s health due to major heart surgery. The Complaint further alleges that “Eisner had demonstrated little or no capacity to work with important or well-known subordinate executives who wanted to position themselves to succeed him,” citing the departures of Disney executives Jeffrey Katzenberg, Richard Frank, and Stephen Bollenbach as examples. Thus, the Board knew that, to increase the chance for long-term success, it had to take extra care in reviewing a decision to hire Disney‘s new president.
But Eisner‘s decision that Disney should hire Ovitz as its president was not entirely well-received. When Eisner told three members of the Old Board in mid-August 1995 that he had decided to hire Ovitz, all three “denounced the decision.” Although
The Complaint then alleges that the Old Board failed properly to inform itself about the total costs and incentives of the Ovitz Employment Agreement, especially the severance package. This is the key allegation related to this issue on appeal. Specifically, plaintiffs allege that the Board failed to realize that the contract gave Ovitz an incentive to find a way to exit the Company via a non-fault termination as soon as possible because doing so would permit him to earn more than he could by fulfilling his contract. The Complaint alleges, however, that the Old Board had been advised by a corporate compensation expert, Graef Crystal, in connection with its decision to approve the Ovitz Employment Agreement. Two public statements by Crystal form the basis of the allegation that the Old Board failed to consider the incentives and the total cost of the severance provisions, but these statements by Crystal were not made until after Ovitz left Disney in Decеmber 1996, approximately 14 1/2 months after being hired.
The first statement, published in a December 23, 1996 article in the web-based magazine Slate, quoted Crystal as saying, in part, “Of course, the overall costs of the package would go up sharply in the event of Ovitz‘s termination (and I wish now that I‘d made a spreadsheet showing just what the deal would total if Ovitz had been fired at any time).”7 The second published statement appeared in an article about three weeks later in the January 13, 1997 edition of California Law Business. The article appears first to paraphrase Crystal: “With no one expecting failure, the sleeper clauses in Ovitz‘s contract seemed innocuous, Crystal says, explaining that no one added up the total cost of the severance package.” The article then quotes Crystal as saying that the amount of Ovitz’ severance was “shocking” and that “[n]obody quantified this and I wish we had.”8 One of the charging paragraphs of the Complaint concludes:
57. As has been conceded by Graef Crystal, the executive compensation consultant who advised the Old Board with respect to the Ovitz Employment Agreement, the Old Board never considered the costs that would be incurred by Disney in the event Ovitz was terminated from the Company for a reason other than cause prior to the natural expiration of the Ovitz Employment Agreement.
Although repeated in various forms in the Complaint, these quoted admissions by Crystal constitute the extent of the factual support for the allegation that the Old Board failed properly to consider the severance elements of the agreement. This Court, however, must juxtapose these allegations with the legal presumption that the Old Board‘s conduct was a proper exercise of business judgment. That presumption includes the statutory protection for a board that relies in good faith on an expert advising the Board.9 We must decide whether plaintiffs’ factual allegations, if proven, would rebut that presumption.
B. The New Board‘s Actions in Approving the Non-Fault Termination
Soon after Ovitz began work, problems surfaced and the situation continued to deteriorate during the first year of his employment. To support this allegation,
The deteriorating situation, according to the Complaint, led Ovitz to begin seeking alternative employment and to send Eisner a letter in September 1996 that the Complaint paraphrases as stating his dissatisfaction with his role and expressing his desire to leave the Company.10 The Complaint also admits that Ovitz would not actually resign before negotiating a non-fault severance agreement because he did not want to jeopardize his rights to a lucrative severance in the form of a “non-fault termination” under the terms of the 1995 Employment Agreement.
On December 11, 1996, Eisner and Ovitz agreed to arrange for Ovitz to leave Disney on the non-fault basis provided for in the 1995 Employment Agreement. Eisner then “caused” the New Board11 “to rubber-stamp his decision (by ‘mutual consent‘).” This decision was implemented by a December 27, 1996 letter to Ovitz from defendant Sanford M. Litvack, an officer and director of Disney. That letter stated:
This will confirm the terms of your agreement with the Company as follows:
1. The Term of your employment under your existing Employment Agreement with The Walt Disney Company will end at the close of business today. Consequently, your signature confirms the end of your service as an officer, and your resignation as a director, of the Company and its affiliates.
2. This letter will for all purposes of the Employment Agreement be treated as a “Non-Fault Termination.” By our mutual agreement, the total amount payable to you under your Employment Agreement, including the amount payable under Section 11(c) in the event of a “Non-Fault Termination,” is $38,888,230.77, net of withholding required by law or authorized by you. By your signature on this letter, you acknowledge receipt of all but $1,000,000 of such amount. Pursuant to our mutual agreement, this will confirm that payment of the $1,000,000 balance has been deferred until February 5, 1997, pending final settlement of accounts.
3. This letter will further confirm that the option to purchase 3,000,000 shares of the Company‘s Common Stock granted to you pursuant to Option A described in your Employment Agreement will vest as of today and will expire in accordance with its terms on September 30, 2002.
Although the non-fault termination left Ovitz with what essentially was a very lucrative severance agreement, it is important to note that Ovitz and Disney had negotiated for that severance payment at the time they initially contracted in 1995, and in the end the payout to Ovitz did not exceed the 1995 contractual benefits. Consequently, Ovitz received the $10 million termination payment, $7.5 million for part of the fiscal year remaining under the
The Complaint charges the New Board with waste, computing the value of the severance package agreed to by the Board at over $140 million, consisting of cash payments of about $39 million and the value of the immediately vesting “A” options of over $101 million. The Complaint quotes Crystal, the Old Board‘s expert, as saying in January 1997 that Ovitz’ severance package was a “shocking amount of severance.”
The allegation of waste is based on the inference most favorable to plaintiffs that Disney owed Ovitz nothing, either because he had resigned (de facto) or because he was unarguably subject to firing for cause. These allegations must be juxtaposed with the presumption that the New Board exercised its business judgment in deciding how to resolve the potentially litigable issues of whether Ovitz had actually resigned or had dеfinitely breached his contract. We must decide whether plaintiffs’ factual allegations, if proven, would rebut that presumption.
Scope of Review
Certain dicta in our jurisprudence suggest that this Court will review under a deferential abuse of discretion standard a decision of the Court of Chancery on a
Our view is that in determining demand futility the Court of Chancery in the proper exercise of its discretion must decide whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.13
By implication, therefore, these dicta would suggest that our review is deferential, limited to a determination of whether the Court of Chancery abused its discretion. Indeed, all parties to this appeal agree that our review is for abuse of discretion.
The view we express today, however, is designed to make clear that our review of decisions of the Court of Chancery applying
Analyzing a pleading for legal sufficiency is not, for example, the equivalent of the
Therefore, our scope of review must be de novo. To the extent Aronson and its progeny contain dicta expressing or suggesting an abuse of discretion scope of review, that language is overruled. We now proceed to decide de novo whether the Complaint was properly dismissed for failure to set forth particularized facts to support the plaintiffs’ claim that demand is excused.
Pleading Requirements in Derivative Suits
Pleadings in derivative suits are governed by
The demand requirement serves a salutary purpose. First, by requiring exhaustion of intracorporate remedies, the demand requirement invokes a species of alternative dispute resolution procedure which might avoid litigation altogether. Second, if litigation is beneficial, the corporation can control the proceedings. Third, if demand is excusеd or wrongfully refused, the stockholder will normally control the proceedings.
The jurisprudence of Aronson and its progeny is designed to create a balanced environment which will: (1) on the one hand, deter costly, baseless suits by creating a screening mechanism to eliminate claims where there is only a suspicion expressed solely in conclusory terms; and (2) on the other hand, permit suit by a stockholder who is able to articulate particularized facts showing that there is a reasonable doubt either that (a) a majority of the board is independent for purposes of responding to the demand, or (b) the underlying transaction is protected by the business judgment rule.26
In setting up its analysis of the amended complaint, the Court of Chancery in this case stated that the standard by which the Complaint is to be tested is as follows: “Where under any set of facts consistent with the facts alleged in the complaint the plaintiff would not be entitled to judgment, the complaint may be dismissed as legally defective.”27 The Court attempted to paraphrase the Court of Chancery decision in Lewis v. Vogelstein for this formulation. The Vogelstein quote is that “[w]here under any state of facts consistent with the factual allegations of the complaint the plaintiff would be entitled to a judgment, the complaint may not be dismissed as legally defective.”28
Plaintiffs argue that the formulation used by the Court of Chancery was error in that it is the opposite of the Vogelstein formulation. Defendants, on the other hand, argue that the formulations are identical. We need not resolve what is essentially a semantic debate. In our viеw, the formulation by the Court of Chancery here is confusing and unhelpful, but not reversible error, particularly in light of our de novo review. The issue is whether plaintiffs have alleged particularized facts creating a reasonable doubt that the actions of the defendants were protected by the business judgment rule. Plaintiffs are entitled to all reasonable factual inferences that logically flow from the particularized facts alleged, but conclusory allegations are not considered as expressly pleaded facts or factual inferences.
Principles of Corporation Law Compared with Good Corporate Governance Practices
This is a case about whether there should be personal liability of the directors of a Delaware corporation to the corporation for lack of due care in the decision-making process and for waste of corporate assets. This case is not about the failure
All good corporate governance practices include compliance with statutory law and case law establishing fiduciary duties. But the law of corporate fiduciary duties and remedies for violation of those duties are distinct from the aspirational goals of ideal corporate governance practices. Aspirational ideals of good corporate governance practices for boards of directors that go beyond the minimal legal requirements of the corporation law are highly desirable, often tend to benefit stockholders, sometimes reduce litigation and can usually help directors avoid liability. But they are not required by the corporation law and do not define standards of liability.29
The inquiry here is not whether we would disdain the composition, behavior and decisions of Disney‘s Old Board or New Board as alleged in the Complaint if we were Disney stockholders. In the absence of a legislative mandate,30 that determination is not for the courts. That decision is for the stockholders to make in voting for directors, urging other stockholders to reform or oust the board, or in making individual buy-sell decisions involving Disney securities. The sole issue that this Court must determine is whether the particularized facts alleged in this Complaint provide a reason to believe that the conduct of the Old Board in 1995 and the New Board in 1996 constituted a violation of their fiduciary duties.
Independence of the Disney Board
The test of demand futility is a two-fold test under Aronson and its progeny. The first prong of the futility rubric is “whether, under the particularized facts alleged, a reasonable doubt is created that . . . the directors are disinterested and independent.”31 The second prong is whether the pleading creates a reasonable doubt that “the challenged transaction was otherwise the product of a valid exercise of business judgment.”32 These prongs are in the disjunctive. Therefore, if either prong is satisfied, demand is excused.33
The facts supporting plaintiffs’ claim that the New Board was not disinterested or independent turn on plaintiffs’ central allegation that a majority of the Board was beholden to Eisner. It is not alleged that they were beholden to Ovitz. Plaintiffs’ theory is that Eisner was advancing Ovitz’ interests primarily because a lavish contract for Ovitz would redound to Eisner‘s benefit since Eisner would thereby gain in his quest to have his own compensation increased lavishly. This theory appears to be in the nature of the old maxim that a “high tide floats all boats.” But, in the end, this theory is not supported by well-pleaded facts, only conclusory allegations. Moreover, the Court of Chancery found that these allegations were illogical and counterintuitive:
Plaintiffs’ allegation that Eisner was interested in maximizing his compensation at the expense of Disney and its shareholders cannot reasonably be inferred from the facts alleged in Plaintiffs’ amended complaint. At all times material to this litigation, Eisner owned several million options to purchase Disney stock. Therefore, it would not be in Eisner‘s economic interest to cause the Company to issue millions of additional options unnecessarily and at considerable cost. Such a gesture would not, as Plaintiffs suggest, “maximize” Eisner‘s own compensation package. Rather, it would dilute the value of Eisner‘s own very substantial holdings. Even if the impact on Eisner‘s option value were relatively small, such a large compensation package would, and did, draw largely negative attention to Eisner‘s own performance and compensation. Accordingly, no reasonable doubt can exist as to Eisner‘s disinterest in the approval of the Employment Agreement, as a matter of law. Similarly, the Plaintiffs have not demonstrated a reasonable doubt that Eisner was disinterested in granting Ovitz a Non-Fault Termination, thus allowing Ovitz to receive substantial severance benefits under the terms of the Employment Agreement. Nothing alleged by Plaintiffs generates a reasonable inference that Eisner would benefit personally from allowing
Ovitz to leave Disney without good cause.37
The Court of Chancery held that “no reasonable doubt can exist as to Eisner‘s disinterest in the approval of the Employment Agreement, as a matter of law,” and similarly that plaintiffs “have not demonstrated a reasonable doubt that Eisner was disinterested in granting Ovitz a Non-Fault Termination.”38 Plaintiffs challenge this conclusion, but we agree with the Court of Chancery and we affirm that holding.
The Complaint then proceeds to detail the various associations that each member of the New Board had with Eisner. In an alternative holding, the Court of Chancery proceeded meticulously to analyze each director‘s ties to Eisner to see if they could have exercised business judgment independent of Eisner.39 Because we hold that the Complaint fails to create a reasonable doubt that Eisner was disinterested in the Ovitz Employment Agreement, we need not reach or comment on the analysis of the Court of Chancery on the independence of the other directors for this purpose.40
In this case, therefore, that part of plaintiffs’ Complaint raising the first prong of Aronson, even though not pressed by plaintiffs in this Court,41 has been dismissed with prejudice. Our affirmance of that dismissal is final and dispositive of the first prong of Aronson.42 We now turn to the primary issues in this case that implicate the second prong of Aronson: whether the Complaint sets forth particularized facts creating a reasonable doubt that the decisions of the Old Board and the New Board were protected by the business judgment rule.
Analytical Framework for the Informational Component of Directorial Decisionmaking
Plaintiffs claim that the Court of Chancery erred when it concluded that a board of directors is “not required to be informed of every fact, but rather is required to be rеasonably informed.”43 Applying that conclusion, the Court of Chancery held that the Complaint did not create a reasonable doubt that the Old Board had satisfied the requisite informational component when it approved the Ovitz contract in 1995.44 In effect, Plaintiffs argue that being “reasonably informed” is too lax a standard to satisfy Delaware‘s legal test for the informational component of board decisions. They contend that the Disney directors on the Old Board did not avail themselves of all material information reasonably available in approving Ovitz’ 1995
The “reasonably informed” language used by the Court of Chancery here may have been a short-hand attempt to paraphrase the Delaware jurisprudence that, in making business decisions, directors must consider all material information reasonably available, and that the directors’ process is actionable only if grossly negligent.46 The question is whether the trial court‘s formulation is consistent with our objective test of reasonableness, the test of materiality and concepts of gross negligence. We agree with the Court of Chancery that the standard for judging the informational component of the directors’ decisionmaking does not mean that the Board must be informed of every fact. The Board is responsible for considering only material facts that are reasonably available, not those that are immaterial or out of the Board‘s reasonable reach.47
We conclude that the formulation of the due care test by the Court of Chancery in this case, while not necessarily inconsistent with our traditional formulation, was too cryptically stated to be a helpful precedent for future cases. Pre-suit demand will be excused in a derivative suit only if the Court of Chancery in the first instance, and this Court in its de novo review, conclude that the particularized facts in the complaint create a reasonable doubt that the informational component of the directors’ decisionmaking process, measured by concepts of gross negligence, included consideration of all material information reasonably available.48 Thus, we now apply this analytical framework to the particularized facts pleaded, juxtaposed with the presumption of regularity of the Board‘s process.
Plaintiffs’ Contention that the Old Board Violated the Process Duty of Care in Approving the Ovitz Employment Agreement
Certainly in this case the economic exposure of the corporation to the payout scenarios of the Ovitz contract was material, particularly given its large size, for purposes of the directors’ decisionmaking process.49 And those dollar exposure
The Court of Chancery interpreted the Complaint to allege that only Crystal (the Board‘s expert)—and not the Board itself—failed to bring to bear all the necessary information because he (Crystal) did not quantify for the Board the maximum payout to Ovitz under the non-fault termination scenario. Alternatively, the Court of Chancery reasoned that even if the Old Board failed to make the calculation, that fact does not raise a reasonable doubt of due care because Crystal did not consider it critical to ascertain the potential costs of Ovitz’ severance package. The Court‘s language is as follows:
With regard to the alleged breach of the duty of care, Plaintiffs claim that the directors were not properly informed before they adopted the Employment Agreement because they did not know the value of the compensation package offered to Ovitz. To that end, Plaintiffs offer several statements made by Graef Crystal, the financial expert who advised the Board on the Employment Agreement, including his admission that “[n]o-body quantified the total cost of the severance package and I wish we had.”
The fact that Crystal did not quantify the potential severance benefits to Ovitz for terminating early without cause (under the terms of the Employment Agreement) does not create a reasonable inference that the Board failed to consider the potential cost to Disney in the event that they decided to terminate Ovitz without cause. But, even if the Board did fail to calculate thе potential cost to Disney, I nevertheless think that this allegation fails to create a reasonable doubt that the former Board exercised due care. Disney‘s expert did not consider an inquiry into the potential cost of Ovitz‘s severance benefits to be critical or relevant to the Board‘s consideration of the Employment Agreement. Merely because Crystal now regrets not having calculated the package is not reason enough to overturn the judgment of the Board then. It is the essence of the business judgment rule that a court will not apply 20/20 hindsight to second guess a board‘s decision, except “in rare cases [where] a transaction may be so egregious on its face that the board approval cannot meet the test of business judgment.” Because the Board‘s reliance on Crystal and his decision not to fully calculate the amount of severance lack “egregiousness,” this is not that rare case. I think it a correct statement of law that the duty of care is still fulfilled even if a Board does not know the exact amount of a severance payout but nonetheless is fully informed about the manner in which such a payout would be calculated. A board is not required to be informed of every fact, but rather is required to be reasonably informed. Here the Plaintiffs have failed to plead facts giving rise to a reasonable doubt that the Board, as a matter of law, was reasonably informed on this issue.50
We believe, however, that the Complaint, fairly read, chаrges that Crystal admitted that “nobody“—not Crystal and not the directors—made that calculation, although all the necessary information presumably was at hand to do so. Thus the reading given by the Court of Chancery to
We regard the Court‘s language as harmless error, however, for the following reason. The Complaint, fairly construed, admits that the directors were advised by Crystal as an expert and that they relied on his expertise. Accordingly, the question here is whether the directors are to be “fully protected” (i.e., not held liable) on the basis that they relied in good faith on a qualified expert under
Although the Court of Chancery did not expressly predicate its decision on
To survive a
Plaintiffs also contend that Crystal‘s latter-day admission is “valid and binding” on the Old Board. This argument is without merit. Crystal was the Board‘s expert ex ante for purposes of advising the directors on the Ovitz Employment Agreement. He was not their agent ex post to make binding admissions.
We conclude that, although the language of the Court of Chancery was flawed in formulating the proper legal test to be used and in its reading of the Complaint, that pleading, as drafted, fails to create a reasonable doubt that the Old Board‘s decision in approving the Ovitz Employment Agreement was protected by the business judgment rule. Plaintiffs will be provided an opportunity to replead on this issue.
Plaintiffs’ Contention that the Old Board Violated “Substantive Due Care” Requirements and Committed Waste Ab Initio with Ovitz’ Employment Agreement
Plaintiffs allege not only that the Old Board committed a procedural due care violation in the process of approving the Ovitz 1995 Employment Agreement but also that the Board committed a “substantive due care” violation constituting waste. They contend that the Court of Chancery erred in holding that the Complaint failed to set forth particularized facts creating a reasonablе doubt that the directors’ decision to enter into the Ovitz Employment Agreement was a product of the proper exercise of business judgment.
Plaintiffs’ principal theory is that the 1995 Ovitz Employment Agreement
Specifically, the Court of Chancery inferred from a reading of the Complaint that the Board determined it had to offer an expensive compensation package to attract Ovitz and that they determined he would be valuable to the Company. The Court also concluded that the vesting schedule of the options actually was a disincentive for Ovitz to leave Disney.60 When he did leave pursuant to the non-fault termination, the Court noted that he left 2 million options (the “B” options) “on the table.”61 Although we agree with the conclusion of the Court of Chancery that this particular Complaint is deficient, we do not foreclose the possibility that a properly framed complaint could pass muster.
Plaintiffs’ disagreement on appeal with the decision of the Court of Chancery is basically a quarrel with the Old Board‘s judgment in evaluating Ovitz’ worth vis à vis the lavish payout to him. We agree with the analysis of the Court of Chancery that the size and structure of executive compensation are inherently matters of judgment.62 As former Chancellor Allen stated in Vogelstein:
The judicial standard for determination of corporate waste is well developed. Roughly, a waste entails an exchange of corporate assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade. Most often the claim is associated with a transfer of corporate assets that serves no corporate purpose; or for which no consideration at all is received. Such a transfer is in effect a gift. If, however, there is any substantial consideration received by the corporation, and if there is a good faith judgment that in the circumstances the transaction is worthwhile, there should be no finding of waste, even if the fact finder would conclude ex post that the transaction was unreasonably risky. Any other rule would deter corporate boards from the optimal rational acceptance of risk, for reasons explained elsewhere. Courts are ill-fitted to attempt to weigh the “adequacy” of consideration under the waste standard or, ex post, to judge appropriate degrees of business risk.63
To be sure, there are outer limits, but they are confined to unconscionable cases where directors irrationally squander or give away corporate assets. Here, however, we
As for the plaintiffs’ contention that the directors failed to exercise “substantive due care,” we should note that such a concept is foreign to the business judgment rule. Courts do not measure, weigh or quantify directors’ judgments. We do not even decide if they are reasonable in this context.64 Due care in the decisionmaking context is process due care only. Irrationality65 is the outer limit of the business judgment rule. Irrationality may be the functional equivalent of the waste test or it may tend to show that the decision is not made in good faith, which is a key ingredient of the business judgment rule.66
Plaintiffs’ Contention that the New Board Committed Waste in Its Decision That Ovitz’ Contract Should be Terminated on a “Non-Fault” Basis
The plaintiffs contend in this Court that Ovitz resigned or committed acts of gross negligence or malfeasance that constituted grounds to terminate him for cause. In either event, they argue that the Company had no obligation to Ovitz and that the directors wasted the Company‘s assets by causing it to make an unnecessary and enormous payout of cash and stock options when it permitted Ovitz to terminate his employment on a “non-fault” basis. We have concluded, however, that the Complaint currently before us does not set forth particularized facts that he resigned or unarguably breached his Employment Agreement.
The Complaint does not allege facts that would show that Ovitz hаd, in fact, resigned before the Board acted on his non-fault termination. Plaintiffs contend, in effect, that the sum total of Ovitz’ actions constituted a de facto resignation. But the Complaint does not allege that Ovitz had actually resigned. It alleges merely that he: (a) was dissatisfied with his role; (b) was underperforming; (c) was seeking and entertaining other job offers; and (d) had written to Eisner on September 5, 1996, “express[ing] his desire to quit.” These are not particularized allegations that he resigned, either actually or constructively.
Additionally, the Complaint is internally inconsistent with plaintiffs’ argument that Ovitz had resigned. The Complaint alleges that Ovitz would not actually resign before he could achieve a lucrative payout under the generous terms of his 1995 Employment Agreement. The clear inference from the Complaint is that he would lose all leverage by resigning. For example, the Complaint paraphrases Robert Slater‘s recent biography of Ovitz as stating that “the only reason Ovitz did not simply state outright that he quit his position at Disney was his realization that doing so would deprive him of all severance benefits” of his Employment Agreement. The Court of Chancery correctly concluded:
As for Plaintiffs’ contention that Ovitz actually or impliedly tendered his resignation before the Board approved the Non-Fault Termination, I do not believe
this conclusion can reasonably be drawn from the facts alleged by Plaintiffs. While I would agree that Ovitz‘s September 5 letter to Eisner and his search for another job provide strong evidence of Ovitz‘s lack of commitment to the Company, they are not legally tantamount to a voluntary resignation.67
The Complaint alleges that it was waste for the Board to pay Ovitz essentially the full amount he was due on the non-fault termination basis because he should have been fired for cause. Ovitz’ contract provided that he could be fired for cause only if he was grossly negligent or committed acts of malfeasance. Plaintiffs contend that ample grounds existed to fire Ovitz for cause under these terms. The Court of Chancery correctly concluded:
The terms of the Employment Agreement limit “good cause” for terminating Ovitz‘s employment to gross negligence or malfeasance, or a voluntary resignation without the consent of the Company. I have reviewed the amended complaint and listened to the parties’ arguments at the hearing in connection with Defendants’ motion to dismiss. Still, I am unable to conclude that any of the facts alleged by Plaintiffs, even accepted as true, demonstrate that Ovitz‘s conduct was either grossly negligent or malfeasant during his tenure at Disney, or that Ovitz resigned voluntarily. For example, Plaintiffs allege that Ovitz sought alternative employment while he was the president of Disney. But Plaintiffs fail to explain how looking for another job constitutes gross negligence or malfeasance. The same holds true for Plaintiffs’ allegation that Ovitz failed to follow Eisner‘s directive to meet with Director Defendant Stephen F. Bollenbach, who was then the senior executive vice president and chief finanсial officer of Disney. This allegation may demonstrate that Ovitz failed to become familiar with Disney‘s finances or that he bucked authority at Disney. However, it does not demonstrate, without more, that Ovitz was grossly negligent or committed malfeasance. None of Plaintiffs’ allegations rise to the level of gross negligence or malfeasance.68
Construed most favorably to plaintiffs, the facts in the Complaint (disregarding conclusory allegations) show that Ovitz’ performance as president was disappointing at best, that Eisner admitted it had been a mistake to hire him, that Ovitz lacked commitment to the Company, that he performed services for his old company, and that he negotiated for other jobs (some very lucrative) while being required under the contract to devote his full time and energy to Disney.
All this shows is that the Board had arguable grounds to fire Ovitz for cause. But what is alleged is only an argument—perhaps a good one—that Ovitz’ conduct constituted gross negligence or malfeasance. First, given the facts as alleged, Disney would have had to persuade a trier of fact and law of this argument in any litigated dispute with Ovitz. Second, that process of persuasion could involve expensive litigation, distraction of executive time and company resources, lost opportunity costs, more bad publicity and an outcome that was uncertain at best and, at worst, could have resulted in damages against the Company.
The Complaint, in sum, contends that the Board committed waste by agreeing to the very lucrative payout to Ovitz under the non-fault termination provision because it had no obligation to him, thus taking the Board‘s decision outside the protection of the business judgment rule. Construed most favorably to plaintiffs, the Complaint contends that, by reason of the New Board‘s available arguments of resignation and good cause, it had the leverage
We agree with the conclusion of the Court of Chancery:
The Board made a business decision to grant Ovitz a Non-Fault Termination. Plaintiffs may disagree with the Board‘s judgment as to how this matter should have been handled. But where, as here, there is no reasonable doubt as to the disinterest of or absence of fraud by the Board, mere disagreement cannot serve as grounds for imposing liability based on alleged breaches of fiduciary duty and waste. There is no allegation that the Board did not consider the pertinent issues surrounding Ovitz‘s termination. Plaintiffs’ sole argument appears to be that they do not agree with the course of action taken by the Board regarding Ovitz‘s separation from Disney. This will not suffice to create a reasonable doubt that the Board‘s decision to grant Ovitz a Non-Fault Termination was the product of an exercise of business judgment. As dеmand is not excused as to Plaintiffs’ claims in connection with the current Board‘s decision to grant Ovitz‘s Non-Fault Termination, these claims must be dismissed.69
To rule otherwise would invite courts to become super-directors, measuring matters of degree in business decisionmaking and executive compensation. Such a rule would run counter to the foundation of our jurisprudence.
Nevertheless, plaintiffs will have another opportunity—if they are able to do so consistent with
No Discovery Permitted; Books and Records May be Available
Plaintiffs complain, in effect, that the system of requiring a stockholder to plead particularized facts in a derivative suit is basically unfair because the Court will not permit discovery under Chancery Rules 26-37 to marshal the facts necessary to establish that pre-suit demand is excused.72 This is a common complaint, one that is echoed in the amicus brief of the Council of Institutional Investors on this appeal. But this argument has been answered by this Court on several occasions.
Plaintiffs may well have the “tools at hand” to develop the necessary facts for pleading purposes.73 For example, plaintiffs may seek relevant books and records of the corporation under
Conclusion
One can understand why Disney stockholders would be upset with such an extraordinarily lucrative compensation agreement and termination payout awarded a company president who served for only a little over a year and who underperformed to the extent alleged. That said, there is a very large—though not insurmountable—burden on stockholders who believe they should pursue the remedy of a derivative suit instead of selling their stock or seeking to reform or oust these directors from office.
Delaware has pleading rules and an extensive judicial gloss on those rules that must be met in order for a stockholder to pursue the derivative remedy. Sound policy supports these rules, as we have noted. This Complaint, which is a blunderbuss of a mostly conclusory pleading, does not meet that burden, and it was properly dismissed.
The order of the Court of Chancery dismissing the Complaint was set forth in three paragraphs.76 Each paragraph stated that certain counts were dismissed. That dismissal operates as an adjudication on the merits.77 That is, the dismissal is with prejudice as to all counts. To the extent that plaintiffs havе appealed the order of the Court of Chancery, we affirm that dismissal in all respects, except that paragraph 1 of the order is affirmed in part, reversed in part and remanded.
The portion of paragraph 1 that dismissed “plaintiffs’ claims for breach of fiduciary duty and waste, as set forth in Counts I and II of the amended complaint . . . for failure to make a demand under
HARTNETT, Justice, concurring:
I agree that the complaint leaves much to be desired and that plaintiffs be given an opportunity to file an amended complaint. In my view, however, the present complaint is adequate as to some of the asserted claims, if only barely so.
Chancery Rules 23.1 and 12(b)(6) are predicated on the Federal Rules of Civil Procedure. The federal precedents therefore carry great weight.79
I agree that the complaint does not create a reasonable doubt as to the disinterestedness or independence of the Board. In my opinion, however, from the totality of the factual allegations in the complaint, a reasonable doubt that the business judgment rule precludes judicial inquiry already exists as to some of the other claims, such as whether the directors were aware of the total cost of Ovitz’ compensation package when they approved it or whether Ovitz had actually resigned before he struck his termination deal.
Plaintiffs must not be held to a too-high standard of pleading because they face an almost impossible burden when they must plead facts with particularity and the facts are not public knowledge. Brushing aside technicalities, the issue here is whether this suit shоuld have been dismissed by the Court of Chancery at this stage of the litigation without any discovery or whether the allegations in the complaint were sufficient to justify at least some discovery. In my opinion, the complaint already sufficiently alleges facts to warrant some limited discovery as to some of the claims.
E. NORMAN VEASEY
CHIEF JUSTICE
Notes
A member of the board of directors, or a member of any committee designated by the board of directors, shall, in the performance of such member‘s duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of the corporation‘s officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person‘s professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation.
Id.It is the essence of the business judgment rule that a court will not apply 20/20 hindsight to seсond guess a board‘s decision, except “in rare cases [where] a transaction may be so egregious on its face that the board approval cannot meet the test of business judgment.” Because the Board‘s reliance on Crystal and his decision not to fully calculate the amount of severance lack “egregiousness,” this is not that rare case. I think it a correct statement of law that the duty of care is still fulfilled even if a Board does not know the exact amount of a severance payout but nonetheless is fully informed about the manner in which such a payout would be calculated. A board is not required to be informed of every fact, but rather is required to be reasonably informed.