Citing "the interests of justice," the Supreme Court of Delaware recently reversed the decision of the Delaware Chancery Court to dismiss with prejudice the breach of fiduciary duty and waste claims that were part of a stockholder derivative complaint filed on behalf of The Walt Disney Company ("Disney") because of an allegedly "extravagant and wasteful" executive compensation agreement entered into between Disney and Michael S. Ovitz. The decision thus permits Disney shareholders to replead their complaint to challenge application of the business judgment rule to the Disney Boards' decisions regarding Ovitz' compensation.
By an agreement dated October 1, 1995, Disney hired Ovitz to serve as the company's president for an initial term of five years. As the court noted, Ovitz's contract was "exceedingly lucrative, if not luxurious." Specifically, termination by Disney without cause required the company to pay Ovitz a $10 million severance payment, plus the present value of his remaining salary payments through September 30, 2000, and an additional $7.5 million for each fiscal year remaining under the deal, while providing for the immediate vesting of 3 million stock options. Under the terms of the agreement, Disney could have terminated Ovitz for "good cause" (i.e. gross negligence or malfeasance), or accepted his voluntary resignation without having to pay him any additional compensation.
Problems surfaced soon after Ovitz began work and the situation continued to deteriorate, ultimately leading Ovitz to seek alternative employment, purportedly in violation of his employment agreement. Ovitz also sent a letter to Disney's Chairman, Michael Eisner, in which Ovitz expressed his desire to leave the company, but not before negotiating a "non-fault" severance agreement that would enable him to obtain the rights provided for in the 1995 Employment Agreement. By letter dated December 27, 1996, Disney's Board confirmed that Ovitz's employment with Disney was terminated without fault, thereby entitling Ovitz to the "very lucrative" severance package contained in the "non-fault termination" provision of the 1995 Employment Agreement.
Disney's shareholders then brought a derivative suit alleging, inter alia, that the Disney board of directors as it was constituted in 1995 had breached its fiduciary duty of care by approving Ovitz's "extravagant and wasteful" Employment Agreement without calculating the potential cost to Disney of terminating Ovitz without cause, and that the Disney board as it was comprised in 1996 breached its fiduciary duty of care and committed waste by agreeing to a "non-fault" termination of Ovitz's employment. Disney then moved to dismiss the complaint under Chancery Rule 23.1, asserting that plaintiffs' failure to make pre-suit demand was not excused because they failed to plead particularized facts that created a reasonable doubt either that (i) the directors were disinterested and independent or (ii) the challenged transactions were the product of a valid exercise of business judgment. The Delaware Chancery Court dismissed the entire complaint with prejudice, holding that the plaintiffs had failed to sustain their demand futility pleading burden.
On appeal, the Delaware Supreme Court made clear that its review of decisions of the Chancery Court applying Rule 23.1 is "de novo and plenary." It "is not a deferential review that requires us to find an abuse of discretion," the court explained. Thus, the court stated that the issue before it on de novo review was whether the plaintiffs had alleged particularized facts creating a reasonable doubt that the actions of the defendants were protected by the business judgment rule. Characterizing the plaintiffs' 88 page, 285 paragraph complaint as a "pastiche of prolix invective" "larded with conclusory language" and permeated with editorial comments from the media, the court affirmed the Chancery Court's dismissal of the complaint for failure to comply with the fundamental mandate of particularized factual pleading.
The court, however, disagreed that the complaint should have been dismissed with prejudice. "This is potentially a very troubling case on the merits," the court stated. Specifically, the court noted that the "casual, if not sloppy and perfunctory" processes of Disney's boards in approving the compensation package and agreeing to the non-fault termination were "hardly paradigms of good corporate governance practices." These concerns, together with "the sheer size of the payout to Ovitz," which the court stated "pushes the envelope of judicial respect for the business judgment of directors in making compensation decisions," ultimately led the court to conclude that "the interests of justice" require that dismissal be without prejudice, thereby allowing plaintiffs to replead their claims by filing an amended complaint. *
Brehm v. Eisner, No. 469, 1998, 2000 WL 174619 (Del. Feb. 9, 2000).