Galactic Stupidity and the Business Judgment Rule - College of Law

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320 The Journal of Corporation Law [Winter VI. DISNEY V IGNORED THE SUBSTANTIVE DUE PROCESS ISSUE In their appeal to the Delaware Supreme Court, the Disney plaintiffs argued that the chancery court was wrong in holding that the directors did not violate either their duty of care or their duty of good faith. In its discussion of both of these issues, the supreme court avoided any serious discussion of the chancery court’s focus on the substantive wisdom of the actions of Poitier and Lozano although it appears that the appellants had explicitly raised the issue. The procedural evidence regarding the approval of Ovitz’s compensation package was sufficient to allow the supreme court to dispose of the duty of care issue. The court reviewed the findings of the chancery court and held that the evidence supported the conclusion that the compensation committee (including Poitier and Lozano) was sufficiently informed about the terms that it was approving. 101 The supreme court made this review with an eye only to the issue of the duty of care—not the duty of good faith. Like the lower court, the supreme court acknowledged that the directors’ conduct fell short of the standard of “best practices” in corporate governance, 102 but nonetheless found that the record plainly supports the conclusion that the compensation committee directors were adequately informed and therefore did not commit gross negligence in approving Ovitz’s compensation package. The appellants also claimed that the chancery court erred in its definition of bad faith and in the way that it applied that standard to the facts at hand. Here, they appear to have raised the issue of the chancery court’s substantive review of some of the directors’ actions. In its ruling, the court notes that the plaintiffs argued, among other things, that the chancery court erred because it “wrongly incorporated substantive elements regarding the rationality of the decisions under review rather than being constrained, as in a due care analysis, to strictly procedural criteria.” 103 Yet the supreme court does not find it necessary to directly address whether the chancery court erred by incorporating such substantive elements into its determination on the good faith issue. The court explains that the failures by the directors on the compensation committee were plainly not “subjective bad faith,” because the record does not suggest that the directors acted with the “actual intent to do harm.” 104 The court also notes that it has already established that the evidence does not even support the conclusion that the defendants acted with gross negligence. 105 There can, however, be something in between. The court correctly recognizes that some actionable bad faith director action could fall between “subjective bad faith” and gross negligence. Using the Court of Chancery’s definition, the supreme court describes this kind of bad faith as “an intentional dereliction of duty, a conscious disregard for one’s responsibilities.” 106 Such level is to examine its substantive wisdom. 101. In re The Walt Disney Co. Derivative Litig. (Disney V), No. 411, 2005, 2006 WL 1562466, at *28. 102. Id. at *18. 103. Id. at *24. 104. Id. at *25. 105. Here, the court takes considerable care to state unequivocally that gross negligence alone cannot constitute bad faith. Id. at *27. As the court explains, section 102(b)(7) would not otherwise make sense because the clear intention of that law was to allow corporations to free directors from liability for gross negligence, but not conduct taken in bad faith. Disney V, 2006 WL 1562466, at *25. 106. Id. at *24.
2007] Galactic Stupidity 321 conduct, the court says, “does not involve disloyalty (as traditionally defined) but is qualitatively more culpable than gross negligence.” 107 Affirming the lower court’s definition of bad faith as consistent with Delaware judicial precedent and with its use in section 102(b)(7), the supreme court sees no need to revisit Chandler’s application of that doctrine to the actions of the Disney directors or to inquire whether Chandler’s review of the substance of some of their decisions was appropriate. A supreme court decision on substantive review of director action will wait for another day. VII. APPLYING THE “GALACTIC STUPIDITY” STANDARD The distinction between a rational director (the accepted standard) and a reasonable director (the standard occasionally applied) is perhaps meaningless. While demonstrating rationality (for example by showing that the director considered the information available in making his decision) is enough to warrant the protection of the business judgment rule, rationality is not the only way for a director to avoid liability. In the absence of such evidence, Delaware courts may well consider the reasonableness of the decision to establish the good faith of the director, even though the evidence does not suggest that the director acted rationally in arriving at that decision. Absent evidence of rational deliberation, a court may then examine the substantive reasonableness of a director’s decision in order to infer the director’s good faith. But this inquiry does not really have to do with the motives or good faith of the director. Rather, it is plainly an inquiry into the substantive reasonableness of the decision. Directors, therefore, get two swings of the bat: they show good faith if they have demonstrated that they made their decision rationally; and they can show good faith if their decision was reasonable, even if they did not arrive at that decision in a rational manner. 108 Even the most ardent opponent of substantive review agrees that, in extreme cases, courts might have to engage in such analysis. While insisting that bad faith almost always arises from self-interest, Stephen Bainbridge nonetheless agrees that sometimes substantive analysis will be necessary; although in keeping with his “abstention doctrine,” he would like to set the bar very high indeed. 109 The set of such cases in which 107. Id. at *26. Here the court’s use of the word “qualitatively” is perhaps hinting at the possibility of substantive review of the directors’ conduct. How can we judge the quality of a decision without taking a look at its substance? But the court does not take its own bait and resists such an evaluation of the directors’ decisions. Its discussion focuses on examples where the intentions of the directors were suspect. Id. 108. This also seems to fit nicely with Robert B. Thompson and D. Gordon Smith’s paraphrase of Justice Vesey’s opinion in Brehm: “courts will sometimes use substance (‘irrationality’) as a proxy for determining good faith.” Robert B. Thompson & D. Gordon Smith, Toward a New Theory of the Shareholder Role: “Sacred Space” in Corporate Takeovers, 80 TEX. L. REV. 261, 278 n.89 (2001). The section of Sean Griffith’s article that was quoted at length in the Disney IV opinion also hints at this, although Chancellor Chandler did not emphasize the language Griffith uses: “Would an ordinarily prudent person lease a corporate asset to a third party on exceedingly generous terms? Would an ordinarily prudent person lavish compensation on a third party and permit the third party to usurp investment opportunities? These are duty-of-loyalty concerns framed as duty-of-care questions.” Griffith, supra note 37, at 42-43, quoted in Disney IV, 2005 WL 1875804 at *31 n.402. According to Griffith, some decisions are so imprudent that they must implicate the duty of loyalty and therefore the duty of good faith. In Disney IV, Chandler examined the conduct of the most imprudent Disney directors in this way without insisting that a finding of bad faith would necessarily constitute a finding of disloyalty. 109. BAINBRIDGE, supra note 55 at 275. In his discussion, Bainbridge himself finds three well known
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