Master Delaware Supreme Court clarifies the standard for corporate director bad faith in the context of executive compensation and a costly severance package. with this comprehensive case brief.
In re Walt Disney Co. Derivative Litigation is a leading Delaware case on the boundaries of directors’ fiduciary duties—especially the meaning of bad faith—in the sensitive context of executive hiring and termination. Sparked by the hiring and rapid departure of Michael Ovitz as Disney’s President, the litigation questioned whether directors who engage in a suboptimal process for approving a lucrative employment agreement and later pay a large severance can be held personally liable for breach of duty, bad faith, or corporate waste.
The Delaware Supreme Court (affirming the Court of Chancery after a lengthy trial) used Disney to sharpen the line between grossly negligent process and bad faith. The court held that while Disney’s process was far from a model of best practices, it did not amount to bad faith or waste. The decision is central to modern corporate law because it both elevates the importance of process and simultaneously sets a high bar for imposing monetary liability on directors, especially when a corporation has a Delaware General Corporation Law § 102(b)(7) exculpation clause.
906 A.2d 27 (Del. 2006), aff’g 907 A.2d 693 (Del. Ch. 2005)
In 1995, Disney CEO Michael Eisner recruited Michael Ovitz, a prominent entertainment executive and longtime personal associate, to serve as Disney’s President. To attract Ovitz, Disney agreed to an employment contract with extremely generous compensation and a substantial non-fault termination (NFT) severance package that could exceed $100 million depending on salary, bonus, and accelerated vesting of stock options. The Compensation Committee and full board were informed and involved in varying degrees, but plaintiffs alleged the process was cursory: the Compensation Committee met briefly, some directors did not receive full documentation in advance, and Eisner largely controlled the process. After approximately fourteen months of a strained working relationship and poor fit, Disney terminated Ovitz without cause in late 1996, triggering an NFT severance estimated at roughly $130 million. Shareholders brought a derivative action alleging breaches of the fiduciary duties of care, loyalty, and good faith by Eisner and the board, along with a claim of corporate waste, arguing that the decision to approve the contract and to effect a non-fault termination—rather than terminate for cause or negotiate harder—was so egregious as to be disloyal or in bad faith.
Did Disney’s directors act in bad faith or commit waste in approving Michael Ovitz’s employment contract and later authorizing a non-fault termination that yielded a very large severance payment, thereby breaching their fiduciary duties and incurring personal liability despite a § 102(b)(7) exculpation clause?
Under Delaware law, directors owe fiduciary duties of care and loyalty, and the obligation to act in good faith operates as a subsidiary element of the duty of loyalty. Bad faith involves either (1) conduct motivated by an actual intent to do harm (subjective bad faith), or (2) an intentional dereliction of duty, a conscious disregard for one’s responsibilities—i.e., knowingly failing to act in the face of a known duty to act. Gross negligence alone (a due care violation) does not constitute bad faith. Where a corporation has a DGCL § 102(b)(7) charter provision, monetary liability for duty of care breaches is exculpated; only non-exculpated claims—loyalty, bad faith, or improper personal benefit—remain. Directors may rely in good faith on officers, employees, and experts under DGCL § 141(e). A claim of waste requires a showing that the consideration received was so inadequate that no person of ordinary, sound business judgment could conclude the corporation received adequate value.
The Delaware Supreme Court affirmed judgment for the defendants: the Disney directors did not act in bad faith, did not breach their fiduciary duties, and did not commit waste in connection with the approval of the Ovitz employment agreement or the subsequent non-fault termination. At most, any shortcomings implicated due care, which was exculpated by Disney’s § 102(b)(7) charter provision.
The Court acknowledged that Disney’s process was imperfect and, in places, fell short of best practices. Nonetheless, the record did not support a conclusion that the directors acted with disloyal intent or consciously disregarded known duties. The Compensation Committee had been advised by counsel and a compensation expert, met and discussed key terms, and the board was apprised of the material features of the arrangement. Even if the process could be characterized as rushed or less thorough than ideal, such deficiencies amount at most to gross negligence—a care issue exculpated by § 102(b)(7)—not the intentional dereliction or subjective malevolence required for bad faith. Regarding the termination decision, the Court found no credible basis to conclude that Ovitz could be fired for cause under the contract. Electing a non-fault termination to avoid risky, uncertain, and potentially costly litigation over a for-cause termination did not reflect bad faith. Instead, it was a business judgment grounded in legal advice and a rational assessment of contractual risk. Because the severance was paid pursuant to a pre-existing bargained-for contractual obligation, the payment could not constitute waste: the relevant inquiry is whether the original agreement and termination decision were so one-sided that no reasonable businessperson would consider them value-enhancing. The Court concluded that the Ovitz package, while costly in hindsight, was not facially irrational ex ante given the competitive market for high-level executives and the potential upside if Ovitz had succeeded. The Court emphasized that bad faith is reserved for cases of intentional misconduct or conscious disregard, not merely suboptimal process or poor outcomes. It also recognized directors’ statutory right to rely on experts under § 141(e), and it reiterated that exculpatory charter provisions bar monetary liability for care-based claims, focusing plaintiffs’ burden on proving loyalty or bad faith. On the waste claim, the high threshold was not met: honoring contractual severance is not waste where the underlying bargain had a rational purpose when made.
Disney is a cornerstone of Delaware fiduciary law for three reasons. First, it sharply delineates bad faith from gross negligence, setting a demanding standard for non-exculpated liability: plaintiffs must prove intentional dereliction or disloyal motive, not merely flawed process. Second, it shows the powerful effect of § 102(b)(7) provisions—most public Delaware corporations have them—channeling derivative plaintiffs into loyalty/bad-faith theories. Third, it guides boards on executive compensation: while courts expect robust process and documentation, judicial review remains highly deferential so long as directors are informed in a basic sense, rely on qualified advisors, and act with a rational corporate purpose. The case also foreshadows Stone v. Ritter’s framing of good faith within the duty of loyalty and continues to influence Caremark and compensation-related litigation.
Disney explains that bad faith is not mere gross negligence. It requires either (1) subjective bad faith—intent to harm—or (2) an intentional dereliction of duty, a conscious disregard for known responsibilities. Failing to achieve best practices or making a poor business decision does not, without more, constitute bad faith.
Disney’s charter exculpated directors from monetary liability for duty-of-care violations. As a result, plaintiffs had to prove non-exculpated breaches—loyalty or bad faith. Because the Court found, at most, care-based shortcomings and no conscious disregard or disloyal motive, the directors avoided personal monetary liability.
Waste requires a transfer so one-sided that no reasonable person could view it as adequate consideration. The severance was a contractual obligation triggered by a non-fault termination. The original employment agreement had a rational business purpose (recruiting a high-profile executive in a competitive market), and choosing NFT over a dubious for-cause termination avoided significant legal risk. Thus, the payment was not waste.
The Compensation Committee received and discussed material terms, relied on counsel and a compensation expert, and the board was informed of the key economic features. Although the process was less thorough than ideal and Eisner exerted strong influence, the directors’ use of advisors and their basic awareness of the deal’s structure supported good-faith reliance under DGCL § 141(e).
Boards should ensure a deliberate process: engage qualified independent advisors; circulate written materials in advance; hold substantive meetings; make and preserve a contemporaneous record reflecting alternatives considered, risks, and rationale; and manage conflicts. Disney shows courts will defer if the process is facially rational and conducted in good faith, but poor process can still fuel litigation and reputational harm.
Yes. The Court accepted the Chancery Court’s factual finding that a for-cause termination was not supported under the contract’s terms. Opting for a non-fault termination, rather than risking a weak for-cause claim and protracted litigation, was within the directors’ good-faith business judgment.
Disney is essential reading for understanding modern Delaware fiduciary duty doctrine. It confirms that courts will not second-guess board decisions simply because they lead to expensive or embarrassing results, especially where a board engaged advisors, had a basic understanding of the transaction, and acted with a rational corporate purpose. The case draws a bright line between sloppy process (care) and intentional misconduct (bad faith), a distinction that often determines director liability in the presence of exculpation provisions.
For students and practitioners, Disney’s practical lesson is twofold: build a strong process and record, and recognize the high bar plaintiffs face in proving bad faith or waste. While Disney protects directors from hindsight-driven liability, it also underscores the expectation that boards take their oversight of executive hiring and compensation seriously and document the deliberation that supports their business judgment.