In Re Walt Disney Co. Derivative Litigation

Facts

Top management at Disney was in serious trouble. One executive died in a helicopter crash, and two others left over Eisner's management style. Eisner chose Michael Ovitz. Ovitz as the new president. Ovitz was founder and head of CAA, a talent agency, but he had never been an executive for a publicly owned entertainment company. Ovitz and Eisner were close friend for over twenty-five years. Eisner decided unilaterally to hire Ovitz. All three board members protested Eisner's decision to hire Ovitz. Eisner sent Ovitz a letter on August 14, 1995 that set forth certain material terms of his prospective employment. Before this, neither the Board nor the compensation committee had ever discussed hiring Ovitz as president of Disney. No discussions or presentations were made to the compensation committee or the Board regarding Ovitz's hiring as president of Walt Disney until September 26, 1995. Concerns were raised about the number of stock options to be granted to Ovitz. The document warned that the number was far beyond the normal standards of both Disney and corporate America and would receive significant public criticism. An executive compensation expert informed one board member that, generally speaking, a large signing bonus is hazardous because the full cost is borne immediately and completely even if the executive fails to serve the full term of employment. Neither of these documents were submitted to either the compensation committee or the Board before hiring Ovitz. Disney prepared a draft employment agreement on September 23, 1995. A copy of the draft was sent to Ovitz's lawyers but was not provided to members of the compensation committee. The compensation committee, consisting of defendants Ignacio Lozano, Jr., Sidney Poitier, Russell, and Raymond Watson, met on September 26, 1995, for just under an hour. The committee spent the least amount of time during the meeting discussing Ovitz's hiring. More time was spent on discussions of paying $250,000 to Board member Russell for his role in securing Ovitz's employment than was actually spent on discussions of Ovitz's employment. All that occurred during the meeting regarding Ovitz's employment was that Russell reviewed the employment terms with the committee and answered a few questions. Immediately thereafter, the committee adopted a resolution of approval. No copy of the September 23, 1995 draft employment agreement was actually given to the committee. Instead, the committee members received, at the meeting itself, a rough summary of the agreement. The summary, however, was incomplete. It stated that Ovitz was to receive options to purchase five million shares of stock, but did not state the exercise price. The committee also did not receive any of the materials already produced by Disney regarding Ovitz's possible employment. No spreadsheet or similar type of analytical document showing the potential payout to Ovitz throughout the contract, or the possible cost of his severance package upon a non-fault termination, was created or presented. Nor did the committee request or receive any information as to how the draft agreement compared with similar agreements throughout the entertainment industry, or information regarding other similarly situated executives in the same industry. No compensation experts had been retained to assist Disney regarding Ovitz's hiring. Thus, no presentations, spreadsheets, written analyses, or opinions were given by any expert for the compensation committee to rely upon in reaching its decision. The committee approved the general terms and conditions of the employment agreement but did not condition their approval on being able to review the final agreement. Instead, the committee granted Eisner the authority to approve the final terms and conditions of the contract as long as they were within the framework of the draft agreement. The Board met, and no expert was present nor were any documents produced to the board for it to review before the meeting regarding the Ovitz contract. The board did not ask for additional information to be collected or presented regarding Ovitz's hiring. The compensation committee did not make any recommendation or report to the board concerning its resolution to hire Ovitz. Only a page and a half-covered Ovitz's possible employment. The Board did not ask any questions about the details of Ovitz's salary, stock options, or possible termination. The Board also did not consider the consequences of a termination, or the various payout scenarios that existed. The Board decided to appoint Ovitz president of Disney. Final negotiation of the employment agreement was left to Eisner, Ovitz's close friend for over twenty-five years. Ovitz was officially hired on October 1, 1995, and began serving as Disney's president, although he did not yet have an executed employment agreement with Disney. On October 16, 1995, the compensation committee was informed, via a brief oral report, that negotiations were ongoing with Ovitz. The committee was not given a draft of the employment agreement either before or during the meeting. A summary similar to the one given on September 26, 1995, was presented. The committee did not seek any further information about the negotiations or about the terms and conditions of Ovitz's agreement, nor was any information proffered regarding the scope of the non-fault termination provision. And, as before, no expert was available to advise the committee as to the employment agreement. The employment agreement was physically executed between Michael Ovitz and the Walt Disney Company on December 12, 1995. It was backdated to October 1, 1995, the day Ovitz began working as Disney's president. The stock option agreement associated with the employment agreement was executed by Eisner (for Disney) on April 2, 1996. Ovitz did not countersign the stock option agreement until November 15, 1996, when he was already discussing his plans to leave Disney's employ. The Board nor the compensation committee reviewed or approved the final employment agreement before it was executed and made binding upon Disney. The final version of the agreement differed significantly and materially from the drafts summarized to the compensation committee on September 26, 1995, and October 16, 1995. By waiting to sign the agreement until December, but not changing the date of the exercise price, Ovitz had stock options that instantly were 'in the money.' This allowed Ovitz to play a 'win-win' game at Disney's expense--if the market price of Disney stock had fallen between October 16 and December 12, Ovitz could have demanded a downward adjustment to the option exercise price; if the price had risen (as in fact it had) Ovitz would receive 'in the money' options. The September 23rd draft agreement stated that non-fault termination benefits would only be provided if Disney wrongfully terminated Ovitz, or Ovitz died or became disabled. The final version of the agreement offered Ovitz a non-fault termination as long as Ovitz did not act with gross negligence or malfeasance. Ovitz was able to receive the full benefits of a non-fault termination, even if he acted negligently or was unable to perform his duties, as long as his behavior did not reach the level of gross negligence or malfeasance. Additionally, a non-compete clause was not included within the agreement should Ovitz leave Disney's employ. The employment agreement had a term of five years. Ovitz was to receive a salary of $1 million per year, a potential bonus each year from $0 to $10 million, and a series of stock options (the 'A' options) that enabled Ovitz to purchase three million shares of Disney stock at the October 16, 1995 exercise price. The options were to vest at one million per year for three years beginning September 30, 1998. At the end of the contract term, if Disney entered into a new contract with Ovitz, he was entitled to the 'B' options, an additional two million shares. There was no requirement, however, that Disney enter into a new contract with Ovitz. Under a non-fault termination, Ovitz was to receive his salary for the remainder of the contract, discounted at a risk-free rate keyed to Disney's borrowing costs. He was also to receive a $7.5 million bonus for each year remaining on his contract, discounted at the same risk-free rate, even though no set bonus amount was guaranteed in the contract. Additionally, all of his 'A' stock options were to vest immediately, instead of waiting for the final three years of his contract for them to vest. The final benefit of the non-fault termination was a lump sum 'termination payment' of $10 million. The termination payment was equal to the payment Ovitz would receive should he complete his full five-year term with Disney, but not receive an offer for a new contract. An expert opined in the January 13, 1997, edition of California Law Business that 'the contract was most valuable to Ovitz the sooner he left Disney.' Ovitz was not a good second-in-command, and he and Eisner were both aware of that fact. Eisner admitted to others he 'had made an error in judgment in who I brought into the company.' Ovitz had an excessively lavish office, an imperious management style, and had started a feud with NBC during his tenure. Ovitz admitted publicly that he knew 'about 1% of what I need to know.' Ovitz studiously avoided attempts to be educated about finance. Ovitz began seeking alternative employment. He consulted Eisner to ensure that no action would be taken against him by Disney if he sought employment elsewhere. Ovitz wanted to leave Disney, but could only terminate his employment if one of three events occurred: (1) he was not elected or retained as president and a director of Disney; (2) he was assigned duties materially inconsistent with his role as president; or (3) Disney reduced his annual salary or failed to grant his stock options, pay him discretionary bonuses, or make any required compensation payment. None of these three events occurred. Eisner agreed to help Ovitz depart Disney without sacrificing any of his benefits. Eisner and Ovitz worked together as close personal friends to have Ovitz receive a non-fault termination. The New Board of directors was aware that Eisner was negotiating with Ovitz the terms of his separation. Neither the New Board of Directors nor the compensation committee had been consulted or given their approval for a non-fault termination. In addition, no record exists of any action by the New Board once the non-fault termination became public on December 12, 1996. Neither the New Board nor the compensation committee reviewed or approved the December 27th letter. No record exists of any New Board action after the December 27th letter became public, nor had any board member raised any questions or concerns since the original December 12th letter became public. Disney's bylaws required board approval for Ovitz's non-fault termination. Eisner and Litvack allegedly did not have the authority to provide for a non-fault termination without board consent.

Issues

Rule of Law

Holding and Decision

Legal Analysis

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