http://www.usatoday.com/money/media/2004-10-18-disney-ovitz-lawsuit_x.htm
Disney lawsuit could ripple through Corporate America
By David Lieberman, USA TODAY
NEW YORK Beginning Wednesday, an unusual mix of Hollywood moguls, high-powered corporate directors and legal scholars will train their eyes on a relatively tiny courtroom in Georgetown, Del., population about 5,000.
That's where the state's Chancery Court will hear a case that could both fundamentally change the laws of corporate governance and shed new light on one of Hollywood's most Shakespearean business sagas: the spectacular collapse of onetime super agent Michael Ovitz in his stint in 1995 and 1996 as president of the Walt Disney Co. (DIS).
Lawyers for Disney shareholders will argue that CEO Michael Eisner and the board including Ovitz violated their fiduciary responsibilities. Shareholders allege they failed to properly scrutinize Ovitz's contract in 1995. In 1996, when Ovitz was in over his head, plaintiffs say, Disney compounded the error by letting Ovitz walk away with $140 million in cash and stock.
Disney says the board's actions were fair and reasonable. It says a sweet contract was needed to lure Ovitz from Creative Artists Agency, which he co-founded and whose client list included Madonna, Tom Cruise, Bill Murray, Kevin Costner and David Letterman.
If the court agrees with the plaintiffs, the precedent could enable shareholders of other companies to try to hold directors personally liable if they fail to pay proper attention to operational decisions particularly, huge compensation deals.
"It could be seismic," says Nell Minow of The Corporate Library. "It's the missing piece. The one group whose complicity (in Enron-era scandals) hasn't been addressed is the board. Absent personal corruption, you almost never see director liability. The Delaware court might say that directors could be liable even without personal corruption. That could affect every corporation in America, including those not incorporated in Delaware."
Paradoxically, Disney could benefit if the plaintiffs win. They seek about $200 million from Ovitz and people on the board while he was at Disney. Since this is a shareholder derivative case, not a class action, the cash would go back to Disney to benefit all investors.
"Any or all can be responsible for the full amount," says the lead attorney for the plaintiffs, Steven Schulman of Milberg Weiss. He calls the case "a wake-up call to boards across the country."
Dry law, juicy details
Hollywood, meanwhile, has feasted on such embarrassing revelations about Ovitz and Eisner as:
Ovitz, once considered the most powerful man in Hollywood, had Disney pay $2 million to renovate his office.
Ovitz expensed $500,000 for charitable contributions, $350,000 for "home catered" breakfasts, $100,000 for Los Angeles Lakers and Dodgers season tickets, $90,000 for a party at his home and $50,000 for a home screening room.
Eisner, in an angry private letter to Ovitz once his best friend complained in 1996 that "you played the angles too much, exaggerated the truth too far, manipulated me and others too much."
But the juicy details are embedded in a case that centers on the "business judgment rule," a key element of corporate law in Delaware, where most major U.S. companies (including Disney) are incorporated. The case is being heard in Chancery Court, a special state court for corporate law, by Chancellor William Chandler III.
The rule gives executives and directors a lot of leeway to run their companies and even make bad decisions without fear that courts will second-guess them. (A big exception is for mergers, where board members might be tempted to protect themselves instead of get the best return for shareholders.)
Chancery Court initially agreed to dismiss the Ovitz case, based largely on the latitude Disney argued it has under the "business judgment rule." But the Delaware Supreme Court stunned the legal community in 2000 by overturning the ruling and ordering Chancery Court to hear the case.
The plaintiff's argument "suggests that the Disney directors failed to exercise any business judgment and failed to make any good-faith attempt to fulfill their fiduciary duties to Disney and its stockholders," Chief Justice E. Norman Veasey wrote. What's more, he wrote, the sheer size of Ovitz's payout "pushes the envelope of judicial respect for the business judgment of directors in making compensation decisions."
Ruling already has ripples
Some court watchers say the Delaware Supreme Court decision already has changed the legal landscape.
"By allowing (the case) to go forward, (Veasey's) created precedent," says Charles Elson, director of the University of Delaware's John L. Weinberg Center for Corporate Governance. "This is a watershed."
He adds, "The stakes are so high, I'm surprised it's going to trial" instead of Disney settling.
As they plow ahead, "the courts are being asked to go to a place they've never been before," says B. Kenneth West, chairman of the National Association of Corporate Directors. "It's a marquee case."
Chandler is seen as a judge who won't shy from making tough calls. "He's very fair-minded and thoughtful," says Jim Kristie, editor of Directors & Boards magazine.
In 2002, Chandler ruled against shareholders, including Walter Hewlett, who wanted to block the merger of computer giants Hewlett-Packard and Compaq.
"That was his first big day in the sun," says John Reed, managing partner and corporate governance litigation specialist at Duane Morris. "I don't think anyone has ever gotten the sense that he's a maverick. He's a straight-shooter ...and he just wants to get the facts."
The facts will take the court back to one of the most tumultuous periods in Disney's history.
On April 3, 1994, president Frank Wells died in a helicopter crash.
That devastated Eisner. Wells kept operations running smoothly while Eisner focused on strategic and creative matters. Worldly and complex, Wells was lured to Disney from Warner Bros., and was one of the few people who could keep Eisner's extravagant ambitions in check.
Three months after Wells' death, Eisner underwent a heart bypass.
Everyone realized that the CEO needed help and a succession plan. But Eisner didn't want to anoint the man many saw as a likely heir: Walt Disney Studios president Jeffrey Katzenberg, who left in August and co-founded DreamWorks SKG with Steven Spielberg and David Geffen.
Succession talk subsided as Eisner returned to the job, but it rose again in July 1995 when he struck a $19 billion deal for Capital Cities/ABC. Investors and analysts agreed that Eisner would need help.
That's when he turned to Ovitz.
The famous, and often feared, agent desperately wanted to run a media giant. That summer, he'd come close. Seagram bought control of MCA, which owned Universal Studios, and CEO Edgar Bronfman Jr. began talking to Ovitz about running the entertainment business. But Bronfman ultimately picked CAA's No. 2, Ron Meyer.
For Eisner and Ovitz, the timing in mid-August 1995 seemed right to join forces at Disney.
Here's where the plaintiffs' and defendants' stories diverge.
The Disney board's foes say Eisner personally negotiated a sweet deal for his friend. In September, the board's compensation committee allegedly rubber-stamped the deal after less than an hour of discussion, with no outside advice, on the basis of a term sheet rather than the contract itself.
The Disney board's version is that Eisner negotiated an arms-length deal giving Ovitz less than he had been offered in talks with Seagram. It also says the compensation committee was fully briefed and had advice from compensation expert Graef Crystal.
But there's little dispute that Ovitz's tenure was disastrous. Some senior executives refused to report to him.
Ovitz saw the writing on the wall, and by October 1996, was trying to work out a deal to go to Sony. If that failed, he wrote to Eisner on Oct. 8, "then I guess you are stuck with me until I can find something to do that works for the both of us."
Eisner wrote back the next day: "I am committed to make this a win-win situation, to keep our friendship intact, to be positive, to say and write only glowing things. You are still the only one who came to my hospital bed and I do remember."
But the Sony talks collapsed. On Nov. 1, Ovitz told Eisner that he wanted to "recommit" himself to Eisner and Disney.
Eisner wasn't interested. "You do not like being number two in a company," he wrote back, "and I do not think you really understand or like or are capable of managing a public company in the Disney style. It cannot work. And I want it to end as soon as possible."
How Ovitz left with millions
The parties disagree again on how Eisner and the board handled Ovitz's exit, announced Dec. 12.
The plaintiffs say that Eisner, obsessed with public relations, unilaterally cut a deal with Ovitz that let him leave in a so-called non-fault termination, even though a case could be made that Ovitz hadn't made a good-faith effort to succeed.
The deal gave Ovitz the maximum payout under his contract, essentially the value as if he had stayed the entire five years.
The plaintiffs say Eisner and Ovitz announced the deal without consulting the board, even though only the directors could authorize the termination.
Disney directors counter that the company's then-general-counsel Sanford Litvack advised Eisner that Ovitz was entitled to a non-fault termination. When Eisner raised the matter with the board on Dec. 12, before the announcement went out, "no director objected."
Gary Naftalis, attorney for Eisner, says in a statement: "We plan to show that the Board was fully involved in all matters concerning Michael Ovitz's employment contract and dismissal, and that upon termination, Mr. Ovitz received not one penny more than his contract required."
Although the court still has to sort through the Disney facts, Minow says the Delaware case already has sent a clear message to Corporate America: "Directors need to do more than show up. They need to say 'no' once in a while."
