Delaware Rules

Reporters descending on the hamlet of Georgetown for The Walt Disney Co.'s Delaware Court of Chancery trial poked fun at the Mayberry-like setting. In Vanity Fair's February 2005 account of the shareholders' star-studded battle to recover the $130 million severance paid to president Michael Ovitz — a settlement pushed through a compliant Disney board by then-CEO Michael Eisner — Dominick Dunne tweaked the "one-street town two hours from Wilmington." Chancellor William B. Chandler III struck Dunne as "a very classy guy, who keeps a bike in the courthouse" and whose local restaurant suggestions "were right on the money."

The chancellor's 180-page opinion last August, In Re The Walt Disney Co., put an end to the lighthearted commentary. Chandler lambasted Eisner for having "enthroned himself as the omnipotent and infallible monarch of his personal Magic Kingdom," and ticked off a series of Disney blunders that fell "significantly short of the best practices of ideal corporate governance." Still, Chandler ruled that Eisner and the board had made their mistakes in good faith, availing them of the protection of what the jurist calls Delaware's "bedrock": the business-judgment rule. (The rule shields companies, directors, and officers from liability — including the ruling of personal liability that the Disney shareholders sought — as long as they act within "the duty of care and the duty of loyalty," the twin components of good faith.)

"Being in Delaware doesn't mean it's small-town. The Court of Chancery is the country's business court," notes Charles Elson, Edgar S. Woolard Jr. chair of corporate governance at the University of Delaware. More than half of America's publicly traded businesses are incorporated in Delaware and thus covered by its statutes, and the court's precedents are frequently adopted in other states.

Across America, directors of companies "breathed a sigh of relief" when the Disney decision was issued, says Beth I. Z. Boland, a partner in the Boston law firm of Bingham McCutchen LLP.

But Chandler is thinking ahead. Struck by the "heightening of tension in the relationship between shareholders and management, and shareholders and the board of directors," he is gearing up to preside over a period of legal history-making he expects to rival the court's last landmark era — two decades ago, during the corporate-takeover craze, when the court worked out ground rules for mergers and acquisitions and poison pills.

Today, the chancellor envisions a proliferation of cases focusing on executive compensation, director independence, and the role that shareholders can have in governance determinations. Questions are already being asked about whether shareholders can adopt bylaws that trump board decisions. "And then when they do, if they have that power, can the board of directors then turn around and negate or change the bylaw?" he asks. "That issue has never been directly faced or answered in Delaware, but I think it's inevitable that it will be decided."

What Chancery rulings say in the near future could establish standards that rival anything that Sarbanes-Oxley and the Securities and Exchange Commission have offered. "Delaware state law governs corporate conduct. It drives best practices," points out Elson. And while the court must wait for cases to be brought before it — unlike regulators that can aggressively root out impropriety — "ultimately the Delaware Chancery Court will have a significant role in changing governance," he says.

Differences of Opinion
What changes may be wrought in Chancery's courtroom remain to be seen. Some rights advocates fear that the court will keep shareholders on the sidelines. "I have this concern that too often their allegiance is to the company management," says Nell Minow, co-founder of The Corporate Library, a corporate-governance research group based in Portland, Maine.

Such concern may be grounded in opinions like In Re Disney, which, despite Chandler's scolding, was still a victory for Disney's board. A recent critique of the Chancery Court in The Deal noted that the Delaware Supreme Court reversed no fewer than five Chancery Court decisions in 2002 and 2003, decisions that had affirmed the actions of a corporate board. The magazine interpreted the reversals as a signal to the lower court that it needed to be tougher on business in the post-Enron era.

But Chandler scoffs at the notion that he was sent a message, and disagrees with the assessment that reversals have toughened up this court. "In my view, the 2002–2003 reversals were not that significant," he says, and "were not a signal of a more stringent standard of review or scrutiny in the post-Enron era. They were fact-specific reversals, rather than broad pronouncements heralding a new enhanced scrutiny of corporate decision-makers."

Chandler says that court watchers "sometimes overemphasize the significance of reversals, viewing them as markers for a shift or change in the direction of Delaware corporate law." That's not how Delaware courts work, he says. Chancery Court jurists are appointed for 12-year terms, he points out, and are protected from political winds.

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