Director Independence and Friendship

In our Top 10 Reasons Why “Independent” Directors Are Not Independent Under Delaware Law, #2 provides that “Delaware courts effectively exclude from the analysis of independence personal relationships (other than those arising from family bonds).”  Let’s look at this issue.

The seminal case on the definition of independence is Aronson. In that case, the Delaware Supreme court broadly defined an independent and disinterested director as one able to decide the issue on the merits, unaffected by “extraneous considerations or influences.” 473 A.2d 805, 816 (Del. 1984).  Nothing in the decision limited the notion of “extraneous considerations” to pecuniary benefits. Nonetheless, for the two decades following the decision, courts did exactly that. Other than some (but not all) family relationships, courts treated personal and outside business relationships as irrelevant to the analysis of independence. Thus, a board could be packed with friends and business partners of the CEO without losing its status as independent.

Perhaps the most extreme example arose in Disney, a case most often discussed because of its good faith and duty of care analysis. See the student post below.  In fact, equally significant has been the treatment of the duty of loyalty and director independence.

The case, as is well known, involved a legal challenge to the approximately $140 million in compensation paid to Michael Ovitz for little more than a year of service as President of Disney. In challenging the compensation, plaintiffs argued the board lacked independence because it was under the control of the CEO, Michael Eisner.  Plaintiffs sought to show, in the pleadings, that Eisner had an interest in the outcome of the transaction by virtue of his close personal friendship (and outside business activities) with Michael Ovitz.  As the Complaint described: “Eisner is a long-time colleague of Ovitz who, at least at the time of the Employment Agreement was ‘negotiated,’ was a close personal friend of Ovitz. In fact, as Ovitz stated in conjunction with the announcement of his departure from the Company, ‘Michael Eisner has been my good friend for 25 years and that will not change . . . ‘” The complaint is here.   In other words, Eisner was interested because of his longstanding friendship with Ovitz. Given his interest in the transaction, the directors under his control and domination lacked independence.

On a motion to dismiss, without the benefit of discovery, the Chancery Court concluded the plaintiffs had not produced “reasonable doubt” about Eisner’s interest in the transaction. The analysis took two sentences and reflected the bias of the Delaware courts against finding that personal relationships result in a director becoming interested or losing his/her independence.  As the court summarily concluded:  “ This argument, however, finds no support under Delaware law. The fact that Eisner has long-standing personal and business ties to Ovitz cannot overcome the presumption of independence that all directors, including Eisner, are afforded.” That was it. No analysis. No facts. No discovery.

On appeal, the Supreme Court relied on the same superficial and cursory reasoning. The decision said nothing about the close relationship between the two men and again in two sentences dismissed the claim.

• The Court of Chancery held that "no reasonable doubt can exist as to Eisner's disinterest in the approval of the Employment Agreement, as a matter of law," and similarly that plaintiffs "have not demonstrated a reasonable doubt that Eisner was disinterested in granting Ovitz a Non-Fault Termination." Plaintiffs challenge this conclusion, but we agree with the Court of Chancery and we affirm that holding.

The court seemed content with the categorical decision that these types of relationships would not render a director interested. Both courts were able to render the decision without allowing plaintiff to engage in discovery to explore the relationship. In other words, the evidence did not even present “reasonable doubt” about the relationship between Ovitz and Eisner. Tomorrow, we will look at what plaintiffs would likely have uncovered had they been allowed discovery on the issue. For a peak on how this comes out, go to my article here.