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In re The Walt Disney Company Derivative Litigation
A New Standard for Corporate Minutes
By Cullen M. "Mike" Godfrey
"One of the officers shall have the duty to record the proceedings of the meetings of the stockholders and directors in a book to be kept for that purpose."

That sentence from section 142 of the General Corporation Law is the only reference to the requirement for corporate minutes contained in the Delaware statutes. There is a lack of significant jurisprudence dealing with corporate minutes, and there are very few treatises on the subject. Nonetheless, following the adoption of the Sarbanes-Oxley Act of 2002 and the recent Delaware Supreme Court case dealing with the Walt Disney Company's termination payments to its president, Michael Ovitz (In re The Walt Disney Company Derivative Litigation, 906 A.2d 27 (Del. 2006)), the significance of corporate minutes and their contents have taken on a whole new level of importance.

A corporation's directors owe a fiduciary duty to the corporation on whose board they serve. Among other issues raised in the Disney case was whether Disney's directors fulfilled that fiduciary duty by properly exercising their constituent duties of care and loyalty. The duty of care, the main issue in the case, requires directors to exercise the level of care that a person in a similar situation would have exercised under the same or similar circumstance. Plaintiff-shareholders argued that Michael Ovitz's board-approved employment agreement that provided for a termination benefit totaling $130 million after he had only been on the job for 14 months must clearly have resulted from a breach of the duty of care by corporate directors.

When evaluating the actions of directors, courts have adopted a standard of judicial review known as the "business judgment rule." Generally stated, the rule presumes that the board acted independently, with due care, in good faith, and in the honest belief that its actions were in the shareholders' best interests. There are two aspects to the rule. First, courts will not substitute their judgment for the board's, and second, the board's action will not be evaluated with the benefit of hindsight, but based on the information that was available at the time a decision was made. Thus, if the board's action was not clearly irresponsible at the time it was made, the business judgment rule should be a complete defense to any claim that the board violated its fiduciary duty.

To the extent that directors' actions are subject to review, the Disney case now demonstrates the need for a record to have been established supporting the judgments made by those directors. In most jurisdictions, including Delaware, minutes are considered to be prima facie evidence of actions taken by the corporation, and in others, minutes are presumed to be credible. Additional evidence will be permitted only when minutes are incomplete or ambiguous.

In the Disney case, the board ultimately prevailed, but only after a lengthy trial on the merits. The board's motion to dismiss the complaint before trial was denied in large part because the minutes of the corporation were not adequate on their face to document the board's informed deliberations and to sustain the board's actions.

In the Disney case, the critical event was a meeting of the company's compensation committee that approved Michael Ovitz's employment agreement as the new president of Disney. Ovitz was leaving a lucrative talent agency business, and he wanted a five-year contract with significant termination protection if he were forced out without cause. The compensation committee meeting was short, and many other items were on its agenda. The court found that "all that occurred during the meeting regarding Ovitz's employment was [one of the members] reviewed the employment terms with the committee and answered a few questions." No draft of the employment agreement was given to the committee, and the only information about the agreement recorded in the minutes was an incomplete summary. Thus, the minutes of the compensation committee were not sufficiently detailed to sustain the presumption that the business judgment rule had been satisfied.

An earlier Delaware Chancery Court opinion in the case noted that before Disney's full board approved the Ovitz agreement, it did not get a report from its compensation committee and only a page and a half of the board's minutes covered Ovitz's possible employment. There was no mention of any questions by the board about the details of Ovitz's salary, stock options, or the consequences of his possible early termination.

The court in the Disney case did permit parol testimony to supplement the minutes in order to demonstrate that the directors had, in fact, given appropriate consideration to hiring Michael Ovitz and to the contract associated with his employment. This is in contrast to the Delaware Supreme Court's 1985 Van Gorkom decision in which the court denied the introduction of parol evidence that would have contradicted the board's minutes. The plaintiff-shareholders in that case prevailed in their derivative action against the board because the corporate minutes did not justify the court's presumption of the business judgment rule with respect to the actions taken in conjunction with the sale of the company.

Notwithstanding the favorable outcome in the Disney case, however, the Delaware Supreme Court opinion clearly signaled that future suits will be dealt with more rigorously. The decision compared the Disney board's actions with the court's view of "best practices" that should have been reflected in Disney's minutes. Best practices would have included receiving a spreadsheet showing various payouts based upon various alternatives and scenarios including early termination; the spreadsheet should have been explained by an expert or other knowledgeable party identified in the minutes; and the spreadsheet should have been an exhibit to the minutes.

The Delaware Supreme Court then noted that had that scenario been followed, there would have been no dispute over what information was furnished to the compensation committee members or when it was furnished. Although the committee's process did not fall below the level required for a proper exercise of due care, it did fall short of what best practices would have counseled.

The court included a telling parenthetical phrase. It said that if the compensation committee had devoted more attention to process and building an adequate record through the minutes of the meeting, there would have been "no basis for litigation." Directly due to the absence of a complete record, the Disney litigation lasted for a total of 10 years, including a 37-day trial on the merits of the plaintiff-shareholders' claim.

In a 2007 Delaware Chancery Court case, In re Netsmart Technologies, Inc. Shareholders Litigation, 924 A.2d 171 (Del. Ch. 2007), Vice Chancellor Strine strongly signaled that a board's minute-taking process will be receiving even closer scrutiny. A special committee of Netsmart's board considered the possible sale of the company over a period of months in 2006. When a shareholder's derivative suit questioned the adequacy of the special committee's actions, the Chancery Court noted that a December 21 meeting of the special committee approved minutes of 10 previous meetings dating back to August 10, and stated "[t]hat tardy omnibus consideration of meeting minutes is, to state the obvious, not confidence inspiring . . ." The clear implication is that corporate minutes should be prepared, reviewed, and approved when events of meetings remain fresh on the minds of directors. Minutes should not be relegated to some pro forma afterthought completed at a later date.

There is now clear direction to what corporate minutes need to contain in terms of their completeness. Materials presented to the board in support of its decisions should be attached as exhibits to the minutes or at least clearly referenced with copies of such materials retained for future review. While minutes, by their nature, are not intended to be verbatim accounts of meetings, they should be sufficiently detailed to explain all that occurred during the course of the meeting. Presentations to the board should be well summarized, and discussions among directors should also be included. A mere recitation that "discussion ensued" may no longer be an adequate demonstration of the board's level of review and informed deliberation.

Prior to the Disney case, there had long been a debate over the content of minutes. One view was to include only brief descriptions of board action. With that, there would be less opportunity for cross-examination and possible embarrassment in any future litigation. In addition, there would be less risk that the minutes might be misconstrued. Fundamentally, according to this view, the purpose of minutes was limited to recording final actions taken by the board. Other means would be available to demonstrate the board's diligence.

It is the author's opinion that such reasoning is no longer viable. Rather, following the Delaware Supreme Court's Disney decision, in order to assure that a corporate board gets the benefit of the business judgment rule, corporate minutes must be comprehensive, definitive, and inclusive of all of the materials, at least by reference, that the board considered prior to making its decision.

In major corporate transactions such as mergers and acquisitions, every director should assume that the board's decision will become the basis for a lawsuit. Failure to document the decision with appropriately detailed minutes risks the time and expense of a lengthy trial and, worse, the possibility of a finding that the business judgment rule has not been satisfied.

The twenty-first century opened with a series of corporate scandals that have brought enhanced scrutiny to the role and responsibilities of corporate directors. Congress reacted with the Sarbanes-Oxley Act of 2002, which has focused much greater attention on the oversight responsibilities of directors, particularly those identified as "independent directors." The business judgment rule is still intact, but the standards required to demonstrate that directors have met their duty of care and are not engaged in self-dealing have been enhanced. The mere recitals of resolutions adopted by a board will no longer suffice. They must be substantiated with background and materials, reflected in the minutes, adequate to underpin the board's informed decision, along with a summary of the directors' discussions in arriving at a consensus. Anything less invites litigation and puts the board in jeopardy that there will be a finding that it did not fulfill its fiduciary duty.
Godfrey is the chief legal officer of the Texas A&M Health Science Center. His e-mail address is godfrey@tamhsc.edu.

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