June 08, 2006
Whither Good Faith?
Posted by Gordon Smith

In my view, the most interesting part of the new Disney opinion is the Court's discussion of the duty of good faith (pp. 60-73). Here are some thoughts on that portion of the opinion:

  • The Court rejected the plaintiffs' contention that Chancellor Chandler changed the definition of "bad faith" between his 2003 opinion ("consciously and intentionally disregarded their responsibilities") and his 2005 opinion ("intentional dereliction of duty, a conscious disregard for one's responsibilities"). The Court stated, "We perceive no substantive difference" between the two, and that seems right to me.
  • The Court clearly embraces the duty of good faith as a distinct duty, separate from care and loyalty. For example, "grossly negligent conduct, without more, does not and cannot constitute a breach of the fiduciary duty to act in good faith." (p. 67)
  • The big question, therefore, is whether plaintiffs can find cases where the directors' conduct would constitute a breach of the duty of good faith, but not a breach of the duty of care or the duty of loyalty. The Court observes, "Cases have arisen where corporate directors have no conflicting self-interest in a decision, yet engage in misconduct that is more culpable than simple inattention or failure to be informed of all facts material to the decision." But it offers no citations. In my view, plaintiffs should be looking for one of three fact scenarios: intentional infliction of harm on the corporation, intentional violations of law, and intentional derelictions of duty.
  • The Court noticed the language in Section 102(b)(7) that Elizabeth Nowicki has been touting as a new basis for liability: "acts ... not in good faith." The Court looked at that statute and found two categories of "subjective bad faith" (which it also describes as "actual intent to do harm): "intentional misconduct" and "knowing violation of law." These are the first two fact scenarios listed in the prior paragraph. The Court says that "acts ... not in good faith" are encompassed by Chancellor Chandler's definition of bad faith, i.e., intentional derelictions of duty. In short, "acts ... not in good faith" are acts of "bad faith."  

Will the duty of good faith be important in future litigation? I assume that it will be argued frequently, at least in the near future, because bad faith is not capable of exculpation under Section 102(b)(7). Nevertheless, I suspect that the number of fact scenarios in which the duty of good faith will have traction is small, with "intentional violations of law" being the largest potential category. See Enron, et al.

All in all, I think that Justice Jacobs did an excellent job with the opinion. I am surprised that the decision was unanimous, and now I am wondering: what took them so long?

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Comments (11)

1. Posted by RR on June 8, 2006 @ 18:05 | Permalink

Despite all that language about good faith, though, the court expressly did not reach the question of whether "good faith" was an independent cause of action. See n. 112. An odd result. We could have dealt with an answer.


2. Posted by Elizabeth on June 8, 2006 @ 18:16 | Permalink

HOGWASH!
Gordon says:
" In short, 'acts ... not in good faith' are acts of "bad faith.""

No, Gordon. More accurate to say "For Delaware's purposes, for now, acts 'not in good faith' are acts of 'bad faith.'" I REFUSE to believe that this is where things will stay. That would be absurd.

Without getting too far into it now, let me just say that
(a) for what possible reason would the Delaware Supreme Court Justices have used raw torts law as the touchstone for definitions in the world of fiduciaries?
(b) just because the Delaware Supreme Court says so, doesn't make it so. Just ask Larry Mitchell.
(c) I apologize to the Delaware Supreme for not getting to them my "in good faith" manifsto in time. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=906518


3. Posted by Kate Litvak on June 8, 2006 @ 23:27 | Permalink

Elizabeth, if you don’t take a vacation this summer, you may end up like that woman in front of my post office who tells people not to send their tax forms because federal income tax is unconstitutional.


4. Posted by Elizabeth Nowicki on June 9, 2006 @ 3:24 | Permalink

Kate, I really, really want to be offended (as a matter of principle) by your ad hominem and slightly *ahem* unprofessional comment. (Please take in the good-natured spirit in which it was typed!)

However, I am laughing much too hard to be offended. Good comment on your part!

You will be happy to know that I board a plane to Orlando in less than 72 hours. In an ironic turn of events, I am taking a vacation. . . to. . . Walt Disney World. (I am not kidding.) I will send you and Gordon Smith a post card.


5. Posted by Elizabeth Nowicki on June 9, 2006 @ 16:12 | Permalink

Ah - the smoke has cleared. The "not in good faith" textualist (literalist?)interpretation of "not in good faith" lives on.

See here:
http://www.concurringopinions.com/movabletype/mt-tb.cgi/948

Kate, next year, around April 1st or so, you might want to track down that woman outside the post office and get more specifics on her position.
(tongue firmly in cheek)


6. Posted by Gordon Smith on June 9, 2006 @ 16:57 | Permalink

Elizabeth,

In the part of that post that was supposed to be mere review, you wrote: "Under my 'not in good faith' theory of liability, directors who basically abdicate their duty or bury their heads – which are acts arguably short of bad faith acts - have violated their fiduciary obligation to act 'in good faith.'"

Huh?

I thought that you were trying to argue that "acts ... not in good faith" are distinct from "acts in bad faith." When I read the above-quoted sentence, however, I see nothing that would distinguish your views from Chancellor Chandler's definitions of "bad faith."

Aren't "directors who basically abdicate their duty or bury their heads" the same as those who "consciously and intentionally disregarded their responsibilities" or commit an "intentional dereliction of duty, a conscious disregard for one's responsibilities"? It seems to me that you are straining at gnats.

In my view, Justice Jacobs was very clear, and you are just muddying the waters. The duty of good faith exists. It is distinct from the duty of care and the duty of loyalty. A director breaches the duty of good faith by acting in "bad faith," which includes intentional infliction of harm on the corporation ("subjective bad faith"), intentional violations of law, and intentional derelictions of duty (what Justice Jacobs refers to as "Chancellor Chandler's definition").

Frankly, the best textualist argument in favor of your position -- and it is very weak -- is a sentence that you didn't cite:

"Because the statute exculpates directors only for conduct amounting to gross negligence, the statutory denial of exculpation for 'acts…not in good faith' must encompass the intermediate category of misconduct captured by the Chancellor’s definition of bad faith."

You might argue that "acts…not in good faith" cannot encompass "bad faith" if the two are congruent. Justice Jacobs' opinion might be read to suggest that "acts…not in good faith" is a broader concept than "bad faith."

Of course, the answer to that line of arguments is available in the opinion itself. Justice Jacobs does not treat "the Chancellor’s definition of bad faith" as encompassing all of "bad faith." He clearly treats "subjective bad faith" as a separate category. And, as I argue in my posts on the duty of good faith, "intentional violations of law" is a third category. Thus, "acts…not in good faith" would include three distinct types of behavior, and all three are "acts of bad faith," too.

P.S. The link in your comment doesn't work. This will work.


7. Posted by Kate Litvak on June 9, 2006 @ 17:01 | Permalink

Elizabeth: I am delighted with the perseverance of your Rasputinoid theory. When something is destined to live on, it will live on.

As to the postal woman, I would’ve happily struck a conversation if she were there only on April 1st. But she normally sticks around until April 15, so I freak out.


8. Posted by Elizabeth Nowicki on June 9, 2006 @ 20:00 | Permalink

Gordon, thanks for the feedback.

As to your confusion about my position, I am picturing sub-sets. The big heading is "Acts that are 'not in good faith.'" "Bad faith" acts are a sub-set of "not in good faith" acts. Bad faith acts are INCLUDED in the recitation of acts that are "not in good faith" but there are other things on that list. There are other "sub-sets" of acts "not in good faith." Your statement that "Justice Jacobs' opinion might be read to suggest that 'acts…not in good faith' is a broader concept than "bad faith" is both (a) accurate and (b) the lynchpin of my "not in good faith" monologue.

So, to summarize, "bad faith" acts - fraud and such - are easily "not in good faith" acts. Where you and I disagree, I thought, was with regard to the OTHER things that I catch in my "not in good faith" net that you would prefer to be unreachable, such as overt inattention and failure to act ala Sidney Poitier.

As to my muddying Justice Jacobs' waters, I would like to think that I am doing nothing of the sort. Did I misread the opinion or did you? Based on the dicta I quote here - http://www.concurringopinions.com/archives/2006/06/the_disney_opin.html - (thank you for the link) Justice Jacobs is saying that "not in good faith" acts *CAN* and *DO* include acts in addition to bad faith acts. Do you not read the dicta that way?

As to my agreement with Chancellor Chandler, I agree with him, but I think he stops short. I think his lanugage is too "intent-heavy" - "consciously and intentionally disregarded their responsibilities" is strong language for a plaintiff to have to meet. I do not see good faith as a matter of intent as Chancellor Chandler does (but that is a very different conversation) - that is not good faith's. . . lineage, despite what some of our brethren have tried to argue.

I would modify Chancellor Chandler's "disregard for one's responsibilities" - I would make it "blatantly" as opposed to "consciously and intentionally" to put a more objective overlay on the discussion. (I can hear you screeching in dismay. But, according to my research, I am on solid ground with this.)

As to Chancellor Chandler's "consciously and intentionally disregarded their responsibilities," does that apply to Poitier if he is so busy that he forgets to review the draft employment agreement or he does not think to ask Crystal for comparables from other Fortune 500 President compensation packages? It is hard to argue that it does. It is for that reason that I do not line myself fully up with the Chancellor. I do not think that he goes far enough. I would view Poitier's failings (in my hypothetical above, mind you!) as acts "not in good faith" whether he intentionally forgot or not. He did not try to act "in the best interests of shareholder or the corporation." I don't *care* whether he intended to or not.

Does that clarify at all? Please remember that Justice Jacobs recognized that there is a land of actionable director liability fitting between "conduct motivated by subjective bad intent and. . . conduct resulting from gross negligence." That is where one should fit the phrase "not in good faith," as I read it. I do not exactly agree with how he phrases it, but I roughly agree with his location of the "zone of not in good faith."


9. Posted by Elizabeth on June 9, 2006 @ 20:02 | Permalink

Gordon, next time you read this way, would you be so kind as to fix the link in my post about four posts up, the one you pointed out to me? I don't think I can do it as just a "posting a comment" person. Thank you.


10. Posted by Gordon Smith on June 9, 2006 @ 21:05 | Permalink

Elizabeth: "Justice Jacobs is saying that 'not in good faith' acts *CAN* and *DO* include acts in addition to bad faith acts. Do you not read the dicta that way?"

No. Step back from page 72 for a second. Look at what he is trying to explain. He is examining "three categories of fiduciary behavior [that] are candidates for the 'bad faith' pejorative label." So his task is to determine what sort of actions should be classified as "bad faith."

1. Subjective bad faith? Yes.
2. Gross negligence? No.
3. "Chancellor’s definition of bad faith"? Yes.

He discusses "acts ... not in good faith" as part of his analysis of the last category. According to Justice Jacobs, some bad faith conduct "ranks between conduct involving subjective bad faith and gross negligence." Frankly, I think that is sort of a goofy way to describe the domain of Chancellor Chandler's definition of "bad faith," but the important point for this discussion is that the conduct of this type is still "bad faith" conduct, not some other category of conduct called "not in good faith."

He uses Section 102(b)(7) to bolster his assertion that certain "bad faith" conduct is distinct from subjective bad faith. Because the statute refers to "intentional misconduct" and a "knowing violation of law" (both of which are subjective bad faith, according to Justice Jacobs), he says that "acts ... not in good faith" refers to something other than subjective good faith. Talk about ipse dixit! Anyway, I am not challenging that claim, just describing it.

And what sort of conduct falls within "acts ... not in good faith"? Well, the conduct captured by Chancellor Chandler's definition of "bad faith."

This section of the opinion is not a model of precision, but I think Justice Jacobs was very clear about what he was trying to do. I see no indication that he was imagining anything like your theory regarding "acts ... not in good faith."

And I really can't say this in any new ways, so this will be my last word on the subject.

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