In 1993 Justice Horsey of the Delaware Supreme Court penned this unfortunate sentence in the second major Technicolor opinion: "To
rebut the [business judgment] rule, a shareholder plaintiff assumes the burden of providing
evidence that directors, in reaching their challenged decision,
breached any one of the triads of their fiduciary duty -- good faith, loyalty or due care."
In Gaylord, Vice-Chancellor Strine tweaked the Delaware Supreme Court for its use of the plural "triads" and for identifying "good faith" as a separate fiduciary duty: "Indeed, the very Supreme Court opinion that refers to a board's 'triads [sic] of fiduciary duty [sic] -- good faith, loyalty [and] due care,' equates good faith with loyalty."
In subsequent opinions, the Delaware courts and commentators charitably reduced the number of triads to one, but confusion remained about the role of "good faith" in fiduciary litigation. We had a lot to say here about the Disney litigation, and if you were following that conversation, you might remember a lingering issue from the Supreme Court's most recent opinion: does the duty of good faith provide an independent basis for director liability?
My initial take on the Disney opinion was unequivocal:
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."
In a subsequent post, I addressed Footnote 112 of Disney, which reads as follows:
[W]e do not reach or otherwise address the issue of whether the fiduciary duty to act in good faith is a duty that, like the duties of care and loyalty, can serve as an independent basis for imposing liability upon corporate officers and directors. That issue is not before us on this appeal.
I argued that "footnote 112 was an afterthought designed to secure a vote for the opinion in pursuit of unanimity." I speculated privately to several colleagues that Justice Holland had demanded the footnote, though what he intended to do with it I wasn't sure.
Now I know. The triad is dead.
Yesterday, the Delaware Supreme Court issued a unanimous, en banc opinion that seems to drive a stake in the heart of "the fiduciary duty of good faith." The following comes from Stone v. Ritter:
It is important, in this context, to clarify a doctrinal issue that is critical to understanding fiduciary liability under Caremark as we construe that case. The phraseology used in Caremark and that we employ here—describing the lack of good faith as a "necessary condition to liability"—is deliberate. The purpose of that formulation is to communicate that a failure to act in good faith is not conduct that results, ipso facto, in the direct imposition of fiduciary liability. The failure to act in good faith may result in liability because the requirement to act in good faith "is a subsidiary element[,]" i.e., a condition, "of the fundamental duty of loyalty." It follows that because a showing of bad faith conduct, in the sense described in Disney and Caremark, is essential to establish director oversight liability, the fiduciary duty violated by that conduct is the duty of loyalty.
This view of a failure to act in good faith results in two additional doctrinal consequences. First, although good faith may be described colloquially as part of a "triad" of fiduciary duties that includes the duties of care and loyalty, the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. Only the latter two duties, where violated, may directly result in liability, whereas a failure to act in good faith may do so, but indirectly. The second doctrinal consequence is that the fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. As the Court of Chancery aptly put it in Guttman, "[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation's best interest."
I will have a lot to say about this at some future date, probably in a law review article, but the first question that springs to mind is this: Has the Delaware Supreme Court been acting in good faith in its development of the duty of good faith?
Over the past decade, the Court has had numerous opportunities to "clarify" this issue, and the Court has consistently muddied the waters. As noted above in my Gaylord citation above, the Court of Chancery responded to Justice Horsey's unfortunate sentence by treating the mysterious duty of good faith as a species of loyalty violation, but the Supreme Court repeatedly emphasized the distinctiveness of "the duty of good faith." I never liked the idea that good faith was part of the duty of loyalty, but if that's where the Supreme Court wanted it, did we really need over a decade to figure that out?
We are told that the duty of good faith is connected to Caremark, which the Supreme Court has cited in three other cases, though never with the complete endorsement of the Caremark standard that appears in Stone. This makes sense to me, given the notion of "good faith" articulated in the Disney cases.
Then we are told that Caremark is really a duty of loyalty case. Not duty of loyalty in the traditional sense -- you know, those cases "involving a financial or other cognizable fiduciary conflict of interest" -- but something different. More like a good faithy version of loyalty. Ok, I think I basically get good faith after Disney, but why dilute a useful and longstanding conception of loyalty with these other fact situations? Was the post-Disney triad broken and in need of repair?
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1. Posted by Darian Ibrahim on November 7, 2006 @ 18:15 | Permalink
Gordon, when I first read your post, I thought you must be kidding about this opinion. I checked the date to make sure it wasn't April 1. But unfortunately, this is no joke. The opinion is at 2006 WL 3169168 (Nov. 6, 2006).
After much uncertainty, the court seemingly put the good faith question to rest by establishing a separate duty in Disney. Yes, it hedged with fn. 112, but bad faith was defined so narrowly -- to include only intentional conduct (either "subjective bad faith" or "a conscious and intentional disregard of duties") -- that it was reasonable to think that the court would take the final step and make its breach compensatable when the appropriate facts came about. Given Disney's narrow conception of the duty, it's hard to see why the court felt the need to move away from it -- and especially so quickly (with no time for things to percolate).
I have great respect for the Delaware judiciary, but this latest twist in the good faith saga seems like tortured jurisprudence. What's going on here?
2. Posted by Gordon Smith on November 7, 2006 @ 21:06 | Permalink
The most startling thing about this to me is that both Disney and Stone were unanimous, en banc opinions. How do five justices get comfortable with both of those opinions?
I am not sure how much I care about the result. Having the SCt embrace Caremark seems fine to me, and I suspect that good faith-loyalty cases will just be treated differently from conflict-loyalty cases.
That said, putting Caremark under the loyalty heading seems silly and the timing is bizarre.
3. Posted by Brett McDonnell on November 8, 2006 @ 8:24 | Permalink
Maybe it's time for a trinity theory of fiduciary duty in Delaware: loyalty = father, care = son, good faith = holy ghost. Three aspects of one overarching duty to conscientiously pursue the best interests of the corporation.
4. Posted by Gordon Smith on November 8, 2006 @ 8:34 | Permalink
Brett ... Brilliant!
5. Posted by Steve on November 8, 2006 @ 9:56 | Permalink
My off-the-cuff question: ultimately, is this largely semantics? From a practical aspect, I'm not sure how this affects director liability or the substantive advice given to directors. It suppose it makes clear, however, that loyalty is a broad duty going beyond a tangible interest (compare, for example, a director being independent vs. disinterested).