Just to begin a theme sure to be repeated throughout the day: Chancellor Chandler is a terrific person. Like Gordon, my wife and I had the chance to visit the Court of Chancery in Georgetown, and we were treated to a tour as well as a wonderful chat with our host. He could not have been more gracious. It is often said that the strength of the Delaware corporate law lies as much (if not more) in its judges as in its statutes, and Chancellor Chandler has exemplified the combination of corporate savvy with down-to-earth sense that makes the court so successful.
The Disney case was an extraordinary event, even for the Delaware Chancery. However, when the case was first presented to Chancellor Chandler, he found that "the issues presented by this litigation, while larger in scale, are not unfamiliar to this Court." In granting the motion to dismiss, he began his opinion with the following analogy:
Just as the 85,000–ton cruise ships Disney Magic and Disney Wonder are forced by science to obey the same laws of buoyancy as Disneyland's significantly smaller Jungle Cruise ships, so is a corporate board's extraordinary decision to award a $140 million severance package governed by the same corporate law principles as its everyday decision to authorize a loan. Legal rules that govern corporate boards, as well as the managers of day-to-day operations, are resilient, irrespective of context. When the laws of buoyancy are followed, the Disney Magic can stay afloat as well as the Jungle Cruise vessels. When the Delaware General Corporation Law is followed, a large severance package is just as valid as an authorization to borrow. Nature does not sink a ship merely because of its size, and neither do courts overrule a board's decision to approve and later honor a severance package, merely because of its size.
In re Walt Disney Derivative Litigation, 731 A.2d 342, 350 (Del. Ch. 1998). This comparison has always fascinated me. Just to give you the visuals, here's the Jungle Cruise ship:
And here's the Disney Magic:
Compare that language to this language, seven years later:
In re Walt Disney Derivative Litigation, 907 A.2d 693, 762-63 (Del. Ch. 2005).
To be certain, the evidence available to Chancellor Chandler in 1998 was much more limited than it was after the trial, due in part to the plaintiffs' initial failure to request corporate records. In fact, the chancellor showed a remarkable openness to seeing the case afresh once the minutes of the board meetings came to light. The Disney case was our transition from the Internet boom to the post-Enron era. And Chancellor Chandler was our Virgil.
One ongoing question about the Delaware Chancery Court is its responsivness to the prevailing corporate and political winds. Is the Chancery successful, at least in part, because it tempers its judgment with a sense of the national mood? And if so, is that an appropriate role for the judiciary? In this regard, I think the Disney case is instructive. Chancellor Chandler had this to say about the role of corporate governance norms within the law:
. . . [T]here are many aspects of defendants' conduct that fell significantly short of the best practices of ideal corporate governance. Recognizing the protean nature of ideal corporate governance practices, particularly over an era that has included the Enron and WorldCom debacles, and the resulting legislative focus on corporate governance, it is perhaps worth pointing out that the actions (and the failures to act) of the Disney board that gave rise to this lawsuit took place ten years ago, and that applying 21st century notions of best practices in analyzing whether those decisions were actionable would be misplaced.
Unlike ideals of corporate governance, a fiduciary's duties do not change over time. How we understand those duties may evolve and become refined, but the duties themselves have not changed, except to the extent that fulfilling a fiduciary duty requires obedience to other positive law. This Court strongly encourages directors and officers to employ best practices, as those practices are understood at the time a corporate decision is taken. But Delaware law does not --indeed, the common law cannot -- hold fiduciaries liable for a failure to comply with the aspirational ideal of best practices, any more than a common-law court deciding a medical malpractice dispute can impose a standard of liability based on ideal-rather than competent or standard-medical treatment practices, lest the average medical practitioner be found inevitably derelict.
Fiduciaries are held by the common law to a high standard in fulfilling their stewardship over the assets of others, a standard that (depending on the circumstances) may not be the same as that contemplated by ideal corporate governance. Yet therein lies perhaps the greatest strength of Delaware's corporation law. Fiduciaries who act faithfully and honestly on behalf of those whose interests they represent are indeed granted wide latitude in their efforts to maximize shareholders' investment. Times may change, but fiduciary duties do not. Indeed, other institutions may develop, pronounce and urge adherence to ideals of corporate best practices. But the development of aspirational ideals, however worthy as goals for human behavior, should not work to distort the legal requirements by which human behavior is actually measured. Nor should the common law of fiduciary duties become a prisoner of narrow definitions or formulaic expressions. It is thus both the province and special duty of this Court to measure, in light of all the facts and circumstances of a particular case, whether an individual who has accepted a position of responsibility over the assets of another has been unremittingly faithful to his or her charge.
Id. at 697-98. The Enron era and the 2008 Financial Crisis have given us many opportunities to see failures of those in a position of responsibility to remain unremittingly faithful to their charges. As we grapple with how to address that faithlessness, and how to minimize it in the future, we will miss having Chancellor Chandler as our guide.
Yesterday’s Wall Street Journal ran a story (password required) on federal prosecutors using the “responsible corporate officer” doctrine to impose personal liability on the officers and directors of drug companies for violations of food & drug laws.
This revives an obscure doctrine that I wrote about a few years ago (see here, pages 313-318) for a book that compared director liability for corporate actions across countries. The responsible corporate officer is understandably extremely worrying for corporate boards and executives because it means civil and even criminal liability when a corporation violates a law absent a director or officer knowing about the violation.
It is important to note that the scope of the doctrine is limited. It sprang forth in the 1943 Supreme Court case U.S. v. Dotterweich which interpreted the Federal Food, Drug and Cosmetic Act. The Court upheld the application of the doctrine to the same statute in 1975 in U.S. v. Park. In the 2003 case Meyer v. Holley, the Court revisited the doctrine and stated that Congress must be fairly explicit in a statute that it intends the doctrine to apply. And the current Supreme Court is unlikely to reverse course on this. The responsible corporate officer doctrine is unlikely to apply to new statutes absent explicit Congressional language.
Even so, the doctrine does apply to more than one federal food & drug statute. I list a number of federal cases in that book chapter I mention above. Moreover, state legislatures and courts have also applied the statute to state laws (and Meyer v. Holley does not necessarily constrain the ability of state courts to apply the doctrine to state statutes more liberally). So this dormant doctrinal strain should only give pause to boards and executives in certain heavily regulated industries that are subject to certain statutes. The doctrine is more limited, but potentially vastly more powerful – because lack of knowledge is not a defense -- than other sources of liability for directors that have been much more analyzed in recent years (for example, securities laws and Disney/Caremark/Stone v. Ritter).
You may remember this story from last spring….
On a crisp Saturday morning in the spring of 2009, a somber group of citizens from the Connecticut towns of Bridgeport and Hartford boarded a tour bus. The tour route did not pass through the lovely Hollywood Hills homes of Oscar-winning actors perched high above the sprawling city of Los Angeles, nor did the tour route pass through Manhattan’s historic and affluent upper east side to visit the brownstone where Carrie Bradshaw lived or the cupcake shop that she visited in a popular television series titled “Sex in the City.” Upon having loaded its passengers, the bus, flanked by national and international media – more journalists in fact than tour participants – took the road to Fairfield County, Connecticut to tour the homes of executives who work for the American International Group, Inc., a mammoth international insurance company with significant financial services operations in more than 130 countries. The bus tour group, organized by Connecticut Working Families, a coalition of community organizations, labor unions and neighborhood activists that lobby to impact issues important to working and middle class families, considered themselves emissaries of a nation frustrated by an economic crisis. As anticipation of a confrontation between the tour participants and the executives and their families grew, AIG executives like David Poling, recipient of a $6.4 million award, began renouncing their bonuses and enhancing their home security devices.
Sharpen your pitch forks and light the torches. Bonus distributions to executives at bailed-out firms made Americans mad. Moreover, the discovery of the role of credit defaults swaps in the crisis has fueled the rage. Justifiable national frustration suggests that federal rules may soon override state court precedent and legislation that protect directors from liability or at least big bonuses will be more closely watched and possibly denied by the exec comp czar. Possibly. Mark Roe has persuasively argued that the real competition in corporate law is not among the states but between the federal government and Delaware. An interpretation of fiduciary duty that excuses corporate management’s failed efforts to oversee enterprise risk management may offer further evidence to support Roe’s theory.
We have seen a flurry of activity to introduce federal oversight of executive compensation packages for companies that are recipients of the federal dole. (See David Zarig's post here.) In her November 1st blog on Jones v. Harris (here), Michelle Harner offered interesting insight into the issues of interestedness and independence in the context of fee structures. I see an easy application of these arguments in the context of executive compensation and parallels in arguments about effective enterprise risk management.
The consequences of a systemically significant institution’s failure to execute risk management policies with care reverberate through many constituencies. Ever increasing numbers of Americans own a broader array of stocks, even if only through mutual funds or retirement funds. In the absence of action on the part of the Delaware legislature or courts, the federal government might easily commandeer the regulatory stage.Federal preemption in the area of executive compensation may pave the road for preemption in other areas of governance, such as risk management. The poster child for this proposition: AIG. My prediction that we may see federal intervention into corporate governance on risk management is based on the brewing national debate on independence and interestedness.
The audit committee and independence standards and other corporate governance reforms adopted as part of SOX offer examples of ghosts from Christmases past. But additional intervention is appearing on the horizons. Congressional proposals for corporate-last-wills-in-testament, a requirements that companies explain in advance their policy for dealing with potential insolvency, present another example of the Feds pending foray into the corporate governance sphere. This funeral legislation, as it has been described, requires firms to state how they would unwind their businesses and gives the Treasury authority over initiating the unwinding of certain systemically significant institutions. Even lower federal courts seem to “want in” on the movement for a broader interpretation of directors’ fiduciary duties, as illustrated by Judge Rakoff’s rejection of the SEC v. Bank of America/ Merrill Lynch settlement negotiation. With all of the frustration we are left to wonder about future interpretations of directors fiduciary duties.
I'm sure that the crisis will make my end-of-the semester class on Corporate Social Responsibility even more lively. I wish I had remembered, but I meant to talk about why Bear Stearns didn't just abandon their two hedge funds in the context of my veil piercing classes. Moral or implicit recourse seems an important lesson; just because shareholders have protection of the corporate veil, doesn't mean they will use it. The crisis also came up in the context of executive compensation and the Disney and Jones v. Harris cases.
The progression in the Klein Ramseyer book from Disney to Jones v. Harris also allowed a brief discussion on unintended consequences of corporate law reform. We talked a little bit about how option based compensation resulted from a desire to cure management entrenchment and better align management incentives with those of shareholders. We then talked a bit about the lesson of being careful in designing options or other compensation or you might stimulate short-term decision-making and accounting gamesmanship.
Jones v. Harris (subject of the Glom's forum two weeks ago) provided an opportunity to talk about how the rise of institutional shareholders was supposed to play a key role in corporate governance. We also discussed how institutional investing just pushes the agency costs to another level.
The law of unintended consequences should be sobering as we discuss reforms to this crisis too.
The Delaware Supreme Court finally issued its long-awaited opinion in Lyondell Chemical Company v. Ryan today. Remember, this is the case in which the directors of Lyondell Chemical Company were accused to breaching their fiduciary duties in connection with a sale of the company. The directors were admittedly independent and disinterested, but the plaintiff shareholders accused the directors of breaching their fiduciary duty of good faith by knowingly shirking their duties under Revlon. Vice-Chancellor Noble refused to grant the directors summary judgment because he wanted to know more facts about whether "the directors may have consciously disregarded their known fiduciary obligations in a sale scenario." (Ryan v. Lyondell Chemical Co., 2008 WL 2923427 (Del. Ch. 2008)).
In reference to that earlier decision, I expressed my frustration with the current state of Delaware law:
The problem with the decision is that [the defendants] can't get a lawsuit like this dismissed. But I don't see how you can pin that on Vice-Chancellor Noble. He is just taking direction from the Delaware Supreme Court.
Others, like Jeff Lipshaw, thought VC Noble was simply bootstrapping a duty of care claim into a non-exculpable duty of good faith claim. (Glom guest blogger Andrew Lund has written a paper about this possibility and how Delaware could more easily avoid it.) In its opinion today, the Delaware Supreme Court agreed with Jeff's assessment of the facts of this case: "At most, this record creates a triable issue of fact on the question of whether the directors exercised due care." (For Jeff's reaction to the opinion, see here.)
Importantly, this conclusion depends on a strikingly narrow understanding of "bad faith" in Delaware fiduciary law. In my first post on this case last August, I observed, "Disney and Stone now have defined 'bad faith' in a manner that does not require illegality or fraud (the traditional meanings of 'bad faith'), or disloyalty -- at least in the traditional sense of self-dealing. 'Bad faith' now has a more expansive meaning, that might include actions by directors who are admittedly independent and disinterested." While all of this remains true, it appears that the Delaware courts still have an extremely narrow view of bad faith. Steve Bainbridge described it this way earlier today: "Ryan ... goes a long way towards constricting the scope of bad faith claims to egregious and highly unusual sets of facts."
To understand how narrow "bad faith" has become, consider VC Noble's initial decision to deny summary judgment. That decision was motivated by a desire to gather more facts before determining that the directors here had not acted in bad faith. VC Noble was under the impression that directors could do something to fulfill their Revlon duties, but still knowingly fall short of doing enough. This is not an unreasonable view, though it would require a fair amount of precision to determine the difference between a care claim and a good faith claim. Chancellor Chandler made a similar point in a recent opinion in In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106 (Del.Ch. 2009):
Business decision-makers must operate in the real world, with imperfect information, limited resources, and an uncertain future. To impose liability on directors for making a “wrong” business decision would cripple their ability to earn returns for investors by taking business risks. Indeed, this kind of judicial second guessing is what the business judgment rule was designed to prevent, and even if a complaint is framed under a theory, this Court will not abandon such bedrock principles of Delaware fiduciary duty law.
The Delaware Supreme Court wants to draw a brighter line in its opinion issued today:
The influence of Caremark is apparent here, and we know from experience that Caremark liability is almost unheard of in Delaware. Of course, Vice-Chancellor Strine recently found support for Caremark claims with respect to the former senior vice chairman of general insurance and former vice chairman of investments and financial services of AIG. See In re American Intern. Group, Inc., 2009 WL 366613 (Del.Ch.2009). In denying a motion to dismiss on this issue, VC Strine observed:
This sort of behavior, if proved at trial, would easily support a finding of "bad faith" under the traditional standards. In other words, the Caremark version of bad faith would be unnecessary. And if the Delaware courts are serious about the standards articulated in Lyondell, I suspect plaintiffs will need facts like these to prevail on a claim of bad faith. So while boosters of the fiduciary duty of good faith had reason to rejoice after VC Noble's initial opinion, they will not be pleased with this latest directive from the Delaware Supreme Court.
Last week I, along with millions of other people, spent part of my Spring Break in California at Disneyland. While there I could not help but think about, and in fact reconsider my impressions of, the Disney decisions. Today when I refer to Disney I view it as a case with important corporate governance implications. Moreover, because I teach the Disney cases as well as the implications of the “vote no” campaign at Disney, I tend to view Disney in terms of its crisis points. As a result, I was frustrated by the final Disney decision, which appeared to enable that company’s officers and directors to get away with observing lax governance standards. However, I too often forget that Disney is a company that produces products that have a tremendous influence on people's lives and our culture. For many people, Disney represents the “magic kingdom.” And perhaps the fact that the kingdom remained in tact in the midst of Disney’s corporate governance troubles validates the business judgment rule’s application to what many viewed as less than ideal governance practices.
Indeed, by all markers, Disneyland appeared to be thriving--at least on the day I visited the park. There were many many children (and some adults) dressed in various Disney costumes, willing to stand in lines up to two hours long to get a glimpse of Mickey Mouse or ride on a simulated Star Wars ship. And visitors paid handsomely for their experience. In fact, I have been told that some days the park gets so full that it must close. Being in Disneyland underscores the fact that Disney sells a remarkable product that holds a special place for many in the US and abroad.
On the one hand, maybe this means that we should care more about the conduct of its board and officers because we want such an iconic company to be a symbol of best practices. On the other hand, so long as the Disney brand remains undisturbed, perhaps we should give the company room to make mistakes. Of course, that is what the business judgment rule is all about. And walking through the park, I could not find fault with such a rule. Because at the end of the day, it appeared that the conduct about which corporate governance experts spilled so much ink, did not impact the experience of park goers. In fact I feel certain that very few people in the park that day gave a passing thought to Michael Ovitz and a case called In re Walt Disney. And as long as that is the case, perhaps the business judgment rule has served its purpose.
The AALS has posted podcasts from the Annual Meeting. You can browse the sessions from this page. If you would like to listen to the Section on Business Associations program on Disney, click here. By the way, I was the first speaker in that session.
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?
Like the Chancery Court, the Supreme Court in Disney distinguished between conduct that violated the duty of care--for which directors were not liable--and conduct that fell below corporate best practices. And both courts agreed that Disney directors engaged in actions that failed to meet the courts' formulations of corporate best practices. I intuitively understand the distinction between conduct that satisfies due care and conduct consistent with corporate best practices--after all, when imposing liability we cannot expect directors' and officers' conduct to be the "best" or perfect. Given this distinction, I wonder what the point is in pinpointing these best practices. Both courts suggest that all directors and officers should use the best practices identified in the opinions as a guide for their own behavior. But why should anyone expect that directors and officers will follow that guide when there are apparently no sanctions for their failure to do so? Indeed, if due care is judged according to a "we don't expect perfection/nobody's perfect" standard, then not only does breaching the standard seem virtually impossible, but also it seems that engaging in behavior that satisfies "best practices" is an option that most corporate actors are free to ignore. Thus, I find myself asking, what is the point in pinpointing aspirational standards that have no connection to the conduct in which we realistically expect directors and officers to engage? Or to put it differently, how do best practices standards help us determine conduct that violates the duty of care? In this regard, I find the distinction frustrating and unhelpful, except to the extent that it suggests that all corporate conduct will satisfy the duty of care because that duty does not require directors and officers to be on their "best" behavior.
Larry asks some provocative questions below, and I think this post addresses the first question and the last question. Um, where is Van Gorkom? I searched the opinion -- no "Van Gorkom." There's not even a "Gorkom."
So, the Supreme Court of Delaware issues an opinion in an appeal that has everyone asking "Is Van Gorkom Dead?" and does not even cite Van Gorkom? And, in the opinion, the court notes, inter alia, that directors do not need to see documentation of transactions they are approving if someone describes those documents to them. That characterization of the facts of the Disney case sound very similar to the facts of Van Gorkom, although those facts, twenty-one years ago, resulted in a different judicial decision. That sounds a lot like the court is rejecting Van Gorkom without saying so. Also telling is the fact that the court never cites Van Gorkom for anything, which is odd for a breach of duty case. So, why doesn't the court explicity overturn Van Gorkom? Why create a blip in the common law that must be explained? I suspected that the court would distinguish the Disney case from Van Gorkom based on the fact that the Ovitz contract was a mere employment matter and that even though the aggregate dollar amount seemed high, the amount was still small compared to the size of the company's budget. Van Gorkom involved the sale of the company, a fundamental change that requires more attention than an employment contract. But the court did not distinguish the facts, but instead analogized them and implied that a different result under the same facts would be erroneous.
Now that the Delaware Supreme Court has finally opined on Disney, maybe the old gang that has gathered in this space before would like to get back together to discuss the case. I've already posted at my home site.
Let me suggest a few topics if anybody wants to join in, most of which are touched on in my post:
1. The future of due care and Van Gorkom. What does this case say about the nature of gross negligence?
2. What are the case's implications for bad faith and the application of 102(b)(7)? What kinds of facts might constitute bad faith? Given the court's view of bad faith, is there any longer a meaningful role for gross negligence?
3. What, if anything, does the case say about how it might address the undecided questions, such as the application of the bjr to officers.
4. What does the case imply about Roe's thesis concerning federal law's impact on Delaware?
5. What can be said now about the relation between Delaware and the federal law of corporate governance? Has federal law taken over the Caremark business just as it has disclosure?
6. What, if any, role do theories of "good governance" and best practices have on directors' liabilities after Disney?
7. What are the decision's implications for the executive compensation debate?
8. What's likely to be the single biggest effect of this decision?
Interestingly, the Supreme Court’s decision also did not reach the merits of the appellants' claim regarding the legitimacy of the director-by-director approach vs. analyzing the board as a collective body. Certainly a lot of attention was given to this approach, particularly after Emerging Communication, which suggested that directors with specialized knowledge may receive some heightened scrutiny. Although the Chancery Court’s decision appeared to back away from this more stringent approach, that court still assessed each Disney director individually in a manner that suggested that in order to be protected from liability, there needed to be a record reflecting that each director had sufficiently informed himself or herself. At the very least this director-by-director approach suggested that all board minutes needed to provide more robust accounts of individual director’s questions and comments. On appeal, the appellants’ claimed that such an approach was improper, and instead argued that the Chancery Court should have assessed the liability of the board as a whole. The Supreme Court declined to rule on the merits of this issue, but rejected the claim in part because appellants had not proven how the Chancery Court’s analysis was prejudicial and yielded an outcome different from a collective analysis. On the one hand the appellants’ argument appears to be taking a step back from the heightened scrutiny apparently required by the individualized approach adopted by the Chancery Court. Hence one could read the Supreme Court’s decision as essentially saying that because the appellants claim did not pass muster under a more stringent standard of review, it certainly would fail under the more lax “collective board” analysis. On the other hand, the Court’s opinion can be viewed as suggesting that there may be no real distinction in the two modes of analysis. If this view is correct, perhaps directors need not be concerned about creating individualized records of their actions.
Lots of bloggers writing about Disney ...
Larry Ribstein makes a bunch of excellent points. I will highlight two. First, he notes that fiduciary duty claims other than self-dealing will be very tough to win:
[T]he only way a board is going to be held liable for breach of fiduciary duty when it it isn't self-dealing is to (1) really not have any idea what it is doing; and (2) not have a 102(b)(7) clause in the charter; or (3) have such a clause but proceed in conscious disregard of the board's responsibility, which would be truly puzzling in the absence of self-dealing. In other words, the board will be liable for non-self-dealing conduct on a cold day in August in Miami under a blue moon.
Second, Larry provocatively asserts:
The opinion resoundingly denounces the federal approach to corporate governance in SOX. The opinion says that the court is going to trust the board's judgment as long as the board shows any sign of actually exercising this judgment.
Hmm. I am not so sure that the Delaware Supreme Court was using this case to "denounce" the feds, but I think we can safely conclude that Delaware has fairly modest aspirations for fiduciary law. And, in my view, that is a good thing.
Steve Bainbridge doesn't like Justice Jacobs' formulation of the business judgment rule. Steve is right that the business judgment rule functions as more than a procedural "presumption," and that framing the rule using that term makes it appear as "nothing more than a restatement of the basic principle that the defendant is entitled to summary judgment whenever plaintiff fails to state a prima facie case."
But I think Steve leaves the track with this statement:
[I]n the opinion (e.g., at 66) we find reference to the idea that "gross negligence (including a failure to inform one’s self of available material facts)," violates the duty of care. The word "including" would seem to imply "but not limited to," which suggests some scope for substantive review of board decisions.
Gross negligence might be evidenced by a failure to inform oneself -- indeed, the obligation to inform oneself is the core requirement of the duty of care -- but there may be other aspects of "care" that do not go to the substantive merits of the decision. For example, in Cede v. Technicolor, Inc., 634 A.2d 345, 368 (Del. 1994), the Court stated that "a director's duty of care requires a director to take an active and direct role in the context of the sale of a company from beginning to end." In the following sentence, the Court mentions the duty to gather information as a separate requirement of the duty of care. In my view, Steve is reading the wrong thing into Justice Jacobs' use of the word "including." Besides, Justice Jacobs clearly segregated the substantive review into the section on "waste."
Steve has a separate post on the duty of good faith in which he takes on the already infamous footnote 112. Steve suggests that resolution of the issue may not matter much: "It's hard to imagine a case in which the defendants would be found to
have acted in bad faith as defined by Justice Jacobs without also
having violated either their care or loyalty duties somewhere along the
line." I think that I agree with this, but I wonder whether "intentional violations of law" will become a viable category of good-faith litigation.
Speaking of "intentional violations of law," Steve asks in another post whether "intentional violation of law = bad faith." Steve writes in response to my post: "I have not seen anything in the opinion squarely so stating and, upon reflection, I think Gordon ought to be wrong - at least insofar as he may be suggesting that intentional law violations per se constitute bad faith."
Responding to the first part of his statement is easy. On page 72, Justice Jacobs describes "knowing violation[s] of law" under Section 102(b)(7) of the DGCL as an example of "subjective bad faith." Justice Jacobs also quotes approvingly from Chancellor Chandler's opinion, which states, "A failure to act in good faith may be shown ... where the fiduciary acts with the intent to violate applicable positive law." So I don't think that there is much doubt about where the Delaware courts stand on this.
As to whether this ought to be the result, Steve argues that "fiduciary obligation and the duty to act lawfully make a bad fit." It's an interesting argument, but it flies in the face of a long history of treating illegality as a form of bad faith. When I was researching The Shareholder Primacy Norm, I found this doctrine used quite commonly among 19th Century courts. It's not likely to be changed now.
As you might imagine, Elizabeth Nowicki is disappointed in the opinion, which makes her flu feel all the more oppressive. Elizabeth criticizes the Court for rejecting the appellants' claim that "directors violate their duty of good faith if they are making material decisions without adequate information and without adequate deliberation." She wonders, "am I to believe that the good court is saying that such decisions *are* acts in good faith?" Whether she believes it or not, the answer is yes.
Elizabeth's indignation has some intuitive appeal. Indeed, the Court recognizes that existence of some overlap between the duty of care and the duty of good faith, but argues that the duties should remain (?) distinct: "The conduct that is the subject of due care may overlap with the conduct that comes within the rubric of good faith in a psychological sense, but from a legal standpoint those duties are and must remain quite distinct." The reason is obvious:
To adopt a definition of bad faith that would cause a violation of the duty of care automatically to become an act or omission “not in good faith,” would eviscerate the protections accorded to directors by the General Assembly’s adoption of Section 102(b)(7).
At one time, I thought the Court might use Disney to reinvigorate Smith v. Van Gorkom, but this statement (and others like it) should put that fear to rest. Litigants will not be allowed to use the duty of good faith to outflank exculpation when the underlying behavior is nothing more than a failure to gather adequate information or a failure to act with adequate deliberation.
This new opinion has lots of little nuggets, and I will attempt to say a few more things later today. As always, your comments are most welcome.
[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 agree with RR that this is odd, and that we could have used an answer. This footnote is in deep tension with the text of the opinion. As I noted below, the Court took pains to distinguish the duty of good faith from the other traditional duties. Also, in January, I explained at length why the plaintiffs misunderstood the role of bad faith in rebutting the business judgment rule. In the opinion today, the Court made the same essential points, though more briefly. The bottom line: bad faith can be used for "rebutting the business judgment rule presumptions" and for "evaluating the availability of charter-authorized exculpation from monetary damage liability after liability has been established." (p. 40) But we don't know if it can be an independent basis for liability?
In addition, the Court describes actions that must be "proscribed" using the duty of good faith: "To protect the interests of the corporation and its shareholders, fiduciary conduct ... which does not involve disloyalty (as traditionally defined) but is qualitatively more culpable than gross negligence, should be proscribed." Does the duty serve as a "proscription" if it cannot be summoned as an independent basis for liability?
Finally, the Court notes that "highly significant consequences" flow from distinguishing the duty of care and the duty of good faith. The two consequences it discusses are exculpation under Section 102(b)(7) and indemnification under Section 145. Strange that the Court does not mention in this part of the opinion the possibility that the duty of care might be the basis of liability (at least, theoretically) while the duty of good faith might not.
All of this suggests to me that footnote 112 was an afterthought designed to secure a vote for the opinion in pursuit of unanimity. But as for why one or more of the justices perceived this to be necessary is not at all clear to me.
As Gordon and our readers have pointed out, the Delaware Supreme Court declined to address issues that it decided did not need to be addressed at this point. One interesting side issue that was raised on appeal by the appellants was whether the business judgment rule applied to officers or only directors. The appellants argued that the BJR did not apply to decisions made by mere officers. At the time, I blogged about this here and so did Steve Bainbridge. It seemed like a good time for the court to clear that question mark up once and far all.
Or not. In footnote #38, the court puts that question on ice:
From the wording of the footnote, I cannot tell whether the fact that the parties "treat both officers and directors as comparable fiduciaries. . . subject to the same fiduciary duties and standards of substantive review" has substantive importance or merely procedural impact.
These claims are asserted against the Disney defendants in their capacity as directors. The appellants also advance, as an alternative claim, an argument that Disney defendants Eisner, Litvack and Russell, are liable in their separate capacity as officers who, unlike directors, are not protected by the business judgment rule or the exculpatory provision of the Disney charter. That alternative argument is procedurally barred, because it was not fairly presented to the Court of Chancery. SUP. CT. R. 8. Indeed, the Chancellor noted in his Post-trial Opinion that the application of the business judgment to Eisner and Litvack was not contested, and that the “parties essentially treat both officers and directors as comparable fiduciaries, that is, subject to the same fiduciary duties and standards of substantive review.” Post-trial Op. at *50, n. 588. To the extent the argument is advanced against Russell, it also is not grounded in fact, because Russell was not an officer of Disney.