The so-called "fiduciary duty of good faith" is hot. In the last couple of months, I have received two working papers from professors who are trying to explain the Delaware Court of Chancery's opinion in the Disney litigation. In addition, a student on the Wisconsin Law Review has asked for my help on a note with regard to that case. Then this morning, I spent over an hour with another student who wanted to write a class paper on good faith. This is a tough issue, but I think I have it figured out. So listen closely; I'm only going to say this once.

You are probably familiar with the facts that led to the Disney litigation. After losing number-two-man Frank Wells to a helicopter crash and two other senior executives -- Jeffrey Katzenberg and Richard Frank -- to other corporations, Disney CEO Michael Eisner hired Michael Ovitz to become the second-in-command. Ovitz's employment agreement was approved by Disney's compensatoin committee, which had hired Graef Crystal for (worthless) advice. To make a long story short, neither the committee nor Crystal ever computed the amount that Disney would be required to pay Ovitz in the event of a non-fault termination. When Ovitz left the company 14 months later pursuant to a non-fault termination agreement, he took with him a severance package with about $140 million. Understandably, shareholders were upset. Some of them sued.

In the first round of litigation, the Delaware Supreme Court affirmed the Chancery Court's dismissal of the compaint -- which the Court called a "blunderbuss of a mostly conclusory pleading" -- but allowed the plaintiff to file an amended complaint with respect to the waste claim. Brehm v. Eisner, 746 A.2d 244 (Del. 2000). A claim for waste describes, in simplest terms, "'an exchange that is so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration." Glazer v. Zapata Corp., Del.Ch., 658 A.2d 176, 183 (1993).

If ever the facts supported a claim of waste, this was the case, and the Delaware Supreme Court was unable to bring itself to dismiss the claim without giving the plaintiffs another bite at the apple. Importantly, the Court also obliterated the notion of "substantive due care":

As for the plaintiffs' contention that the directors failed to exercise "substantive due care," we should note that such a concept is foreign to the business judgment rule. Courts do not measure, weigh or quantify directors' judgments. We do not even decide if they are reasonable in this context. Due care in the decisionmaking context is process due care only. Irrationality is the outer limit of the business judgment rule. Irrationality may be the functional equivalent of the waste test or it may tend to show that the decision is not made in good faith, which is a key ingredient of the business judgment rule.

This passage is crucial to understanding what subsequently happened to the doctrine of good faith in Delaware. Although the Court does not like the phrasing, "substantive due care," the idea underlying that notion remains intact. In the future, we are told, litigants and courts should call it "waste" or "bad faith."

When the case returned to the Court of Chancery, therefore, the "fiduciary duty of good faith" became the focus and was equated with something akin to irrationality. Chanceller Chandler described a board that had made no attempt at all to fulfill its obligations. (One might say that the directors acted irrationally in the sense that their failure to act could not be explained.) In Chandler's own words:

These facts, if true, do more than portray directors who, in a negligent or grossly negligent manner, merely failed to inform themselves or to deliberate adequately about an issue of material importance to their corporation. Instead, the facts alleged in the new complaint suggest that the defendant directors consciously and intentionally disregarded their responsibilities, adopting a "we don't care about the risks" attitude concerning a material corporate decision. Knowing or deliberate indifference by a director to his or her duty to act faithfully and with appropriate care is conduct, in my opinion, that may not have been taken honestly and in good faith to advance the best interests of the company. Put differently, all of the alleged facts, if true, imply that the defendant directors knew that they were making material decisions without adequate information and without adequate deliberation, and that they simply did not care if the decisions caused the corporation and its stockholders to suffer injury or loss. Viewed in this light, plaintiffs' new complaint sufficiently alleges a breach of the directors' obligation to act honestly and in good faith in the corporation's best interests for a Court to conclude, if the facts are true, that the defendant directors' conduct fell outside the protection of the business judgment rule.

And thus we see that the new formulation of the fiduciary duty of good faith is nothing new at all, but simply a reinvigoration of substantive due care. I say "reinvigoration" because substantive due care has long been considered a moribund doctrine, but this new duty of good faith could have legs. At a minimum, we see a dramatic change in the tone of the Court of Chancery, which had until this case treated the fiduciary duty of good faith with some disdain. See, e.g., Emerald Partners v. Berlin (Del. Ch. 2001) ("Although corporate directors are unquestionably obligated to act in good faith, doctrinally that obligation does not exist separate and apart from the fiduciary duty of loyalty. Rather, it is a subset or 'subsidiary requirement' that is subsumed within the duty of loyalty, as distinguished from being a compartmentally distinct fiduciary duty of equal dignity with the two bedrock fiduciary duties of loyalty and due care.").

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