January 26, 2006
Not in Good Faith Means Not in Good Faith
Posted by Elizabeth Nowicki

"Not in Good Faith Means Not in Good Faith"

This statement should have been of the utmost importance yesterday in the appellants’ oral arguments before the Delaware Supreme Court in the Disney appeal. The meaning of “not in good faith” is the issue, in my view, on which the appellants’ could have gotten a reversal. But the phrase “not in good faith” was never uttered. Indeed, the point was never even made in passing that “Not in Good Faith Means Not in Good Faith.” I find that astounding.

Let me back up a step and observe three things before I go further:

1. Directors are obligated to act in good faith.

2. The business judgment rule’s protection is based in part on the rebuttable presumption that the director at issue acted in good faith.

3. DGCL 102(b)(7) does not protect a director from personal liability to his shareholders "for acts or omissions not in good faith."

Keeping the above three observations about good faith in mind, I am of the strong view that the appellants should have based their oral argument yesterday on “good faith.” The appellants should have maintained that Chancellor Chandler erred as a matter of law in analyzing issues of good faith by using the phrase “bad faith” as a substitute for “not in good faith.” Specifically, the Chancellor failed to assess whether the Disney directors’ acts were undertaken “not in good faith,” such that they were outside the protection of the business judgment rule presumption and DGCL 102(b)(7).

Some of you might be thinking that I must have skipped many of the 174 pages of Chancellor Chandler’s August 9, 2005, Disney opinion, as the Chancellor held, on page 133, that “the only reasonable application of the law to the facts as I have found them, is that the defendants did not act in bad faith.” But that is just my point (and I did read all 174 pages) – the Chancellor’s bad faith analysis is a misapplication of the law. Bad faith has nothing to do with anything in this case. It is the absence of good faith that is important. Respectfully, I suggest that Chancellor Chandler should have analyzed whether the plaintiffs proved that the complained of directorate decisions and actions reflected a lack of good faith. (In fairness, Chancellor Chandler acknowledged on page 120 that he was using “bad faith” because it is difficult to define and work with “good faith.”)

Not In Good Faith Does Not Mean "Bad Faith (Not In Good Faith Means Not In Good Faith, revisited)

Many jurists and academics do exactly what Chancellor Chandler did – equate an act “not in good faith” with a “bad faith” act. But “bad faith” and “not in good faith” mean two different things. By obligating a plaintiff to prove that a director acted in bad faith, the court is obligating the plaintiff to identify facts much worse than those that would establish the lack of good faith. That is to say, “bad faith” conduct is roughly conduct that is affirmatively against the interests of the corporation (such as fraudulent conduct). Good faith conduct is conduct that is in the best interest of and taken for the purpose of benefiting the corporation. So “not in good faith” conduct is conduct that is not taken for the purpose of benefiting the corporation- conduct that is not deliberately chosen as being in the best interest of the corporation. An act "not in good faith" does not have to be a nasty, fraudulent, selfish, etc. act. The phrase “not in good faith” does include these “bad faith” acts, but the phrase also includes acts that are not venal or otherwise ill-motivated, such as an abdication of duties due to time pressure.

For example, the failure of Sidney Poitier to ask for more specific information about Ovitz’s pay package and potential termination package was not an act intended by Poitier to harm the Walt Disney Co. (as best I can tell). It was not a “bad faith” act. But it was (in my view, not having the full record in front of me) an act or omission not taken in good faith. It was an omission that was not made for purposes of benefiting the corporation. The English is sticky, but you get the point. If Poitier was not acting for the purpose of benefiting the corporation – if he was not acting in the best interests of the corporation – then he was not acting in good faith.

Is This How the "Not-in-Good-Faith" Story Ends?

To finish this post out, allow me to note that I was a bit disappointed with the oral arguments in part because it is my sense (and I hope that I am wrong) that the Delaware Supreme Court will likely not be inclined to raise the issue of “not in good faith” in an opinion sua sponte. However, the precise issue of the definition of good faith and the meaning of the phrase “an act. . . not in good faith” does not often come before the Delaware Supreme Court in a manner that is teed up to allow the Court to address the definitional issues directly. My concern is that the opportunity presented by this case to get some guidance from the highest court in Delawaron “not in good faith” is not going to come around again any time soon. In the meanwhile, each time a lower court (in any jurisdiction) or an academic commits to writing the bastardizing of the phrase “not in good faith” into “bad faith,” without even acknowledging the shorthand, the momentum behind this inaccurate wordsmith work will grow. My fear is that, at some point, it will just be a given that “not in good faith” in the director liability world actually means “bad faith,” and the current grey area of director abdication of duties will by default move almost entirely beyond the reach of shareholder plaintiffs. It will then be too late to subvert the dominant paradigm. This troubles me.

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