March 12, 2009
Opting Out of Good Faith
Posted by Andrew Lund

In my last post on Delaware's emergent good faith doctrine, I concluded that attempts to establish a usable test for distinguishing due care claims from conscious disregard claims are likely to fail.  These tests are laible to be either vague, underinclusive (so as to not capture cases of conscious disregard) or overinclusive (swallowing up simple due care claims).  The intractability of the problem assumes that there are reasons to value both due care exculpation as well as a knowledge-based culpability standard distinct from negligence or even gross negligence.  Suffice it to say, I think there are reasons to value both, though others may disagree.

So what to do?  Because of the uncertainty regarding the relative values of these competing considerations, there is a risk of regulatory error.  Ideally, the parties to each corporate contract would be allowed to make their own determinations about the appropriate level of accountability.  In this case, that would mean freeing up firms to exculpate directors for conscious disregard claims.  In that scenario, the Delaware courts would do best to establish a relatively determinate and potentially overinclusive standard for determining conscious disregard (perhaps Brett McDonnell and Claire Hill's "structural bias" idea).  Managers and shareholders would then determine whether to exculpate for care and the liberalized conscious disregard standard, care only or neither.

Of course, this solution is subject to concerns about the charter amendment process.  In my paper I try to demonstrate why that process should be reasonably trustworthy in the context of conscious disregard exculpation.  At the very least, anyone who wants to argue the other side would need to explain how conscious disregard exculpation is more problematic than due care exculpation (or else say that due care exculaption is not to be trusted either).

One final note: if the alternative is the Delaware Supreme Court adopting an underinclusive standard that truly protects due care exculpation, this solution may provide better optics for Delaware.  Those concerned about federal preemption responding to Delaware's perceived pro-director bias should feel better having to defend shareholder-approved measures rather than a court-adopted standard.

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