February 24, 2005

Disney and Good Faith: Two Duties or Three?

As we wait for Chancellor Chandler to hand down his decision in Disney (and many of us try to decide whether to commit a weekend to reading James Stewart's new book on Disney), it's worth thinking about the "good faith" duty that has been a key theme in the case. There's a growing debate as to how this duty fits with the traditional duties of care and loyalty: is it part of the duty of loyalty, so that there are still two basic duties, or is it a third duty? At least one Delaware judge has suggested that the good faith duty is part of the duty of loyalty, while several academics (including Hillary Sale and Mel Eisenberg) have characterized it as a separate duty. Is this a difference that matters? I think it does. If the good faith duty becomes part of the duty of loyalty, the duty of loyalty will no longer be limited to conflicts of interest-- the problems that arise when a director or officer is on both sides of the table. The result will be a serious loss of clarity in one of the few areas of corporate governance that has remained relatively clear. If the good faith duty is treated as a separate duty, on the other hand, it is far more likely to remained cabined to the context that has spawned it-- exculpation clauses under section 102b-7 that protect directors from monetary liability for ordinary breaches of the duty of care. Here it can flourish or not, as occasion dictates, without infecting the traditional dichotomy between care and loyalty.

Long ago, Samuel Arsht, the leading Delaware corporate lawyer of his time (a lawyer to whom I am indebted in many ways, including my title) suggested that Delaware corporate law comes down to a single concept: good faith. I think he was right then, and is right now. But the best way to make sense of this general expectation of good faith is to treat the new, more explicit good faith obligation as a separatae duty, and to hive it off from the traditional duties of care and loyality.

Posted by David at February 24, 2005 10:24 AM | Corporate Governance