A director's good faith

Buffalo Law Review

Volumn 55, Issue 2, 2007, Pages 457-535

  Nowicki, Elizabeth A ^a  

^a LEE UNIVERSITY   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 34548349185     PISSN: 00239356     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (213)

1. Discussions about loyalty and conflicts are deliberately omitted from this Article.
2. See Owen Moritz, Bada Boeing! CEO Out 37M, DAILY NEWS (N.Y.), Mar. 11, 2005, at 18 (discussing how former Boeing CEO, Harry Stonecipher, violated the company code of ethics when he had an affair with a company vice-president).
3. See Mark Maremont, Amid Crackdown, The Jet Perk Suddenly Looks a Lot Pricier, WALL ST. J., May 25, 2005, at A1 (discussing personal use by corporate executives of corporation-owned jets; values of the personal use were often well above $500,000 for 2004).
4. "In 1986 Carl Icahn gave this account of a directors' meeting at a big company: 'Literally, half the board is dozing off. The other half is reading the Wall Street Journal. And then they put slides up a lot and nobody can understand the slides and when it gets dark they all doze off."' Asleep in the Boardroom, WASH. POST, May 23, 2002, at A32.
5. See Constance L. Hays, As Stewart Attends Hearing, Company Studies Options, N.Y. TIMES, Mar. 9, 2004, at C1 (discussing the board of directors of Martha Stewart Living Omnimedia grappling with Martha Stewart's position in the company after she was convicted of criminal obstruction of justice).
6. See David Barboza, From Enron's Rubble, Life on a Luxury Tightrope, N.Y. TIMES, May 19, 2002, § 3, at 1 (describing how thousands of former Enron employees lost millions of dollars in retirement benefits); see also Ronald Brownstein, Enron Fallout Proves Personal Loss Can Have Big Political Consequences, L.A. TIMES, Feb. 20, 2002, at A10 (discussing how widespread increases in the diversity of stock ownership over the past twenty-five years has led to widespread interest in the Enron scandal, particularly with respect to how the stock of Enron was devastated by the scandals).
7. Many of the failures we have seen at the helm of many large corporations - much of the lax behavior and inattention in the boardroom-would be cause for termination in any other line of employment. Yet, such behavior is tolerated in the world of corporate governance. See generally Lyman P.Q. Johnson & David Millon, Recalling Why Corporate Officers Are Fiduciaries, 46 WM. & MARY L. REV. 1597 (2005) (discussing fiduciary duties in the context of the role that corporate officers and directors have played in recent corporate scandals).
8. DEL. CODE ANN. tit. 8, § 102(b)(7) (2001).
9. See ADOLF A. BERLE, JR. & GARDINER C. MEANS, THE MODERN CORPORATION AND PRIVATE PROPERTY 84-89 (1932).
10. See id.; see also DEL. CODE ANN. tit. 8, § 141(a) (2001). As a practical matter, most boards of directors of large corporations delegate their authority for managing the daily minutiae of the corporation to officers, pursuant to the authority to delegate given to directors in DGCL § 141(a) (or the equivalent in the statutory code for the state in which the corporation is incorporated). Throughout this Article, Delaware will be used as the primary state of reference for purposes of statutory analysis or close examination of case law, given that Delaware is home to 60 percent of the Fortune 500 and 50 percent of all publicly traded companies in the United States. See Delaware Division of Corporations, http://www.state.de.us/corp/default.shtml (last visited Mar. 16, 2007). Much has been written about the ramifications of Delaware's pro-management statutory and judicial efforts to encourage corporations to incorporate in Delaware, and the debate continues among academics as to whether Delaware's efforts and the responsive efforts of other states have led to a "race to the bottom" in terms of corporate management deference and protection. See, e.g., ARTHUR R. PINTO & DOUGLAS M. BRONSON, UNDERSTANDING CORPORATE LAW 14 n.52 (1999) (citing William Gary, Federalism and Corporate Law: Reflections Upon [sic] Delaware, 83 YALE L.J. 663 (1974)); accord Liggett v. Lee, 288 U.S. 517, 557-58 (1933) (Brandeis, J., dissenting). See generally 2005 Annual Report: Delaware Department of State, Department of Corporations, http://www.state.de.us/corp/2005%20doc%20ar.pdf (last visited Mar. 16, 2007) (showing statistics and discussing the State's efforts to increase the number of corporations incorporated in Delaware). While I find the "race to the bottom" discussion fascinating, it is beyond the scope of this Article. I will note, however, that I am sympathetic to Professor Lawrence Mitchell's position: "The laxity of Delaware law, or its significance, has long been a subject of dispute. With such shameful and disingenuous opinions as In re Caremark Int'l, 698 A.2d 959 (Del. Ch. 1996) and Lewis v. Vogelstein, 699 A.2d 327 (Del. Ch. 1997), I believe the matter can no longer be in dispute." Lawrence E. Mitchell, The Sarbanes-Oxley Act and the Reinvention of Corporate Governance?, 48 VILL. L. REV. 1189, 1189 n.2 (2003). Professor Mitchell reflects what was so poetically penned by other corporate law scholars almost a decade before regarding the state of Delaware corporate jurisprudence: "Predicting the course of Delaware law from prior case law is like watching clouds. They seem, at times, to take on recognizable shapes and forms, even to resemble something familiar. But you know that whatever shapes you think you see can vanish in a puff of wind." Lawrence A. Cunningham & Charles M. Yablon, Delaware Fiduciary Duty Law After QVC and Technicolor: A Unified Standard (and the End of Revlon Duties?), 49 BUS. LAW. 1593, 1626 (1994).
11. See DEL. CODE ANN. tit. 8, §141(a) (2001); Smith v. Van Gorkom, 488 A.2d 858, 872-73 (Del. 1985).
12. Useful discussions of the issues underpinning this question are contained in STEVEN M. BAINBRIDGE, CORPORATION LAW AND ECONOMICS §§ 5.2-5.3, at 194-95 (2002).
13. See Stephen M. Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 VAND. L. REV. 83, 85-86 (2004) (discussing the two competing views among academics as to which constituency's interests should prevail). The discussion of whether directors actually prioritize shareholder interests as opposed to the directors' own interests has been the fodder for much debate. Some academics embrace the "shareholder primacy model" of corporate governance, and others focus on the "director primacy model" of corporate discussion. For purposes of this discussion, neither perspective alters the fact that directors are inarguably fiduciaries for something (the corporation) or someone (the shareholders) else.
14. This discussion of the benefits to investors of their corporate management's willingness to take calculated risks that the shareholder can arguably diversify away is summarized nicely by Judge Winter in Joy v. North, 692 F.2d 880, 885-86 (2d Cir. 1982): Since shareholders can and do select among investments partly on the basis of management, the business judgment rule merely recognizes a certain voluntariness in undertaking the risk of bad business decisions. . . . The entrepreneur's function is to encounter risks and to confront uncertainty . . . [and] because profit often corresponds to the potential risk, it is very much in the interest of shareholders that the law not create incentives for overly cautious corporate decisions. Some opportunities offer great profits at the risk of very substantial losses, while other alternatives offer less risk of loss but also less potential profit. Shareholders can reduce the volatility of risk by diversifying their holdings.
15. The question of what specific label is appropriate for directors as fiduciaries - whether agent, trustee, or bailiff - is a challenging question to answer. Traditionally, corporate officers and directors have been viewed as agents. See, e.g., FLOYD R. MECHEM, A TREATISE ON THE LAW OF AGENCY 34 (1889) ("[O]nly through the employment of agents [can] the executive functions of the corporation ... be exercised."); FRANCIS B. TIFFANY, HANDBOOK OF THE LAW OF PRINCIPAL AND AGENT 104 (1903) ("[A] corporation . . . can act only through the intervention of agents."); John W. Pratt & Richard J. Zeckhauser, Principles and Agents: An Overview, in PRINCIPALS AND AGENTS: THE STRUCTURE OF BUSINESS 1, 2 (John W. Pratt & Richard J. Zeckhauser eds., 1985) ("The corporate executive ... is an agent for the shareholders."). However, some scholars argue that officers and directors cannot be agents because the relationship between the director and the shareholder (the "agent" and the "principal," as it were) is not a product of contract, as it would be in the traditional agency relationship. See Robert C. Clark, Agency Costs Versus Fiduciary Duties, in PRINCIPALS AND AGENTS: THE STRUCTURE OF BUSINESS, supra, at 55, 56 ("Directors are not agents of the corporation but are sui generis . . . neither [are] directors . . . agents of the stockholders.") (italicization added). Dean Clark seems to view the relationship between directors and the corporation or directors and the stockholders as one of both contract and statute as opposed to agency, but he seems unable to pin down a useful characterization of the relationship, if not an "agency" relationship. See id. at 56-59. I suppose the historical treatment of the manager/corporate relationship as one of agency can be partially reconciled with Dean Clark's position by viewing the manager and corporation/stockholder relationship as one of implied contract and, therefore, agency, as was done in Protection Life Ins. Co. v. Foote, 79 Ill. 361, 368-69 (1875): [I]t must be presumed that each person, in becoming a member of the company, impliedly consents that it shall be represented by such officers and agents as are reasonably necessary for the transaction of its business, and that they shall possess the powers and perform the duties ordinarily possessed and performed by such officers and agents. In any event, the characterization of the relationship between a corporation and its managers ("managers" meaning both directors and officers) as an agency relationship has a long history. See 2 VICTOR MORAWETZ, A TREATISE ON THE LAW OF PRIVATE CORPORATIONS § 575, at 547 (2d ed. 1886) ("Corporations almost invariably act through agents."). Indeed, while a corporation is a legal entity, able to contract and engage in other legal acts on its behalf, "[t]here are few acts which a corporation aggregate can possibly perform without the intervention of an agency of some kind." Id. However, case law also indicates that the director-shareholder-corporation relationship involves both a trust relationship and an agency relationship: "[T]he ordinary rules of law relating to an agent are applicable in considering the acts of a board of directors in behalf of a corporation when dealing with third persons . . . [whereas] [t]he relation of the directors to the stockholders is essentially that of trustee and cestui que trust." People ex rel. Manice v. Powell, 94 N.E. 634, 637 (N.Y. 1911) (italicization added). Yet the Restatement of Trusts notes that: There are many similarities and also differences in the roles and duties of trustees and those of corporate officers or directors, partners of various types of partnerships, and member-managers of limited-liability companies. For example, trustees and corporate officers and directors, as fiduciaries, manage the affairs, respectively, of the trust or the corporation for the benefit of the beneficiaries or the shareholders. Corporate officers and directors, however, do not hold title to the property of the corporation and therefore are not trustees; accordingly their fiduciary duties are not within the scope of this Restatement. RESTATEMENT (THIRD) OF TRUSTS § 5 cmt. g (2003). Thus, there are at least three ways to characterize the fiduciary relationship between a director and stockholders: pure agency (director is an agent, stockholder is the principal); pure trust (the director is a trustee with respect to the shareholder, who is the principal); and a combination of both (director is an agent with respect to the corporation as principal, and the director is a trustee with respect to his shareholders). Where does this ambiguity leave us? Nowhere of great import, as it is undisputed that directors hold some sort of fiduciary relationship with respect to their corporation and its shareholders. Moreover, the obligations of agents and...
16. See BAINBRIDGE, supra note 12, § 6.2, at 242-43.
17. The two fiduciary duties of directors have historically been the duty of care and the duty of loyalty. See In re Walt Disney Co. Derivative Litig., 825 A.2d 275, 286 (Del. Ch. 2003). Interestingly, however, over the past several years, the Delaware Supreme Court has, on occasion, referred to the fiduciary duties as a "triad," including the duties of care, loyalty, and good faith. See Emerald Partners v. Berlin, 787 A.2d 85, 90 (Del. 2001) ("The directors of Delaware corporations have a triad of primary fiduciary duties: due care, loyalty, and good faith."). This third duty-the duty of good faith-appears to have become a "duty" (which I take to mean something beyond merely an obligation, and something for which independent recourse exists) essentially overnight. Compare Emerald Partners, 787 A.2d at 90, and Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993) (referring to "the triads of [a directors'] fiduciary duty-good faith, loyalty or due care"), with Paramount Commc'n Inc. v. QVC Network Inc., 637 A.2d 34, 43 (Del. 1994) ('"[T]he directors must act in accordance with their fundamental duties of care and loyalty.'" (quoting Barkan v. Amsted Indus., Inc., 567 A.2d 1279, 1286 (Del. 1989))), and Citron v. Fairchild Camera & Instrument, 569 A.2d 53, 54 (Del. 1989) ("Eight of Fairchild's nine directors are charged with breach of their fiduciary duties of good faith and due care . . . ."). The Delaware Supreme Court has never explained where they pulled this third duty from, and, indeed, more than one jurist on the Delaware Chancery Court has questioned the appearance of this new "duty." In addition, the Delaware Supreme Court has not been consistent in including this duty of good faith in its recitations of a director's fiduciary duties. While I certainly agree that directors have the obligation to act in good faith, the obligation to act in good faith has historically been subsumed both in the duty of care and the duty of loyalty as opposed to being a stand-alone duty. See Continuing Creditors' Comm. of Star Telecomm. Inc. v. Edgecomb, 385 F. Supp. 2d 449, 460 n.9 (D. Del. 2004) ("Although the Plaintiff also invokes the duty of good faith as separate from the duty of loyalty, Delaware case law states that the two duties are identical.").
18. For purposes of this Article, I am ignoring the duty of loyalty. Professor Lyman Johnson, however, makes a convincing argument that the duty of care issues that come up in cases such as Smith v. Van Gorkom, 488 A.2d 585 (Del. 1985), and In re Walt Disney Co. Derivative Litig., 825 A.2d at 286, could also be addressed as duty of loyalty issues. Are you being loyal, Professor Johnson would ask, and are you being faithful, when you (the director) pay little attention to the compensation of senior executives (for example)? In a more user-friendly hypothetical, would we call a friend, whom we have authorized to use our money, to pay our dog sitter while we are on vacation "loyal" if that friend gave the dog sitter a $200 tip just because the dog sitter showed up every day (like she was obligated to do anyway)? No. Our friend was not loyal; she was frittering away our money needlessly. If we view "loyal" conduct in the director context the way we view "loyal" conduct in real life-faithful conduct for the benefit of the one we are loyal to-then many "duty of care" fact patterns could just as well be viewed as "duty of care" cases. See Lyman Johnson, After Enron: Remembering Loyalty Discourse in Corporate Law, 28 Del. J. Corp. L. 27 (2003); see also Johnson & Millon, supra note 7 (discussing fiduciary duties in the context of the role that corporate officers and directors have played in recent corporate scandals).
19. Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125, 130 (Del. 1963); accord 1 DENNIS J. BLOCK ET AL., THE BUSINESS JUDGMENT RULE: FIDUCIARY DUTIES OF CORPORATE DIRECTORS 109 (5th ed. 1998) ("[T]he duty of care requires that directors exercise the care that a person in a like position would exercise under similar circumstances."). Some states (such as New York and California) have codified the standard of conduct for directors, while other states (such as Delaware) have no such statutory provisions. See CAL. CORP. CODE § 309 (West 2006); N.Y. BUS. CORP. LAW § 717 (McKinney 2001). See generally 1 AM. LAW INST., PRINCIPLES OF CORPORATE GOVERNANCE § 4.01(a) (1994).
20. See MELVIN ARON EISENBERG, CORPORATIONS AND OTHER BUSINESS O RGANIZATIONS 544-45 (8th ed. 2000) ("On their face, the duties of directors are fairly demanding, insofar as they are measured by reasonability. In practice, however, the standards of review applied to the performance of these duties are less stringent than the standards of conduct on which the duties are based."). Judge Winter of the Second Circuit similarly went so far as to admit in an opinion: While it is often stated that corporate directors and officers will be liable for negligence in carrying out their corporate duties, all seem agreed that such a statement is misleading. ... [A] corporate officer who makes a mistake in judgment as to economic conditions, consumer tastes or production line efficiency will rarely, if ever, be found liable for damages suffered by the corporation. Joy v. North, 692 F.2d 880, 885 (2d Cir. 1982) (citation omitted).
21. See EISENBERG, supra note 20, at 546.
22. See id.
23. See id. at 545.
24. See E. Norman Veasey, Access to Justice: The Social Responsibility of Lawyers, 12 WASH. U. J.L. & POL'Y 1, 6 (2003).
25. Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (citing Kaplan v. Centex Corp., 284 A.2d 119, 124 (Del. Ch. 1971); Robinson v. Pittsburgh Oil Refinery Corp., 126 A. 46 (Del. Ch. 1924)), overruled by Brehm v. Eisner, 746 A.2d 244 (Del. 2000) (overruling on other grounds).
26. See id. at 812; see also EISENBERG, supra note 20, at 545.
27. See EISENBERG, supra note 20, at 545. The business judgment rule presumption, with its very deferential "irrationality" standard of review, serves a sound policy goal: it encourages directors to exercise their discretion in making decisions based on then-existing facts without fear of being second-guessed. See id. at 547-48. See generally Bainbridge, supra note 13 (discussing the two competing views among academics as to which constituency's interests shall prevail). A lenient measure of post hoc review protects against hindsight bias: As a result of a systematic defect in cognition known as the hindsight bias, however, under a reasonableness standard of review fact-finders might too often erroneously treat decisions that turned out badly as bad decisions, and unfairly hold directors liable for such decisions. Experimental psychology has shown that in hindsight people consistently exaggerate the ease with which outcomes could have been anticipated in foresight. EISENBERG, supra note 20, at 547-48; see Joy v. North, 682 F.2d 880, 886 (2d Cir. 1982) ("[C]ourts recognize that after-the-fact litigation is a most imperfect device to evaluate corporate business decisions. The circumstances surrounding a corporate decision are not easily reconstructed in a courtroom years later . . . ."). A court will not, therefore, second-guess a decision made by a director that, in hindsight, was merely wrong, a mistake, or an unfortunate choice made when faced with multiple options. See BLOCK ET AL., supra note 19, at 109. Although the relatively recent Delaware case of Aronson v. Lewis, 473 A.2d at 805, is usually cited to support this deference, this concept is actually not a modern one. See, e.g., MECHEM, supra note 15, § 502, at 337-38 ("The law does not presume negligence on the part of the agent. On the other hand, it presumes that the agent has done his duty, until the contrary appears, and the burden of proof is upon him who alleges a misfeasance, to establish it."). This deference to directors is sensible, because we want directors to make somewhat "risky" decisions, given that "potential profit often corresponds to the potential risk." See Joy, 692 F.2d at 886 (discussing the risk and reward calculus that weighs in favor of directors sometimes making riskier decisions to achieve greater benefits for the shareholders because shareholders can diversify away a corporation's risk); see also EISENBERG, supra note 20, at 540-44; Dennis J. Block & H. Adam Prussin, The Business Judgment Rule and Shareholder Derivative Actions: Viva Zapata?, 37 BUS. LAW. 27, 32 (1981). Shareholders, knowing of this risk-reward calculus, can either elect not to buy stock, given that the market offers an array of other investment vehicles, or shareholders can mitigate the risk inherent in any given investment by diversifying their investment portfolio and holding many different stocks in disparate industries. See Joy, 692 F.2d at 885-86. This diversification or voluntary decision to invest in stock with an understanding of the general volatility of the market frees the directors of each individual corporation to more broadly make appropriately risky decisions. See WILLIAM A. KLEIN & JOHN C. COFFEE, JR., BUSINESS ORGANIZATION AND FINANCE: LEGAL AND ECONOMIC PRINCIPLES 233-35 (8th ed. 2002); see also EISENBERG, supra note 20, at 540-42 (quoting KLEIN & COFFEE, supra). The Second Circuit in Joy v. North, 692 F.2d at 886, went so far as to say that "[g]iven mutual funds and similar forms of diversified investment, courts need not bend over backwards to give special protection to shareholders who refuse to reduce the volatility of risk by not diversifying." A presumption of judicial abstention from substantive review of directors' decisions encourages directors to make these decisions as quickly as business imperatives require without the hamstring of liability fears. EISENBERG, supra note 20, at 540-44.
28. As noted above, the four factual assumptions identified in Aronson v. Lewis as justifying the business judgment rule presumption are (1) a decision having been made, (2) after the directors became reasonably informed about the matter at issue, and (3) the directors acted in good faith, (4) without any self-interest or conflict. Aronson, 473 A.2d at 812; accord In re Caremark Int'l Inc. Derivative Litig., 698 A.2d 959, 967 (Del. Ch. 1996) (stating that the business judgment presumption is based on the assumption that "the decision made was the product of a process that was either deliberately considered in good faith or was otherwise rational"); see also BLOCK ET AL., supra note 19, at 110; EISENBERG, supra note 20, at 545.
29. See EISENBERG, supra note 20, at 545-46; see also Aronson, 473 A.2d at 812.
30. See BLOCK ET AL., supra note 19, at 112 n.20; EISENBERG, supra note 20, at 545-46 (discussing Cede & Co. v. Technicolor, Inc., 634 A.2d 345 (Del. 1993)); see also McGowan v. Ferro, 859 A.2d 1012, 1028 (Del. Ch. 2004) ("If the director defendants had disabling conflicts of interest or acted in bad faith . . . they would have to prove the fairness of the transaction."). Given that Professor Eisenberg cites the Cede case to support his position that the standard of review regarding a duty of care claim is based on irrationality when a director is outside the protections of the business judgment rule, let me use this opportunity to note that the Cede case is the typical Delaware case I was thinking of in my introduction when I noted that the Delaware courts often seem befuddled. See supra note 10. In the Cede opinion, the court states that "the breach of the duty of care ... is sufficient to rebut the business judgment rule." Cede, 634 A.2d at 371. The court goes on to say that "[a] breach of either the duty of loyalty or the duty of care rebuts the presumption" of the business judgment rule. Id. What does that mean? It is my view (and I thought that of Professor Eisenberg, based on page 545 of his text) that the reverse of what the Cede court said is true. That is to say, if the business judgment rule is rebutted, the court will review an alleged duty of care claim on a "fairness and reasonableness" standard. If the claim is not fair and reasonable, the directors will be liable for breaching their duty of care. The Cede court cites the Van Gorkom opinion to support its backward position. See Cede, 634 A.2d at 368 (citing Smith v. Van Gorkom, 488 A.2d 858, 893 (Del. 1985)). The Cede court cites the final page of the majority opinion in Van Gorkom, wherein that court notes: [T]he directors of Trans Union breached their fiduciary duty to their stockholders (1) by their failure to inform themselves of all information reasonably available to them and relevant to their decision to recommend the Pritzker merger; and (2) by their failure to disclose all material information such as a reasonable stockholder would consider important in deciding whether to approve the Pritzker offer. Van Gorkom, 488 A.2d at 893. I do not read this language to say, as the Cede court suggests, that a breach of the duty of care rebuts the business judgment rule presumption. Rather, I read this language-the above language quoted from page 893 of the Van Gorkom opinion-to say, if anything, the opposite: the failure to satisfy the third of the business judgment rule prerequisites (becoming reasonably informed) leads to a breach of the duty of care. Of course, the Van Gorkom opinion is no model of clarity itself. The above quoted language from Van Gorkom would have been made more clear (and thereby useful as precedent) and more representative of the law if it read as follows: The Trans Union directors removed themselves from the generous protections of the business judgment rule by being grossly negligent in their efforts to become informed. By failing to become informed about all material reasonably available to them and relevant to their decision to recommend the Pritzker merger, thereby being grossly negligent and relinquishing the presumption's protection, the director's alleged breach of the duty of care will be reviewed against a reasonable and fairness standard. And we conclude that the directors of Trans Union did not meet this standard, and thereby breached their duty of care, when they (1) failed to inform themselves of all information reasonably available to them and relevant to their decision to recommend the Pritzker merger; and (2) failed to disclose all material information such as a reasonable stockholder would consider important in deciding whether to approve the Pritzker offer. Such failings are neither fair nor reasonable. Mind you, the Van Gorkom opinion does not include the second half of my duty of care calculus: the opinion does not say "by being grossly negligent in their efforts to become informed" and thereby forfeiting the business judgment rule presumption, "the director's alleged breach of the duty of care will be reviewed against a reasonable and fairness standard." The opinion says nothing of that at all. Rather, by only its actual language, the court seems to say that once the business judgment rule presumption is rebutted, the directors are liable for breaching their duty of care. Yet, that cannot be. It seems to me that the value of a presumption is to shift the burden off of the director to allow him to be free of the fear of always being second-guessed with hindsight. Once the burden is shifted back to the defendant, however, this now-burdened party can still prove he is not liable (by establishing fairness and reasonableness), as opposed to immediately being held liable. That is the point of burdens and burden-shifting; they deal with proof....
31. See Aronson, 473 A.2d at 812: [T]o invoke the [business judgment] rule's protection directors have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them. Having become so informed, they must then act with requisite care in the discharge of their duties. While the Delaware cases use a variety of terms to describe the applicable standard of care, our analysis satisfies us that under the business judgment rule director liability is predicated upon concepts of gross negligence.
32. Most states in the union have a statutory provision limiting a director's personal liability for duty of care breaches. See ALA. CODE § 10-2B-2.02(b)(3) (1999) (adopted in 1994); ALASKA STAT. § 10.06.210(1)(N) (2006) (adopted in 1988); ARIZ. REV. STAT. ANN. § 10-202(B)(1) (2007) (adopted in 1994); ARK. CODE ANN. § 4-27-202(b)(3) (2001) (adopted in 1987); CAL. CORP CODE § 204(a)(10) (West 2007) (adopted in 1987); COLO. REV. STAT. ANN. § 7-108-402(1)-(2) (West 2006) (adopted in 1993); CONN. GEN. STAT. ANN. § 33-636(b)(4)-(5) (West 2005) (adopted in 1994); DEL. CODE ANN. tit. 8, § 102(b)(7) (2001) (adopted in 1986); GA. CODE ANN. §14-2-202(b)(4) (2003) (adopted in 1988); IDAHO CODE ANN. § 30-1-202(2)(d) (2006) (adopted in 1997); 805 ILL. COMP. STAT. 5/2.10 (2005) (adopted in 1994); IOWA CODE § 490.832 (2007) (adopted in 1989); KAN. STAT. ANN. § 17-6002(b)(8) (1995) (adopted in 1987); KY. REV. STAT. ANN. § 271B.2-020 (LexisNexis 2003) (adopted in 1988); LA. REV. STAT. ANN. §12:24(C)(4) (1994) (adopted in 1987); ME. REV. STAT. ANN. tit. 13-C, § 202(2)(D) (2004) (adopted in 2001); MD. CODE ANN., CORPS. & ASS'NS §§ 2-104(b)(8), 2-405.2 (LexisNexis 1999); MD. CODE ANN., CTS. & JUD. PROC. § 5-418(a) (LexisNexis 2006) (adopted in 1997); MASS. GEN. LAWS ch. 156B, §13 (2006) (adopted in 1986); MICH. COMP. LAWS §450.1209 (2006) (adopted in 1987); MINN. STAT. § 300.64 (2006) (adopted in 1987); MISS. CODE ANN. §79-4-2.02 (2006) (adopted in 1991); MO. REV. STAT. § 351.055 (2006) (adopted in 2000); MONT. CODE ANN. §35-2-213(2)(e) (2005) (adopted in 1991); NEB. REV. STAT. § 21-2018(2)(d) (1997) (adopted in 1995); N.H. REV.-STAT. ANN. § 293-A:2.02 (2005) (adopted in 1992); N.J. STAT. ANN. § 14A:2-7(3) (West 2003) (adopted in 1987); N.Y. BUS. CORP. LAW § 402(b) (McKinney 2003) (adopted in 1987); N.C. GEN. STAT. § 55-2-02(b)(3) (2006) (adopted in 1989); N.D. CENT. CODE §10-19.1-50(5) (2005) (adopted in 1993); OKLA. STAT. ANN. tit. 18, §1006(B)(7) (West 1998) (adopted in 1987); OR. REV. STAT. § 60.047(2)(d) (2005) (adopted in 1987); R.I. GEN LAWS § 7-1.2-202(b)(3) (Supp. 2006) (adopted in 2004); S.D. CODIFIED LAWS §47-2-58.8 (2000) (adopted in 1987); TENN. CODE ANN. §§ 48-12-102(a)(3) (2002) (adopted in 1987); TEX. REV. CIV. STAT. ANN. art. 1302, § 7.06(B) (2003) (adopted in 1987); UTAH CODE ANN. §16-10a-841 (2005) (adopted in 1992); VT. STAT. ANN. tit. 11A, §2.02(b)(4) (1997) (adopted in 1993); VA. CODE ANN. § 13.1-692.1(A) (2006) (adopted in 1988); WASH. REV. CODE § 23B.08.320 (1994) (adopted in 1989); W. VA. CODE ANN. § 31D-2-202(b)(4) (LexisNexis 2003 & Supp. 2006) (adopted in 2002); WYO. STAT. ANN. § 17-16-202(b)(iv) (2005) (adopted in 1989).
33. DEL. CODE ANN. tit. 8, § 102(b)(7) (2001). A few states offer statutory duty of care protection that differs slightly from Delaware's protection, but the differing statutes still serve to limit the personal liability exposure of the directors. For example, Virginia's statutory insulation offers directors protection via a monetary liability cap. The Virginia code limits the recoverable damages that can be garnered from any one director in any proceeding brought by, or in the right of, the corporation or its shareholders to the lesser of the monetary cap specified in the articles of incorporation or shareholder-approved by-laws, or the greater of $100,000 or the cash compensation received by the director from the corporation over the twelve months prior to the actions alleged to be fiduciary violations. VA. CODE ANN. § 13.1-692.1(A) (2006).
34. I say that DGCL § 102(b)(7) allows corporations "to clearly" insulate their directors against liability, because the reality is that the business judgment rule presumption as discussed in Aronson, 473 A.2d at 812, does, in effect, exactly the same thing as § 102(b)(7). See Emerald Partners v. Berlin, 787 A.2d 85, 91 (Del. 2001) ("The statutory enactment of Section 102(b)(7) was a logical corollary to the common law principles of the business judgment rule."). Apparently corporate directors wanted even more assurances than the business judgment rule presumption offered.
35. See Malpiede v. Townson, 780 A.2d 1075, 1092 (Del. 2001) (quoting Emerald Partners, 726 A.2d at 1223).
36. DGCL § 102(b)(7) does not prohibit a plaintiff stockholder from suing a director to seek injunctive relief.
37. See Malpiede, 780 A.2d at 1092-93. A defendant director can raise a DGCL § 102(b)(7) defense "on a Rule 12(b)(6) motion to dismiss (with or without the filing of an answer), a motion for judgment on the pleadings (after filing an answer), or a motion for summary judgment (or partial summary judgment) under Rule 56 after an answer, with or without supporting affidavits." Id. at 1092 (Citations omitted); accord Emerald Partners, 787 A.2d at 91 n.85.
38. See Emerald Partners, 787 A.2d at 91-92; E. Norman Veasey, Musings on the Dynamics of Corporate Governance Issues, Director Liability Concerns, Corporate Control Transactions, Ethics, and Federalism, 152 U. PA. L. REV. 1007, 1010-11 (2003).
39. Again, recall that I do not support the position taken by some that directors have three fiduciary duties, this new "duty of good faith" being the third. See supra note 17.
40. See supra note 27 and accompanying text.
41. I have not come across a case where a defendant failed an irrationality analysis.
42. See supra note 28.
43. See, e.g., In re Walt Disney Co. Derivative Litig., 825 A.2d 275, 286 (Del. Ch. 2003).
44. Despite my statement in the text acceding to the basic majority view on what DGCL § 102(b)(7) means, I have long been of the view that DGCL § 102(b)(7) does not actually insulate against duty of care violations based on a director's obligation to act in good faith. Phrased differently, as I read Aronson together with DGCL § 102(b)(7), a stockholder in a corporation with a DGCL § 102(b)(7) provision in its charter cannot sue for a duty of care violation if the claim is based on the director's failure to become adequately informed prior to making a decision. However, I vary from the majority, it seems, in that I read the "good faith" language in DGCL § 102(b)(7) as leaving room for duty of care claims that are based on allegations of the absence of good faith, as opposed to allegations that the directors were grossly negligent in becoming informed. I have yet to find an academic who mirrors my view. For that reason, for purposes of this discussion, it is easier, and makes no real difference, to accord with the majority view.
45. The terms of these statutes usually exclude duty of loyalty breaches, and intentional violations of the law, both of which are beyond the scope of this discussion.
46. "Good faith" becomes an issue in at least two contexts when dealing with director liability for fiduciary failings. First, recall from above, that good faith is a factual prerequisite to the protections of the business judgment rule presumption. If a plaintiff can establish that a director did not act in good faith, the director defendant will not be afforded the protection of the business judgment rule presumption, and the director's actions will be reviewed under a reasonableness and fairness analysis. Emerald Partners v. Berlin, 787 A.2d 85, 91 (Del. 2001) ("If the presumption of the business judgment rule is rebutted . . . the burden shifts to the director defendants to prove to the trier of fact that the challenged transaction was 'entirely fair' to the shareholder plaintiff."). Second, the text of most state exculpatory statutes such as DGCL § 102(b)(7) does not protect directors from personal liability for acts taken "not in good faith." DEL. CODE ANN. tit. 8, § 102(b)(7) (2001). A corporation can include in its certificate of incorporation "[a] provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty," but such provision cannot eliminate or limita director's liability "for acts or omissions not in good faith." Id. In addition, some would maintain that a director's duty of loyalty is breached if the director fails to act in good faith, such that a good faith assessment is relevant for the review of an alleged duty of loyalty claim. See In re Gaylord Container Corp. S'holders Litig., 753 A.2d 462, 476 (Del. Ch. 2000) (noting that the Delaware Supreme Court has "equate [d] good faith with loyalty"). Some would also argue that good faith is its own independent fiduciary duty, see supra note 17, and some take the position that good faith is an ephemeral concept binding directors in all that they do. See David Rosenberg, Making Sense of Good Faith in Delaware Corporate Fiduciary Law: A Contractarian Approach, 29 DEL. J. CORP. L. 491, 513 (2004). For purposes of this Article, I will focus on only the first two situations in which good faith becomes relevant, as I am not convinced of the validity of the three other invocations of the "good faith" language.
47. This "good faith" obligation imposed on directors is nothing new, as fiduciaries have always been obligated to act in good faith, and directors qua fiduciaries are no exception. For this reason, it is interesting that the Delaware Supreme Court has not yet defined "good faith" in the context of director liability, given the reputation of the Court to be the ultimate arbiter of corporate law. To be fair, I have found no evidence that the Delaware Supreme Court has been directly asked to define good faith. Indeed, in the recent Disney shareholder litigation where the issue of whether the directors acted in good faith was crucial, plaintiff-appellant's counsel did not propose an affirmative definition of good faith even one time. See Transcript of Oral Argument, In re Walt Disney Co. Derivative Litig., 906 A.2d 27 (Del. 2006) (No. 411) (on file with author). The fact, then, that no such firmly rooted definition of good faith exists in the director liability context affords me the luxury to work through a principled calculus below to generate a sensible, useful definition of good faith.
48. That being said, much has recently been published regarding a director's good faith obligation. In addition to the many law review articles cited throughout this Article, note also: Robert Baker, In Re Walt Disney: What It Means to the Definition of Good Faith, Exculpatory Clauses, and the Nature of Executive Compensation, 4 FLA. ST. U. BUS. REV. 261 (2004); Christopher M. Bruner, Good Faith, State of Mind, and the Outer Boundaries of Director Liability in Corporate Law, 41 WAKE FOREST L. REV. 1131 (2006); Tara L. Dunn, The Developing Theory of Good Faith in Director Conduct: Are Delaware Courts Ready to Force Corporate Directors to Go Out-of-Pocket After Disney IV?, 83 DENV. U. L. REV. 531 (2005); Andrew S. Gold, A Decision Theory Approach to the Business Judgment Rule: Reflections on Disney, Good Faith, and Judicial Uncertainty, 66 MD. L. REV. 398 (2007); Renee M. Jones, Law, Norms, and the Breakdown of the Board: Promoting Accountability in Corporate Governance, 92 IOWA L. REV. 105 (2006); Janet E. Kerr, Developments in Corporate Governance: The Duty of Good Faith and Its Impact on Director Conduct, 13 GEO. MASON L. REV. 1037 (2006); Elizabeth A. Nowicki, Fiduciary Duties and Standards of Review in the Context of Going Private Transactions, 1597 PRAC. L. INST. CORP. 147 (2007); Matthew R. Berry, Note, Does Delaware's Section 102(b)(7) Protect Reckless Directors From Personal Liability? Only If Delaware Courts Act in Good Faith, 79 WASH. L. REV. 1125 (2004); David H. Cook, Comment, The Emergence of Delaware's Good Faith Fiduciary Duty: In re Emerging Communications, Inc. Shareholders Litigation, 43 DUQ. L. REV. 91 (2004); Jaclyn J. Janssen, Note, In Re Walt Disney Company Derivative Litigation: Why Stockholders Should Not Put Too Much Faith in the Duty of Good Faith to Enhance Director Accountability, 2004 WIS. L. REV. 1573 (2004).
49. Friedrich K. Juenger, Listening to Law Professors Talk About Good Faith: Some Afterthoughts, 69 TUL. L. REV. 1253, 1254 (1995). I am not sympathetic to the argument that "good faith" is too difficult to define. "[T]he words in question, 'in good faith' are clear and unambiguous, are words in common usage, and therefore need not be defined." State v. A.G., 670 S.W.2d 516, 517 (Mo. Ct. App. 1984). '"The phrase 'good faith' in common usage has a well-defined and generally understood meaning, being ordinarily used to describe that state of mind denoting honesty of purpose, freedom from intention to defraud, and, generally speaking, means being faithful to one's duty or obligation."' Id. (quoting People v. Nunn, 296 P.2d 813, 818 (Cal. 1956)).
50. See Sean J. Griffith, Good Faith Business Judgment: A Theory of Rhetoric in Corporate Law Jurisprudence, 55 DUKE L.J. 1, 15-16 (2005) ("The mystery of good faith has been a part of Delaware law for as long as the business judgment rule. It has been an express component of the rule at least since the oft-cited Aronson formulation appeared in 1984 and an explicit part of the statute [DGCL § 102(b)(7)] since it was amended in 1987. Yet the concept was unexplored for almost two decades, until the chancery court's development of good faith jurisprudence in 2003.").
51. See id.
52. See generally Melvin A. Eisenberg, The Duty of Good Faith in Corporate Law, 31 DEL. J. CORP. L. 1 (2006).
53. See generally Joseph Scott Miller & James A. Hilsenteger, The Proven Key: Roles and Rules for Dictionaries at the Patent Office and the Courts, 54 AM. U. L. REV. 829 (2005).
54. BLACK'S LAW DICTIONARY 701 (7th ed. 1999). However, beneath the definition is a paragraph of text that seems to imply that good faith is not so easily defined. The paragraph quotes the Second Restatement of Contracts in which it is noted that '"[t]he phrase 'good faith' is used in a variety of contexts, and its meaning varies somewhat with the context.'" Id. (quoting RESTATEMENT (SECOND) OF CONTRACTS § 205 cmt. a (1981)).
55. Although the language in the definition refers to "[a] state of mind," see supra text accompanying note 54, it seems that courts would have to view the acts at issue objectively, as opposed to using the subjective viewpoint of the director under fire, if good faith is going to have any value in guiding a director's fulfillment of his fiduciary duties.
56. These facts represent a generalization of the facts implicated in the recent Disney director litigation related to the hiring and firing of Michael Ovitz as Disney President. See infra Part II.B.4.
57. See, e.g., Amoco Prod. Co. v. S. Ute Indian Tribe, 526 U.S. 865, 874 (1999) (determining the plain meaning of the word "coal" by consulting a dictionary); State v. Bradford, 368 So. 2d 317, 325 (Ala. Crim. App. 1979) (DeCarlo, J., dissenting) (quoting People v. Nunn, 296 P.2d at 818) (citing both Words and Phrases and Bouvier's Law Dictionary)). See generally John F. Manning, Textualism and the Equity of the Statute, 101 COLUM. L. REV. 1 (2001) (discussing the propriety of reading statutes in a manner true to the words within the statute).
58. "The term 'good faith' is not easily defined and the requirement is not capable of pragmatic and mechanical application. In the last analysis it is the same as pornography, one cannot define it but will readily recognize it when one sees it." In re Noll, 172 B.R. 122, 124 (Bankr. D. Fla. 1994) (citing Jacobellis v. Ohio, 378 U.S. 184, 197 (1964) (Stewart, J., concurring)).
59. State v. A.G., 670 S.W.2d 516, 517 (Mo. Ct. App. 1984) (quoting People v. Nunn, 296 P.2d 813, 818 (Cal. 1956) (defining "good faith" in a statute criminalizing the unlawful sale of narcotics by physicians)).
60. See Bradford, 368 So.2d at 325 (quoting Smith v. State, 13 N.E.2d 562, 565 (Ind. 1938)) (defining "good faith" in a statute criminalizing the unlawful sale of narcotics by physicians).
61. Id. (quoting State v. Weeks, 335 So.2d 274, 277 (Fla. 1976) (reversing prior decision holding doctor guilty of selling narcotic drugs) (internal citations omitted)).
62. Ault v. State, 668 P.2d 951, 956 (Alaska 1984) (defining a good faith purchaser of property); accord Estate of Skvorak v. Sec. Union Title Ins. Co., 89 P.3d 856, 861 (Idaho 2004) (defining the good faith purchaser of property); Beard v Dansty, 2 S.W. 701, 702 (Ark. 1886) (defining good faith belief of ownership in a land dispute).
63. Wood v. Strickland, 420 U.S. 308, 321 (1975) (defining "good faith" regarding the immunity standard in a 42 U.S.C. § 1983 action against school administrators).
64. See GA. CODE ANN. § 51-7-80 (2000) (defining "good faith" in the context of abusive litigation).
65. Id.
66. United States v. Shapiro, 43 F. Supp. 927, 929 (S.D. Cal. 1942) (defining good faith required of aliens seeking naturalization).
67. In re Walway Co., 69 B.R. 967, 973 (Bankr. E.D. Mich. 1987) (citing Cap Santa Vue Inc. v. NLRB, 424 F.2d 883, 889 (D.C. Cir. 197O)) (stating that debtor must act in good faith in an attempt to reach an agreement).
68. Serv. Employees Int'l Local Union 316 v. State Educ. Labor Relations Bd., 505 N.E.2d 418, 424 (111. App. Ct. 1987) (describing good faith bargaining in an unfair labor practice dispute).
69. W. Hartford Educ. Ass'n v. DeCourcy, 295 A.2d 526, 538 (Conn. 1972) (describing board of education's duty to negotiate in good faith).
70. Van Bibber v. Norris, 404 N.E.2d 1365, 1373 (Ind. Ct. App. 1980).
71. IND. CODE ANN. § 26-1-1-201 (LexisNexis 2006) (defining "good faith" in Indiana transactions).
72. Universal C.I.T. Credit Corp. v. Shepler, 329 N.E.2d 620, 623 (Ind. Ct. App. 1975) (defining creditor's obligation to investigate in good faith the security of the indebtedness); accord AquaSource, Inc. v. Wind Dance Farm, Inc., 833 N.E.2d 535, 539 (Ind. Ct. App. 2005); Hamlin v. Steward, 622 N.E.2d 535, 540 (Ind. Ct. App. 1993).
73. Michael P. Van Alstine, The Death of Good Faith in Treaty Jurisprudence and a Call for Resurrection, 93 GEO. L.J. 1885, 1907-08 (2005).
74. See id. at 1907.
75. See generally WILLIAM R. RODGERS, JR., ENVIRONMENTAL LAW § 7.26 (1992 & Supp. 2004).
76. Claire Moore Dickerson, From Behind the Looking Glass: Good Faith, Fiduciary Duty & Permitted Harm, 22 FLA. ST. U. L. REV. 995, 978-92 (1995) (discussing a good faith "continuum") .
77. Sauvage v. Gallaway, 66 N.E.2d 740, 743 (Ill. App. Ct. 1946); see Sokoloff v. Harriman Estates Dev. Corp., 754 N.E.2d 184, 188-89 (N.Y. 2001) (quoting W. Elec. Co. v. Brenner, 360 N.E.2d 1091, 1094 (N.Y. 1977)) (discussing an action by prospective homeowners, who had hired a contractor to provide pre-construction services for construction of a home on their property, seeking specific performance of contractor's contract with architect hired to design home, stating, "fundamental to the principal-agent relationship 'is the proposition that an [agent] is to be loyal to his [principal] and is prohibited from acting in any manner inconsistent with his agency or trust and is at all times bound to exercise the utmost good faith and loyalty in the performance of his duties'"); see also In re Marriage of Petrie, 19 P.3d 443, 447 (Wash. Ct. App. 2001) (quoting Esmieu v. Schrag, 563 P.2d 203, 207 (Wash. 1977)) (discussing an action to remove children's father as custodian for his children's investment accounts and as trustee of their real estate trust for breach of his fiduciary duties, stating "[a] trustee owes the beneficiaries of the trust 'the highest degree of good faith, care, loyalty and integrity'"); Hardy v. Hardy, 263 S.W.2d 690, 694-95 (Ark. 1954). Using particularly compelling language in a disciplinary hearing against an attorney who mishandled his clients fund, the Supreme Court of Oklahoma said: A trustee is a fiduciary of the highest order in whom the hope and confidence of the settlor are placed with the expectation that the trustee will exercise the obligations of the office for the exclusive benefit of the cesnui [sic] que trust. A trustee always owes to the cestui que trust uberrima fides. State ex rel. Okla. Bar Ass'n v. Wallace, 961 P.2d 818, 826 (Okla. 1998). As the court notes, uberrima fides means '"the most abundant good faith, absolute and perfect candor or openness and honesty.'" Id. at 826 n.23 (quoting BLACK'S LAW DICTIONARY 1690 (4th ed. 1968)). This obligation has deep historical roots: When a trustee, in the discharge of his legal duty, has received into his hands good funds, and seeks to discharge himself from liability therefor, on the ground that the same has been converted by him into Confederate money and lost, the burden of proof is upon the party who insists upon such loss, and he should be required to make clear and satisfactory proof that he has acted with entire good faith to entitle him to be protected. Westbrook v. Davis, 48 Ga. 471, 474 (1873).
78. As one court noted: The fiduciary owes a duty of the most perfect and scrupulous good faith ("uberrima fides") to his principal. . . . Not many rules of law are as entrenched or honored in our system of justice in the United States as are the fiduciary's duty of full disclosure and the fiduciary's duty of good faith and loyalty. . . . The duty of good faith and loyalty specifies that a fiduciary must act in accordance with the highest standard of integrity, with utmost good faith, and with scrupulous openness, fairness, and honesty, and a court of equity can and will require such behavior. All the power, influence, and skill of a fiduciary is to be used for the advantage of the principal, and not for the personal gain of the fiduciary. Myer v. Preferred Credit, Inc., 117 Ohio Misc. 2d 8, 15-16 (Ct. Com. Pl. 2001) (affirming an award of punitive damages for mortgage broker's improper, fraudulent, and dishonest dealings under the Mortgage Broker's Act).
79. Goddard v. Cont'l Ill. Nat'l Bank & Trust Co., 532 N.E.2d 435, 437 (Ill. App. Ct. 1988) (emphasis added, internal citations and quotations omitted) (quoting the trial court and reversing and remanding for reasons not related to the definition of "good faith"). Note that the Illinois Supreme Court never chimed in as requested.
80. Enders v. Parker, 66 P.3d 11, 17 (Alaska 2003); see ALASKA STAT. § 13.16.435 (2006) (stating that a personal representative who defends or prosecutes any proceeding in good faith is entitled to receive necessary expenses and disbursements from the estate).
81. See LEE R. RUSS & THOMAS F. SEGALLA, COUCH ON INSURANCE § 198:6 (3d ed. 2005) [hereinafter COUCH]; see also Neal v. Farmers Ins. Exch., 582 P.2d 980 (Cal. 1978) (stating that the insurer's duty of good faith to the insured imposes a number of obligations, including, but not limited to, the duty of an insurer to accept reasonable settlements of third party claims against its insured and the duty not to withhold payments due under a policy without good reason). An insurer's duty to investigate claims filed by an insured may arise from an insurer's duty of good faith and fair dealing. See Gilderman v. State Farm Ins. Co., 649 A.2d 941 (Pa. Super. Ct. 1994) (including duty to investigate as part of an insurer's duty of good faith and fair dealing owed to the insured); Warren v. Am. Family Mut. Ins. Co., 361 N.W.2d 724 (Wis. Ct. App. 1984); see also COUCH, supra, § 198.27 n.37 (citing both of the above cases).
82. See Comunale v. Traders & Gen. Ins. Co., 328 P.2d 198, 201 (Cal. 1958).
83. See Cook v. Principal Mut. Life Ins. Co., 784 F. Supp. 1513, 1518 (D. Mont. 1990); Pemberton v. Farmers Ins. Exch., 858 P.2d 380, 382 (Nev. 1993); see also COUCH, supra note 81, § 198:16 (citing the above cases); 13 SAMUEL WILLISTON & RICHARD A. LORD, A TREATISE ON THE LAW OF CONTRACTS § 38:15 (4th ed. 1993 & Supp. 2004) [hereinafter WILLISTON ON CONTRACTS].
84. See COUCH, supra note 81, § 198:8.
85. See, e.g., Ace v. Aetna Life Ins. Co., 139 F.3d 1241 (9th Cir. 1998) (recognizing an actionable tort against insurers for breach of implied covenant of good faith and fair dealing).
86. See COUCH, supra note 81, § 198:11.
87. See id. ("[T]he precise nature of the duty imposed may vary considerably.").
88. See Theriot v. Midland Risk Ins. Co., 694 So. 2d 184, 187-88 (La. 1997); Smith v. Midland Risk Ins. Co., 699 So. 2d 1192, 1196-97 (La. Ct. App. 1997); see also COUCH, supra note 81, § 198:11 (citing the above cases).
89. See Theriot, 694 So. 2d at 187-88.
90. See Smoral v. Hanover Ins. Co., 322 N.Y.S.2d 12, 14 (App. Div. 1971) ("Good faith in this connection [auto insurance settlement] means more than an absence of intent to harm. It means an adequate protection of the interests of the assured." (citation omitted)); see also Shell Oil Co. v. Nat'l Union Fire Ins. Co., 52 Cal. Rptr. 2d 580, 588 (Ct. App. 1996) (quoting Smoral, 322 N.Y.S.2d at 14).
91. See Shell Oil Co., 52 Cal. Rptr. 2d at 588.
92. Id.
93. See Hassard, Bonnington, Roger & Huber v. Home Ins. Co., 740 F. Supp. 789, 791 (S.D. Cal. 1990); 1 JEFFREY W. STEMPEL, LAW OF INSURANCE CONTRACT DISPUTES §§ 10.01 n.7, 10.02(a) (2d ed. Supp. 2005); see also Force v. ITT Hartford Life & Annuity Ins. Co., 4 F. Supp. 2d 843 (D. Minn. 1998); Zilisch v. State Farm Mut. Auto. Ins. Co., 995 P.2d 276, 279-80 (Ariz. 2000); Jonathan Neil & Assocs., Inc. v. Jones, 94 P.3d 1055, 1068 (Cal. 2004); Communale v. Traders & Gen. Ins. Co., 328 P.2d 198, 198-202 (Cal. 1958) (stating that the covenant of good faith and fair dealing arises out of the contractual relationship but it also creates a duty of care toward the policyholder); Powers v. United Servs. Auto. Ass'n, 962 P.2d 596, 602 (Nev. 1998). Given the fiduciary nature of the insurer-insured relationship, it should come as no surprise that the "not in good faith" versus "bad faith" debate discussed later in this Article, rears its ugly head in the insurance context as well. See infra Part IV. Regarding the suggestion made that an insurer's lack of good faith should be proven by a complaining insured by establishing bad faith, Professor Couch says: Dissenters abound, however, frequently on the ground that it is both intellectually and practically indefensible to define one term by its opposite, or its absence. Nor is the attempt to define good faith by reference to bad faith likely to be entirely satisfactory, given that bad faith itself has been described as "an imprecise label for what is essentially some kind of unreasonable insurer conduct, and such words serve only to obscure and oversimplify the rationale of the decisions." COUCH, supra note 81, § 198:6 (quoting Austero v. Nat'l Cas. Co., 148 Cal. Rptr. 653, 670 n.22 (Ct. App. 1978), overruled on other grounds by Egan v. Mut. of Omaha Ins. Co., 620 P.2d 141 (1979)).
94. See COUCH, supra note 81, §§ 198:7, 198:14; see also EMERIC FISCHER, PETER NASH SWISHER & JEFFREY W. STEMPEL, PRINCIPLES OF INSURANCE LAW 93 (3d ed. 2004); STEMPEL, supra note 93, § 10.01 n.7 (providing extensive commentary and citations regarding fiduciary status). "Note that while the characteristics which mark a 'good-faith relationship' contract are not exactly, or not always exactly, the same as those which characterize a fiduciary relationship, they are similar." COUCH, supra note 81, § 198:14. But [s]ince the contract specifies the terms upon which the subservient party's consideration becomes due, it can be strongly argued that once these terms are met in fact, the subservient party becomes the owner of the benefits called for by the contract, although the dominant party retains temporary possession of those funds-a true fiduciary relationship. Id.; see also id. § 198:7.
95. See COUCH, supra note 81, § 198:7; see also supra notes 90-94.
96. See COUCH, supra note 81, § 198:7; see also Nationwide Mut. Ins. Co. v. Nat'l Catastrophe Adjusters, 185 F. Supp. 2d 854, 860 (S.D. Ohio 2002) (citing Guar. Sav. & Loan Ass'n v. Ultimate Sav. Bank, F.S.B., 737 F. Supp. 366, 370 (W.D. Va. 1990)); Chavez v. Chenoweth, 553 P.2d 703, 708-10 (N.M. Ct. App. 1976).
97. See COUCH, supra note 81, § 198:3 (explaining first versus third-party claims and the duty to settle); STEMPEL, supra note 93, §§ 2.06(f), 9.03(a).
98. See, e.g., Short v. Dairyland Ins. Co., 334 N.W.2d 384, 387 (Minn. 1983).
99. See Fid. & Cas. Co. of N.Y. v. Robb, 267 F.2d 473, 476 (5th Cir. 1959); Am. Fid. & Cas. Co. v. All Am. Bus Lines, Inc., 179 F.2d 7, 9 (10th Cir. 1949); Rova Farms Resort, Inc. v. Investors Ins. Co. of Am., 323 A.2d 495, 505 (N.J. 1974).
100. See Keefe v. Prudential Prop. & Gas. Ins. Co., 203 F.3d 218, 227-28 (3d Cir. 2000) (applying Pennsylvania law); Force v. ITT Hartford Life & Annuity Ins. Co., 4 F. Supp. 2d 843, 853-54 (D. Minn. 1998) (holding relationship is true fiduciary); Hassard, Bonington, Roger & Huber v. Home Ins. Co., 740 F. Supp. 789, 792 (S.D. Cal. 1990); Zilisch v. State Farm Mut. Auto. Ins. Co., 995 P.2d 276, 279-80 (Ariz. 2000) (holding relationship is a true fiduciary one); Berges v. Infinity Ins. Co., 896 So. 2d 665, 677 (Fla. 2004); O'Neill v. Gallant Ins. Co., 769 N.E.2d 100, 109-10 (Ill. App. Ct. 2002) ("[W]hen a liability insurance company employs policy terms that obtain the irrevocable power to determine whether an offer to compromise a personal-injury claim will be accepted or rejected, it creates a fiduciary relationship between it and the insured with resulting duties that grow out of that relationship."); Erie Ins. Co. v. Hickman, 622 N.E.2d 515, 518-19 (Ind. 1993); Powers v. United Servs. Auto. Ass'n, 962 P.2d 596, 602 (Nev. 1998); Brown v. Progressive Ins. Co., 860 A.2d 493, 500 (Pa. Super. Ct. 2004); Campbell v. State Farm Mut. Auto. Ins. Co., 840 P.2d 130, 140 (Utah Ct. App. 1992); Myers v. Ambassador Ins. Co., 508 A.2d 689, 690-91 (Vt. 1986); Tank v. State Farm Fire & Cas. Co., 715 P.2d 1133, 1136 (Wash. 1986); Anderson v. Cont'l Ins. Co., 271 N.W.2d 368, 375-76 (Wis. 1978); Alt v. Am. Family Mut. Ins. Co., 237 N.W.2d 706, 712 (Wis. 1976). Interestingly, a few courts, including some of those in Delaware, seem to have taken, or at least toyed with, the position that no heightened duties are owed to a policyholder in any instance because the policyholder-insurer relationship is purely contractual. See Corrado Bros. v. Twin City Fire Ins. Co., 562 A.2d 1188, 1192 (Del. 1989) (holding insurer owes no special duties to policyholder even when resulting settlement required policyholder to pay retroactive premiums, but noting that the insurer has the burden of demonstrating that it acted reasonably and in good faith when its interests diverged from those of the policyholder); Johnson v. Fed. Kemper Ins. Co., 536 A.2d 1211, 1213 (Md. Ct. Spec. App. 1988); Duncan v. Andrew County Mut. Ins. Co., 665 S.W.2d 13, 19 (Mo. Ct. App. 1983). But see Tackett v. State Farm Fire & Cas. Ins. Co., 653 A.2d 254, 265 n.6 (Del. 1995) ("The Tacketts argue that, like" Cummings, their claim arose in a relationship of 'trust and confidence. While there may be a fiduciary obligation in an insurer's handling of a third-party claim, '[t]he mere relationship of insurer and insured does not import an obligation of trust."' (quoting Craig v. Iowa Kemper Mut. Ins. Co., 565 S.W.2d 716, 723 (Mo. Ct. App. 1978) (emphasis added)).
101. See E. Allan Farnsworth, Good Faith Performance and Commercial Reasonableness Under the Uniform Commercial Code, 30 U. CHI. L. REV. 666, 668 (1963).
102. Id.
103. See id. Professor Farnsworth gives us two illustrations: Whether the holder of a negotiable instrument is a holder in due course depends, under the Code, on whether he purchased in good faith. Whether the purchaser of goods takes good title from a seller whose own title is voidable because of fraud depends, under the Code, on whether he purchased in good faith. Id. (citing U.C.C. §§ 2-403(1), 3-205, 3-302 (1958)).
104. Id. at 668-69. If the parties to a sales contract leave price or performance terms open, to be fixed by either buyer or seller, that party is to fix them, under the Code, in good faith. If they describe the quantity as seller's output or buyer's requirements, their obligations are defined under the Code in terms of such output or requirements as may occur in good faith. If a merchant buyer is left in possession of goods that he has rightfully rejected, his obligation to effect salvage under the Code is one of good faith. Or if the seller, before performance, has assigned his right to payment under his contract with the buyer, their power to modify their agreement, even after notice, is limited by the requirement that the modifications must be made in good faith. In each of these instances "good faith" would appear to be used in the sense of good faith performance. And each represents a specific application of the general obligation of good faith-resulting in an implied term of the contract requiring cooperation on the part of one party to the contract so that another party will not be deprived of his reasonable expectations. Id. (citing U.C.C. §§ 2-305(2), 2-306(1), 2-311(1), 2-603(3), 9-318(2) (1958)).
105. The late Professor Allan Farnsworth, principal draftsman of the Uniform Commercial Code and the Second Restatement of Contracts, argued that good faith in the performance aspects of contracts jurisprudence hinged on an objective standard. He maintained that fixing good faith performance on a subjective standard would make no sense, as "[s]urely the test is not whether one party actually believed that he was acting decently, fairly or reasonably. Surely he must do more than form an honest judgment. Otherwise no more than knowing and deliberate unfairness, maliciousness, trickery and deceit would be forbidden." Id. at 672.
106. At one point, I was convinced that Vice Chancellor Strine indirectly addressed the point with the following language from Guttman v. Huang, 823 A.2d 492, 506 n.34 (Del. Ch. 2003): 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. For this reason, the same case that invented the so-called "triad[ ]" of fiduciary duty, also defined good faith as loyalty. It does no service to our law's clarity to continue to separate the duty of loyalty from its own essence; nor does the recognition that good faith is essential to loyalty demean or subordinate that essential requirement. There might be situations when a director acts in subjective good faith and is yet not loyal (e.g., if the director is interested in a transaction subject to the entire fairness standard and cannot prove financial fairness), but there is no case in which a director can act in subjective bad faith towards the corporation and act loyally. The reason for the disloyalty (the faithlessness) is irrelevant, the underlying motive (be it venal, familial, collegial, or nihilistic) for conscious action not in the corporation's best interest does not make it faithful, as opposed to faithless. (citations omitted). Upon reflection, Vice Chancellor Strine's last sentence perplexes me. With that sentence, he seems to be saying that faithfulness is judged objectively, with no reference to underlying motive. I would take that to mean that good faith (e.g., "faithfulness") is judged objectively. Yet Strine uses the phrase "faithful" to pertain to the duty of loyalty assessment. So he seems to be saying that good faith can be a subjective assessment, while loyalty will be an objective assessment, despite the fact that he uses "faithfulness," which I almost view as a synonym for "good faith," to refer only to loyalty.
107. The U.C.C. was proposed to create a uniform body of contract law and has been adopted by forty-nine states. See LON L. FULLER & MELVIN ARON EISENBERG, BASIC CONTRACT LAW 71-73 (West 2001) (1946). The preamble to the U.C.C. states that it applies to "[c]ertain Commercial Transactions in or regarding Property and Contracts and other Documents concerning them." E. ALLAN FARNSWORTH, FARNSWORTH ON CONTRACTS § 1.9(a) (2d ed. 1998). It is unclear whether provisions of Article I of the U.C.C. apply only to transactions within the scope of those in later articles or whether it applies to all "commercial" contracts. See id. However, provisions that are generally accepted, such as U.C.C. § 1-203 on good faith, are usually applied broadly in the commercial transactions and contracts realm. See id. Additionally, even where a provision is not directly applicable to a transaction, the principle within the provision may still serve as a source of law. See FULLER & EISENBERG, supra, at 72. Therefore, even where the contract at issue does not directly fall into a category covered by the U.C.C., the principles of the U.C.C. are often still viewed as persuasive authority and are followed.
108. U.C.C. § 1-304 (2004).
109. U.C.C. § 1-201(19) (2004). Farnsworth criticizes such a characterization of good faith, noting that the U.C.C. definition leaves the duty of good faith "so enfeebled that it could scarcely qualify... as an 'overriding' or 'super-eminent' principle." Farnsworth, supra note 101, at 674. Apparently the good faith definition was enfeebled by the practicing bar's objections to the language in prior drafts, which practicing attorneys saw as affording to courts "opportunities... to create innovative commercial obligations." Clayton P. Gillette, Limitations on the Obligation of Good Faith, 1981 DUKE L.J. 619, 624 (1981).
110. See Robert S. Summers, "Good Faith" in General Contract Law and the Sales Provisions of the Uniform Commercial Code, 54 VA. L. REV. 195, 196, 232-43 (1968). Professor Steven Burton helpfully describes Professor Summers's excluder analysis as follows: "the function of 'good faith' is not to contribute positively to the characterization of anything, but to exclude possible ways of being in bad faith, which are both numerous and varied." Steven J. Burton, More on Good Faith Performance of a Contract: A Reply to Professor Summers, 69 IOWA L. REV. 497, 498 (1984). It is worth adding a bit more detail to my description of Professor Summers's excluder analysis. Professor Summers argues in his much extolled article that good faith in the context of general contract law and the U.C.C. should be treated as an excluder, defined in a context-specific way by reference to bad faith and things that do not exhibit good faith. Summers, supra, at 200. To wit, Professor Summers maintains that good faith should be defined by things that were intended to be excluded from occurring by being deemed acts of bad faith. Id. If we can identify acts that constitute bad faith, we can define good faith by pointing to the absence of any of the bad faith acts. Professor Summers argued both that the gossamer nature of the phrase lends itself to this sort of post hoc defining and that it is practical to define the phrase this way "because the typical judge who uses this phrase is primarily concerned with ruling out specific conduct." Id. at 202. Colorfully, Professor Summers summarized his justification for his dogma by saying "general definitions of good faith either spiral into the Charybdis of vacuous generality or collide with the Scylla of restrictive specificity." Id. at 206. For those less familiar with erudite words, Merriam-Webster Online dictionary defines Charybdis as "whirlpool off the coast of Sicily personified in Greek mythology as a female monster," Merriam-Webster OnLine, http://www.m-w.com/dictionary/charybdis (last visited Mar. 12, 2006); and Scylla is defined as "a nymph changed into a monster in Greek mythology who terrorizes mariners in the Strait of Messina." Merriam-Webster OnLine, http://www.m-w.com/dictionary/scylla (last visited Mar. 12, 2006).
111. See Summers, supra note 109. Indeed, Professor Farnsworth concludes that the Second Restatement of Contracts adopts this excluder analysis, by providing that: A complete catalogue of types of bad faith is impossible, but the following types are among those which have been recognized in judicial decisions: evasion of the spirit of the bargain, lack of diligence and slacking off, willful rendering of imperfect performance, abuse of a power to specify terms, and interference with or failure to cooperate in the other party's performance. FARNSWORTH, supra note 106, § 7.17b (quoting RESTATEMENT (SECOND) OF CONTRACTS § 205 cmt. d (1981)). However, for a discussion of the problems of defining one term by its opposite, see infra notes 177-85 and accompanying text.
112. Steven J. Burton, Breach of Contract and the Common Law Duty to Perform in Good Faith, 94 HARV. L. REV. 369, 369, 373 (1980); see also Centronics Corp. v. Genicom Corp., 562 A.2d 187, 193 (N.H. 1989) ("[U]nder an agreement that. . . invest[s] one party with a degree of discretion in performance sufficient to deprive another party of a substantial proportion of the agreement's value, the parties' intent to be bound by an enforceable contract raises an implied obligation of good faith to observe reasonable limits in exercising that discretion . . . ."); FARNSWORTH, supra note 106, § 7.17b n.19 (citing both Professor Burton and Centronics Corp.).
113. Burton, supra note 111, at 373.
114. See DENNIS M. PATTERSON, GOOD FAITH AND LENDER LIABILITY: TOWARD A UNIFIED THEORY 58-59 (1990). Notwithstanding the fact that Professor Summers's excluder analysis picked up considerable momentum after the publication of his article in 1968, not everyone then agreed with or now agrees with his analysis. See id. at 59.
115. The U.C.C. draft dealing with good faith in the context of commercial transaction was drafted by Karl N. Llewellyn and adopted by the National Conference of Commissioners on Uniform State Laws (NCCUSL) and the American Law Institute (ALI) in 1952 and later adopted by the individual states. See FULLER & EISENBERG, supra note 106, at 72. The Second Restatement of Contracts was primarily drafted by Farnsworth and Robert Braucher and was adopted in 1981. See FARNSWORTH, supra note 106, § 1.8.
116. Kirke La Shelle Co. v. Paul Armstrong Co., 188 N.E. 163, 167 (N.Y. 1933) (citation omitted); see also Anthony's Pier Four, Inc. v. HBC Assocs., 583 N.E.2d 806, 821 (Mass. 1991) (covenant of good faith and fair dealing is implied even "in contracts between sophisticated businesspeople"); FARNSWORTH, supra note 106, § 7.17 n.3 (citing the above cases). Similarly, good faith is implicated in the performance and enforcement of every contract. See Kirke La Shelle Co., 188 N.E. at 167; see also U.C.C. § 1-304 (2004) ("Every contract or duty within [the Uniform Commercial Code] imposes an obligation of good faith in its performance and enforcement."); RESTATEMENT (SECOND) OF CONTRACTS § 205 (1981) ("Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement."); FARNSWORTH, supra note 106, § 7.17; 2 JOSEPH M. PERILLO & HELEN HADJIYANNAKIS BENDER, CORBIN ON CONTRACTS: FORMATION OF CONTRACTS § 5.27 (1995) [hereinafter CORBIN] ("[E]very contract contains an implied obligation of good faith and fair dealing in its performance and enforcement.").
117. See FARNSWORTH, supra note 106, § 7.17. For example, "the duty may not only proscribe undesirable conduct, but may require affirmative action as well." Id.
118. Unfortunately, many academics employ the terms duty, obligation, and covenant interchangeably when discussing good faith. See id. This Article employs the term obligation.
119. See id. Note that good faith is distinguishable from the concept of "best efforts" in the contract context: Good faith is a standard that has honesty and fairness at its core and that is imposed on every party to a contract. Best efforts is a standard that has diligence as its essence and is imposed on those contracting parties that have undertaken such performance. The two standards are distinct and that of best efforts is the more exacting, though it presumably falls short of the standard required of a fiduciary, who is required "to act primarily for the benefit of another in matter connected with his undertaking." Id. (citing RESTATEMENT (SECOND) OF AGENCY § 313 cmt. a (1958)).
120. Carmichael v. Adirondack Bottled Gas Corp. of Vt., 635 A.2d 1211, 1216 (Vt. 1993); see also FARNSWORTH, supra note 106, § 7.17 n.6 (citing the same). The U.C.C. also recognizes that the duty of good faith may not be completely waived: The obligations of good faith, diligence, reasonableness, and care prescribed by [the Uniform Commercial Code] may not be disclaimed by agreement. The parties, by agreement, may determine the standards by which the performance of those obligations is to be measured if those standards are not manifestly unreasonable. Whenever [the Uniform Commercial Code] requires an action to be taken within a reasonable time, a time that is not manifestly unreasonable may be fixed by agreement. U.C.C. § 1 302(b) (2004).
121. See FARNSWORTH, supra note 106, § 7.17b ("Many courts have endorsed abstract and sweeping definitions of good faith.").
122. RESTATEMENT (SECOND) OF CONTRACTS § 205 (1979). As noted, E. Allan Farnsworth and Robert Braucher were primarily responsible for the drafting of the Second Restatement of Contracts. See FARNSWORTH, supra note 106, § 1.8. The American Law Institute began revising the Restatement of Contracts in 1962, with Braucher serving as its Reporter until his appointment to the Supreme Judicial Court of Massachusetts in 1971. See id.; Robert Braucher, N.Y. TIMES, Aug. 27, 1981, at D19. Farnsworth then replaced Braucher as the Reporter and worked on the draft until it was published in 1981. See FARNSWORTH, supra note 106, § 1.8.
123. RESTATEMENT (SECOND) OF CONTRACTS § 205 cmt. a (1981).
124. Id. § 205 cmt. d; FARNSWORTH, supra note 106, § 7.17b (quoting part of the same).
125. See FARNSWORTH, supra note 106, § 7.17b ("Many courts have endorsed abstract and sweeping definitions of good faith.").
126. Wendling v. Cundall, 568 P.2d 888, 890 (Wyo. 1977) (quoting Gress v. Evans, 46 N.W. 1132, 1134 (Dakota 1877)); FARNSWORTH, supra note 106, § 7.17b (citing the same).
127. Conoco, Inc. v. Inman Oil Co., Inc., 774 F.2d 895, 908 (8th Cir. 1985) (citation omitted); FARNSWORTH, supra note 106, § 7.17b (citing the same).
128. See Baker v. Ratzlaff, 564 P.2d 153, 156-57 (Kan. Ct. App. 1977). With respect to the exercise of discretion in performance of a contract, good faith "requires the party vested with discretion under a contract to 'exercise that discretion reasonably and with proper motive . . . not . . . arbitrarily, capriciously, or in a manner inconsistent with the reasonable expectations of the parties."' Ford Motor Co. v. Motor Vehicle Review Bd., 788 N.E.2d 187, 196 (Ill. App. Ct. 2003) (quoting Dayan v. McDonald's Corp., 466 N.E.2d 958, 972 (Ill. App. Ct. 1984)) (discussing performance under a franchise agreement).
129. WILLISTON ON CONTRACTS, supra note 83, § 38:15; see also CORBIN, supra note 115, § 5.27.
130. Farnsworth, supra note 101, at 672.
131. See E. Norman Veasey, State-Federal Tension in Corporate Governance and the Professional Responsibilities of Advisors, 28 J. CORP. L. 441, 448 (2003) (noting that "the jurisprudence of good faith is unresolved"). To be clear, understand that the phrase "good faith" has long been appearing in the context of director liability. See infra note 193. Most frequently, however, the phrase is left undefined or it is accompanied by an additional phrase such as "in . . . the best interests of the corporation [and/or shareholder] . . . ." Baker v. Health Mgmt. Sys., 264 F.3d 144, 150 (2d Cir. 2001) ("A corporation may indemnify any person ... if such director or officer acted, in good faith, for a purpose which he reasonably believed to be in ... the best interests of the-corporation . . . ." (quoting N.Y. BUS. CORP. LAW § 722(a) (McKinney 1986 & Supp. 2000)); FDIC v. Castetter, 184 F.3d 1040, 1044 (9th Cir. 1999) ("A director shall perform the duties of a director... in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders . . . ." (quoting CAL. CORP. CODE § 309(a) (West 1998)); Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) ("[The business judgment rule] is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company."). It is curious to me that the latter phrase often accompanies "good faith," because, as I discuss in Part III, infra, I am of the view that good faith means "in the best interests of the shareholder." The question then becomes whether the writers who include language directing that a director is obligated to act "in good faith and in the best interests of the corporation" realize that they are being redundant, are intending to emphasize the meaning of good faith by repeating it, or do not believe that they are being redundant.
132. WLR Foods, Inc. v. Tyson Foods, Inc., 155 F.R.D. 142, 146 (W.D. Va. 1994) (discussing an action to determine the constitutionality of corporate acts under the Virginia Control Share Acquisition Act and to validate a rights plan adopted by the board of directors).
133. Guttman v. Huang, 823 A.2d 492, 506 n.34 (Del. Ch. 2003) (citing Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993) (Cede II)) (emphasis added). Note that the Cede II opinion did not explicitly define "good faith" as loyalty on the page cited by Vice Chancellor Strine. Rather, on page 361 of the Cede II opinion, the Cede court says: "To rebut the [business judgment rule], a shareholder plaintiff assumes the burden of providing evidence that directors . . . breached any one of the triads of their fiduciary duty-good faith, loyalty or due care." Cede & Co., 634 A.2d at 361. However, note 36 on page 368 of the Cede II opinion states that "a board's actions must be evaluated in light of relevant circumstances to determine if they were undertaken with due diligence [care] and good faith [loyalty]." Id. at 368 n.36 (quoting Barkan v. Amsted Indus., Inc., 567 A.2d 1279, 1286 (Del. 1989)). Vice Chancellor Strine is not alone with the argument that "good faith" really only refers to the director's avoidance of conflicts (divided loyalty). Agency and trust cases often discuss good faith in a manner that suggests it is synonymous with loyalty. State ex rel. Okla. Bar Ass'n v. Wallace, 1998 OK 65, 961 P.2d 818, 826 (discussing a disciplinary hearing against an attorney who mishandled his client's trust funds and stating that good faith recognizes that "the hope and confidence of the settlor are placed with the expectation that the trustee will exercise the obligations of the office for the exclusive benefit of the cesnui [sic] que trust"). Yet, in those cases, and many others, the phrases "good faith and loyalty" and
134. The Disney cases include: In re Walt Disney Co. Derivative Litig., 906 A.2d 27 (Del. 2006); In re Walt Disney Co. Derivative Litig., 907 A.2d 693 (Del. Ch. 2005); In re Walt Disney Co. Derivative Litig., 825 A.2d 275 (Del. Ch. 2003); and Brehm v. Eisner, 746 A.2d 244 (Del. 2000).
135. I would like to blame the Delaware Supreme Court for this substantive failing, but the reality is that neither the appellants nor the appellees raised the issue of defining good faith at oral argument before the court. One would have thought that the Delaware Supreme Court would have brought up the issue sua sponte, as they are permitted. One would be wrong. It is for reasons like this that I chuckle when reading Delaware Supreme Court's statement that "Delaware has a substantial interest in defining, regulating and enforcing the fiduciary obligations which directors of Delaware corporations owe to such corporations and the shareholders who elected them." Armstrong v. Pomerance, 423 A.2d 174, 179 n.8 (Del. 1980) (quoting 61 Del. Laws c. 119 (1977)). Delaware does have a substantial interest in defining, regulating, and enforcing the fiduciary obligations of directors, but this interest obviously does not always result in the Delaware Supreme Court's robust definition, regulation, and enforcement of those obligations. It should be no surprise that I am sympathetic to the "race-to-the-bottom" discussion regarding Delaware's director-coddling statutes and permissive fiduciary common law.
136. In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 753 (Del. Ch. 2005) (citations omitted). The Chancellor later added, "To act in good faith, a director must act at all times with an honesty of purpose and in the best interests and welfare of the corporation." Id. at 755. The Chancellor goes on to justify his decision to define good faith by way of bad faith in the way that the Chancellor recognizes most courts have done by saying "[t]his may be so because Delaware law presumes that directors act in good faith when making business judgments." Id. 753. I address this issue in Part I.B, supra. The upshot is that defining good faith affirmatively does not result in directors being stripped of the good faith business judgment rule presumption from Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). Note that Chancellor Chandler continues in his good faith opining to say: Bad faith has been defined as authorizing a transaction "for some purpose other than a genuine attempt to advance corporate welfare or [when the transaction] is known to constitute a violation of applicable positive law." In other words, an action taken with the intent to harm the corporation is a disloyal act in bad faith. A similar definition was used seven years earlier, when Chancellor Allen wrote that bad faith (or lack of good faith) is when a director acts in a manner "unrelated to a pursuit of the corporation's best interests." It makes no difference the reason why the director intentionally fails to pursue the best interests of the corporation. Id. at 753-54 (quoting Gagliardi v. TriFoods Int'l, Inc., 683 A.2d 1049, 1051 n.2 (Del. Ch. 1996); In re RJR Nabisco, Inc. S'holder Litig., No. 10389, 1989 WL 7036 (Del. Ch. Jan. 31, 1989)). Yet, in a footnote five pages later, Chancellor Chandler appears to embrace a much broader interpretation of what good faith requires, going well beyond traditional "bad faith," by referencing Professor Lyman Johnson's article, in which he advocates broadly interpreting a director's duty of loyalty to compel directors to be loyal to-faithful to-shareholders in the broader sense, much the way one would act loyally to a friend. Id. at 760 n.487 (citing Lyman P.Q. Johnson, After Enron: Remembering Loyalty Discourse in Corporate Law, 28 DEL. J. CORP. L. 27 (2003)). In this schizophrenic footnote, referring to situations where the directors are alleged to be under the thumb of the CEO, the Chancellor says: It is precisely in this context-an imperial CEO or controlling shareholder with a supine or passive board-that the concept of good faith may prove highly meaningful. The fiduciary duties of care and loyalty, as traditionally defined, may not be aggressive enough to protect shareholder interests when the board is well advised, is not legally beholden to the management or a controlling shareholder and when the board does not suffer from other disabling conflicts of interest, such as a patently self-dealing transaction. Good faith may serve to fill this gap and ensure that the persons entrusted by shareholders to govern Delaware corporations do so with an honesty of purpose and with an understanding of whose interests they are there to protect. Id. at 760 n.487 (internal citations omitted).
137. Barkan, 567 A.2d at 1288.
138. See, e.g., White v. Panic, 783 A.2d 543, 553-54 n.36 (Del. 2001) (discussing a derivative action, alleging that the board failed to take action to stop or sanction sexual misconduct of a corporate officer and stating that "[t]o prevail on a waste claim or a bad faith claim, the plaintiff must overcome the general presumption of good faith by showing that the board's decision was so egregious or irrational that it could not have been based on a valid assessment of the corporation's best interests"); Citron v. Fairchild Camera & Instrument Corp., 569 A.2d 53, 64 (Del. 1989) (discussing an action where a shareholder of a purchased corporation sued former board of directors alleging breach of fiduciary duty and gross negligence and stating that "[t]he [business judgment rule] presumption initially attaches to a director-approved transaction within a board's conferred or apparent authority in the absence of any evidence of 'fraud, bad faith, or self-dealing in the usual sense of personal profit or betterment'") (quoting Grobow v. Perrot, 539 A.2d 180, 187 (Del. 1988)). Though not speaking for the Delaware Supreme Court, former Chief Justice of the court, Norman Veasey, stated in a speech that: [G]ood faith requires an honesty of purpose and eschews a disingenuous mindset of appearing or claiming to act for the corporate good, but not caring for the well-being of the constituents of the fiduciary.... [A]n argument could be made that reckless, disingenuous, irresponsible, or irrational conduct-but not necessarily self-dealing or larcenous conduct-could implicate concepts of good faith. E. Norman Veasey, Speech, Corporate Governance and Ethics in the Post-Enron Worldcom Environment, 38 WAKE FOREST L. REV. 839, 851 (2003). Additionally, Delaware Supreme Court Justice Joseph Walsh, while not specifically speaking of good faith and not speaking for the court, noted that a director qua fiduciary is obligated to, among other things, act "affirmatively to protect the interests of the corporation committed to his charge." Joseph T. Walsh, The Fiduciary Foundation of Corporate Law, 27 J. CORP. L. 333, 333-34 (2002).
139. Rosenberg, supra note 46, at 513.
140. Hillary A. Sale, Delaware's Good Faith, 89 CORNELL L. REV. 456, 493 (2004) ("Although a breach of good faith need not be intentional or conscious, it does require some sort of obvious, deliberate, or egregious failure. That standard is like the standard of review applied to pleadings of scienter in securities fraud claims: motive is relevant, but not required. Intentional misstatements or omissions are actionable and intentional breaches of fiduciary duties should be as well.").
141. Id. at 493. With due respect, note that it appears that Professor Sale cites no source for the very strong language in her statement.
142. Id. at 487. Professor Sale continues to say that good faith conduct does not include conduct that is "deliberately indifferent, egregious, subversive, or knowing," though she does not tell us what any of these terms mean. Id. at 488. In addition, at one point Professor Sale suggests that "egregious, subversive, or deliberately indifferent conduct" does not evince good faith. Id. at 490. It is unclear to me, however, how deliberately indifferent conduct differs substantively from normal indifference or inadvertent indifference. I suppose that that is a subtlety much like the difference between "intentionally subverted" conduct, which would violate a director's fiduciary duties according to Sale, and unintentionally subversive conduct. Id. at 485.
143. See id. at 490.
144. Griffith, supra note 50, at 34.
145. See generally Eisenberg, supra note 52.
146. Chancellor Chandler, in the recent Disney litigation, seems to almost suggest that importing a definition might have been worth considering, when he says, "[d]espite the existence of significant jurisprudence with respect to good faith in the contractual context of the covenant of good faith and fair dealing, Delaware decisions have shown a reluctance to importing these contractual standards into the corporate fiduciary realm." In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 753 n.449 (Del. Ch. 2005) (citation omitted).
147. Some would argue that directors are merely parties to a contract with the shareholders or the corporation itself, such that the directors are neither trustees nor agents. This contractual relationship argument strikes me as still-born, given the clear historical foundation supporting the proposition that corporations can only act through agents, such being directors and officers. See MERTON PERSON, PRINCIPLES OF AGENCY § 295, at 413 (1954) ("[A]n agent is a fiduciary in relation to his principal . . . ."); FRANCIS B. TIFFANY, HANDBOOK OF THE LAW ON PRINCIPAL AND AGENT 187-88 (2d ed. 1924) ("[A] corporation, being impersonal, can act only through the intervention of agents.").
148. See infra Part III; Malone v. Brincat, 722 A.2d 5, 10 (Del. 1998) ("The directors of Delaware corporations stand in a fiduciary relationship not only to the stockholders but also to the corporations upon whose boards they serve."); Walsh, supra note 137, at 334 ("[T]he fiduciary underpinnings of director responsibility have been clearly established . . . ."). 'Fiduciary' includes a trustee under any trust, expressed, implied, resulting or constructive, executor, administrator, guardian, conservator, curator, receiver, trustee in bankruptcy, assignee for the benefit of creditors, partner, agent, officer of a corporation, public or private, public officer, or any other persons acting in a fiduciary capacity for any person, trust, or estate. UNIF. FIDUCIARIES ACT § 1(1), 7A U.L.A. 367 (1922). As aforementioned, scholars have consistently been inconsistent as to whether the fiduciary position of directors was one of trust or agency. Professor Evans spoke to this issue well over a century ago: All trustees . . . ,are agents; but all agents are not trustees. A trustee is an agent and something more. An agent is simply one placed in the stead of another; he is a trustee only so far as there is vested in him for the benefit of another some estate, interest, or power in or affecting property of any description .... Directors are persons selected to manage the affairs of a company for the benefit not of themselves but of the shareholders. Their office is one of trust. WILLIAM EVANS, THE LAW OF PRINCIPAL AND AGENT 319, 339 (2d. ed. 1888). That said, the distinction might well be irrelevant for our purposes given that "[i]t is well settled that an agent is a fiduciary in relation to his principal just as a trustee is a fiduciary in relation to his cestui que trust." FERSON, supra note 146, § 295, at 413.
149. As one scholar noted: [T]he law makes it unnecessary for a principal who delegates power to manage his property to an agent to provide by contract an array of prohibitions against the agent diverting to himself the principal's assets. The law of fiduciary obligations does that. It thereby facilitates specialization in economic enterprise, which enhances productivity for society, by saving the cost of individually contracting for the agent's loyalty in a myriad of situations, not all of which can be anticipated. Victor Brudney & Robert Charles Clark, A New Look at Corporate Opportunities, 94 HARV. L. REV. 997, 999 (1981).
150. See D. Gordon Smith, The Critical Resource Theory of Fiduciary Duty, 55 VAND. L. REV. 1399, 1402 (2002) ("[Fiduciary relationships form when one party (the 'fiduciary') acts on behalf of another party (the 'beneficiary') while exercising discretion with respect to a critical resource belonging to the beneficiary.").
151. See Taylor v. GWR Operating Co., 820 S.W.2d 908, 911 n.2 (Tex. App. 1991) (citing BLACK'S LAW DICTIONARY 563 (5th ed. 1979)). "The term 'fiduciary' is derived from the civil law. It is impossible to give a definition of the term that is comprehensive enough to cover all cases. Generally speaking, it applies to any person who occupies a position of peculiar confidence towards another. It refers to integrity and fidelity." Kinzbach Tool Co. v. Corbett-Wallace Corp., 160 S.W.2d 509, 512 (Tex. 1942).
152. Professors Adler and Mann actually chart out in tables the interplay between the fiduciary nature of the "good faith" relationship at issue and the contracting protection offered to the aggrieved party by the court. See Robert S. Adler & Richard A. Mann, Good Faith: A New Look at an Old Doctrine, 28 AKRON. L. REV. 31, 45, 51-52 (1994).
153. As Ernest Huffcut noted long ago: The relation existing between a principal and his agent is a fiduciary one, and consequently the most absolute good faith is essential. The principal relies upon the fidelity and integrity of the agent, and it is the duty of the agent, in return, to be loyal to the trust imposed in him, and to execute it with the single purpose of advancing his principal's interests. ERNEST W. HUFFCUT, THE LAW OF AGENCY § 90, at 110 (1901) (citing Michoud v. Girod, 45 U.S. (4 How.) 503 (1846)). Black's Law Dictionary defines the phrase "fiduciary duty" to mean: A duty of utmost good faith, trust, confidence, and candor owed by a fiduciary (such as a lawyer or corporate officer) to the beneficiary (such as a lawyer's client or a shareholder); a duty to act with the highest degree of honesty and loyalty toward another person and in the best interests of the other person (such as the duty that one partner owes to another). BLACK'S LAW DICTIONARY 545 (8th ed. 2004).
154. EVANS, supra note 147, at 275; accord, UNIF. BUS. CORP. ACT § 33, 9 U.L.A. 186 (1942) ("Officers and directors shall be deemed to stand in a fiduciary relation to the corporation, and shall discharge the duties of their respective positions in good faith, and with that diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions.").
155. Adler & Mann, supra note 151, at 35.
156. See HUFFCUT, supra note 152, and the text quoted therein. The duty of the agent to exercise good faith results from the fiduciary character of the relation. Of necessity the principal must repose confidence in the agent, and must rely upon his good faith and loyalty to the interest which is committed to him. The agent must therefore act solely in the interest of his employer, and not in his own interest or in the interest of another. TIFFANY, supra note 15, § 146, at 387.
157. See Burdett v. Miller, 957 F.2d 1375, 1381 (7th Cir. 1992) ("A fiduciary duty is the duty of an agent to treat his principal with the utmost candor, rectitude, care, loyalty, and good faith-in fact to treat the principal as well as the agent would treat himself."); Swinney v. Keebler Co., 480 F.2d 573, 578 (4th Cir. 1973) ("[I]f the sellers of control [majority shareholders] are in a position to foresee the likelihood of fraud on the corporation . . . their fiduciary duty imposes a positive duty to investigate the motives and reputation of the would-be purchaser . . . ."); Mid-Northern Oil Co. v. Walker, 211 P. 353, 355 (Mont. 1922) ("[T]he fiduciary relationship existing between the United States and the particular Indian wards imposed upon the government a positive duty to lease the Indian lands and to secure for the Indians the most advantageous terms available . . . ."); Rova Farms Resort, Inc. v. Investors Ins. Co., 323 A.2d 495, 507 (N.J. 1974) ("[A]n insurer . . . has a positive fiduciary duty to take the initiative and attempt to negotiate a settlement within the policy coverage.").
158. See supra note 156 and accompanying text.
159. Adler & Mann, supra note 151.
160. Id. at 31.
161. See id. at 34.
162. BLACK'S LAW DICTIONARY 543 (8th ed. 2004). We can also compare our director-shareholder-corporation relationship to the "duty-based" relationship a first year law student learns about in his torts class. The first-year law student is given the following hypothetical in his torts class: It is a beautiful spring morning, and a former Olympic swimmer, and her husband are going for their morning walk. They walk past the community pool, where they witness an adorable lab-mix puppy fall into the pool. The puppy is bobbing and barking, clearly unable to swim despite his lab heritage and semi-webbed feet. Luckily, the Pope, who was formerly a champion swimmer in the masters division prior to ascending to the papacy, drives by in his Popemobile. The Holy Father sees the struggling puppy bobbing in the deep end of the pool, and the Pope selflessly jumps into the pool to rescue the puppy. Unfortunately, the Pope's papal regalia weighs him down in the water, such that now both he and the puppy are in trouble. By pure stroke of chance, the President of the United States, George W. Bush is jogging by on his morning run, and he jumps into the pool to save the puppy and the Pope. The President, however, is not strong enough to support both the Pope in his resplendent regalia and the puppy, and the President is soon struggling as well. The former Olympic swimmer witnesses this three-party aqua drama as she ambles along on her morning walk and she pauses, clearly moved. She hears the desperate chorus of the trio-the puppy is howling, the Pope calling for help in Latin, and the President is yelling something unintelligible. The swimmer's husband says to her "Spouse, you love animals, you are a devout Catholic, and you still believe the stuff about the weapons of mass destruction. You must save those three. You have been trained in advanced water rescue, you swam competitively in the Olympics, you now teach swimming and water safety, and you know that I cannot save the drowning three because I cannot swim. Please, please save them. It would be easy for you to save them." In response, the Olympic swimmer says "I am not about to save them. I have a busy day planned. I have no time for such tomfoolery. Besides, it will mess up my hair." The President and the Pope continue to beg for help (or so one assumes, since neither of them can be understood) as the puppy continues to howl. The Olympic swimmer looks at them, looks at her husband, and then says "Folks, sorry. I have a big day today, and I just cannot waste the time to deal with your problems." She then walks briskly away. The first-year law student is outraged. "How could that morning exerciser just leave everyone in the pool to drown? The morning marauder could have easily saved them. She can't just leave them when she could just as easily have saved them. It was wrong for her to walk away. Just wrong." In response, the law school professor explains to his outraged student, "It might have been morally offensive for the champion swimmer to walk away instead of saving the pathetic trio, but it was not a liability creating event. The champion swimmer had no duty to the Pope, the President, or the puppy. Without a duty, we cannot obligate our innocent bystander to act. Our bystander had no duty to any of the three." Such is the rule in tort law-without a duty to act (including having created a dangerous situation such that you obligate yourself to act), a person has no obligation to take affirmative action. However, if the bystander has a duty to the group-if, for example, she was the life guard on her shift-she will be obligated to take affirmative action to help or be liable. Similarly, a director has a duty to his corporation and shareholders. The director cannot be passive any more than the lifeguard can be passive. The same way that the lifeguard has the obligation to jump in, throw a life ring, call for help, find a life pole, or do something else affirmatively intended to help the drowning group, the corporate director has the obligation to affirmatively act in the best interest of the corporation. In first-year torts parlance, the director has a duty.
163. William L. Prosser, Palsgraf Revisited, 52 MICH. L. REV. 1, 15 (1953).
164. BLACK'S LAW DICTIONARY 544 (8th ed. 2004). Note that Black's Law Dictionary also defines specifically the phrase "duty to act." Black's defines such as duty as a "duty to take some action to prevent harm to another, and for the failure of which one may be liable depending on the relationship of the parties and the circumstances." Id.
165. See Gillette, supra note 108, at 620. This relationship-the fiduciary relationship-requires something affirmative, and something other than what is generally required by good faith. The factual context and the power and control disparities in the fiduciary context mandate something more exacting.
166. See supra note 164 and accompanying text.
167. See generally Dickerson, supra note 76, at 978-85.
168. See Adler & Mann, supra note 151, at 31 ("[T]hose contracting parties who are considered to deal at arm's length receive a substantially lower level of protection than those who, because of a special relationship (fiduciary or confidential) between them, are not deemed to deal at arm's length.").
169. See supra note 154 and accompanying text.
170. See 1 JAMES D. COX & THOMAS LEE HAZEN, COX & HAZEN ON CORPORATIONS § 10.01, at 476-77 (2d ed. 2003) ("In fiduciary relationships, such as exists between the principal and her agent, the party on whom the principal relies for representation and protection is not permitted to bargain with the principal at arm's length or to claim immunity for questionable practices under the bargaining privilege of caveat emptor. Directors . . . are fiduciaries in a position of great power.").
171. Farnsworth, supra note 101, at 672 n.33 (quoting U.C.C. § 1-208 (1958)).
172. Id. (emphasis added).
173. Gillette, supra note 108, at 620 (emphasis added); see also id. ("This conclusion is predicated on arguments that an expansive obligation extends the responsibilities of commercial actors beyond bargained-for risk allocations, subjects bargains to inconsistent and uncertain enforcement, and does not produce offsetting benefits in commercial conduct.").
174. Professors Adler and Mann offer an extensive dialogue on the substantive difference between good faith in the pure arms-length contracts realm and in the context of a "special relationship." See Adler & Mann, supra note 151, at 31.
175. Id. at 35 (quoting Meinhard v. Salmon, 164 N.E. 545, 546 (N.Y. 1928)).
176. See supra Part II.C. I am not alone in my reluctance to adopt in full a good faith definition from a different area of the law. For example, Professor Claire Moore Dickerson similarly regards good faith as variable depending on the legal context; she basically views good faith on a continuum. Dickerson, supra note 76, at 979 (opining that the lowest level of good faith in contracts common law might mean only the obligation "to prevent the agreement from being meaningless, or, in contract terms, illusory"). Additionally, Professor Clayton Gillette recognizes this difference in good faith definitions, but he views the differences not as testament to a continuum, but rather as evidence of "the intractable difficulty of defining the scope of the obligation to perform and enforce one's contract in good faith." Gillette, supra note 108, at 619. An interesting observation from Professor Gillette that is relevant later in this Article in Part II.C is that "[m]easurement of the proper scope of the good faith obligation requires understanding its intended function in ordering commercial behavior." Id. at 621. I take the position in Part II.B.3 of this Article that a director has contractually obligated himself, via a formal or unwritten employment agreement, to act in the best interests of the corporation. This is, to me, valuable to remember for the purposes Professor Gillette suggests.
177. See Kimberlee K. Kovach, Good Faith in Mediation-Requested, Recommended, or Required? A New Ethic, 38 S. TEX. L. REV. 575, 600 (1997) ("An examination of good faith in the other contexts where it has been used provides a starting point for its definition.").
178. Ashford v. Thos. Cook & Son (Bankers) Ltd., 471 P.2d 530, 535 (Haw. 1970) (quoting with affirmance the jury charge of a trial court: "[a] thing is done in good faith when it is in fact done honestly whether it is done negligently or not"); see also Davis v. Easley, 13 Ill. 193 (1851).
179. Interestingly, this motive-based assessment of good faith is often referred to as "bona fides." An actor is required to have "bona fides" in order to exhibit good faith. This is a curious usage of the phrase bona fides, however, given that bona fides, literally translated from Latin, means "good faith."
180. See Turner v. Orr, 759 F.2d 817, 819 (11th Cir. 1985).
181. In re Walway Co., 69 B.R. 967, 973 (Bankr. E.D. Mich. 1987) (citation omitted).
182. See ARIZ. REV. STAT. ANN. § 13-3925(f)(1) (2006) ('"Good faith mistake' [by a peace officer obtaining evidence] means a reasonable judgmental error concerning the existence of facts that if true would be sufficient to constitute probable cause.").
183. See Arthur B. Laby, Resolving Conflicts of Duty in Fiduciary Relationships, 54 AM. U. L. REV. 75, 117 (2004) ("[A] director's fiduciary duty entails positive actions to benefit the corporation and its shareholders . . . .").
184. Many thanks to Professors David Frisch (University of Richmond) and Tim Zinnecker (South Texas College of Law) for sharing their thoughts.
185. Eisenberg, supra note 52.
186. Adler & Mann, supra note 151, at 33 ("The parties to a contract are deemed not at arm's length when they have a special relationship, either confidential or fiduciary. In such relationships the law imposes additional duties beyond those required in an arm's length transaction upon one of the parties resulting in 'heightened' protection for the other party. In these relationships the law establishes a duty of full disclosure, utmost good faith, and fair dealing."). For lack of a better place to go further with dispensing specifically of Professor Summers's "excluder" analysis in terms of its potential to be applied in the director liability context, allow me to offer the following: Recall that many commercial and contract law scholars have embraced the "excluder" method of defining good faith, based on Professor Summer's 1968 law review article. This excluder analysis, as discussed supra Part II.B.3, entails defining good faith by reference to the absence of bad faith acts that the phrase "good faith" is intended to exclude, as a standard of conduct. Summers, supra note 109. More articles than not on "good faith" in the corporate law realm define good faith by reference to "bad faith"-a director has acted in "good faith" if a complaining shareholder has not been able to show that the director acted in bad faith. See, e.g., Sale, supra note 139, at 482-89 (giving examples of "bad faith" or violations of the duty of good faith in Delaware case law); Filippo Rossi, Making Sense of the Delaware Supreme Court's Triad of Fiduciary Duties 40-43 (June 22, 2005) (unpublished essay), available at http://ssrn.com/abstract=755784 (examining the concept of bad faith in Delaware case law and proposing a test formulated by the House of Lords to assess bad faith). In addition, as discussed in Part IV, infra, some courts have sidestepped discussing what good faith is in the context of director behavior by instead defining what good faith is not. For example, in McCall v. Scott, 250 F. 3d 997, 1001 (6th Cir. 2001), the Sixth Circuit gave some definition to what it concluded would constitute a breach of a director's duty of good faith under Delaware law. Citing a Court of Chancery opinion authored by Vice Chancellor Strine, the McCall panel stated that "the duty of good faith may be breached where a director consciously disregards his duties to the corporation, thereby causing its stockholders to suffer." Id. at 1001 (discussing Nagy v. Bistricer, 770 A.2d 43, 49 (Del. Ch. 2000)). I do not view Summers's "excluder" analysis and its related "bad faith" definitional implications for good faith compelling, both in the abstract and as one would argue could be applied in the director liability context. First, the words of Professor Summers's own good faith work indicate that the "excluder analysis" was not developed with an eye to addressing good faith in all areas of law, including corporate governance. Admittedly, Professor Summers often makes general references to good faith in the absolute sense without limiting his discussion to the contracts or commercial area of law: If good faith had a general meaning or meanings of its own-that is, if it were either univocal or ambiguous-there would seldom be occasion to derive a meaning for it from an opposite; its specific uses would almost always be readily and immediately understood. But good faith is not that kind of doctrine. Summers, supra note 109, at 201. Yet, this "performance-based" invocation of good faith appears in the bulk of the article mainly with reference to the commercial or contracts law realms. There is nothing to indicate that Professor Summers intended to speak specifically to every other area of the law. Moreover, Professor Summers generally qualifies his good faith opining after the fact by noting that his statements pertain specifically to the contracts and commercial areas of law or by using illustrative facts pertinent only to those areas of the law by saying things such as "[i]n contract law, taken as a whole, good faith is an 'excluder.'" Id. In addition, Professor Summers provides a list of conduct-pertaining to commercial or contract-related factual scenarios-that constitutes bad faith, after which he provides related meanings of good faith based on the specific examples of bad faith conduct in the commercial and contracts law realm. Id. at 203 (discussing situations such as "seller concealing a defect in what he is selling. . . arbitrarily and capriciously exercising a power to terminate a contract, . . . [and] adopting an overreaching interpretation of contract language"). Finally, Professor Summers discusses only the contracts area of the law when analyzing forms of relief and making proposals regarding the same. Id. at 252-62 ("IV. Theories and Forms of Relief for Contractual Bad ...
187. See Rosenberg, supra note 46, at 513 ("A director who agrees to adhere to the terms of a corporate charter must do so in good faith: he must honestly try to be loyal; he must do his best to use care; and he must honestly try to carry out any other promise he has made to those who have entrusted him with control of their corporation. Good faith is merely a way of interpreting whether the parties adhered to the duties imposed upon them by the corporate charter or by contractual agreement.").
188. RESTATEMENT (SECOND) OF CONTRACTS § 205 cmt. a (1981).
189. Other agreements would include the implicit agreement that the directors will do a decent job but will make no effort to do the best job that they can or the agreement that the directors will do a perfect job. Of the range of potential implicit agreements, it seems that an agreement on acting in the best interests of the corporation would be reasonable.
190. See, e.g., RESTATEMENT (SECOND) OF CONTRACTS § 205 cmt. a (1981) ("Good faith performance or enforcement of a contract emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party . . . ."); Burton, supra note 185, at 3 ("[G]ood faith performance, as used by the courts, generally serves to effectuate the intentions of the parties, or to protect their reasonable expectations.").
191. See Elizabeth A. Nowicki, 10(b) or Not 10(b)?: Yanking the Security Blanket for Attorneys in Securities Litigation, 2004 COLUM. BUS. L. REV. 637, 676-80 (2004) (discussing textualism and defining words in accordance with their plain meaning); see also Amoco Prod. Co. v. S. Ute Indian Tribe, 526 U.S. 865, 874 (1999) (consulting a dictionary to determine the plain meaning of the word "coal").
192. I am not sure that I have done enough research to convince myself that I could say that good faith requires "best efforts," though I have no trouble maintaining that a director's fiduciary obligation to act in good faith requires some level of effort proportionate to the issue at stake. Note that Professor Farnsworth has said: [g]ood faith is a standard that has honesty and fairness at its core and this is imposed on every party to a contract. Best efforts is a standard that has diligence as its essence and is imposed on those contracting parties that have undertaken such performance. The two standards are distinct and that of best efforts is the more exacting, though it presumably falls short of the standard required of a fiduciary .... FARNSWORTH, supra note 106, § 7.17c.
193. When I initially conceived of this Article, I intended to present one, succinct, almost universally-applicable definition of good faith for use in the director liability context. Though I still propound that is possible, I have changed my goal for the Article to a more modest one. It strikes me that it is sensible to have more discussion about a draft good faith definition before committing to a terminal definition of good faith.
194. In terms of the objectivity or subjectivity of the phrase "good faith," that discussion might itself merit its own law review article. At least one scholar in the corporate realm has concluded that a director need only act in subjective good faith. See Sale, supra note 139, at 488 ("Good faith based liability, then, moves the bar... to deliberately indifferent, egregious, subversive, or knowing behavior, and thereby raises issues related to the motives of the actors."). Yet the late Professor Allan Farnsworth adamantly (and logically, I would submit) argued that good faith performance cannot be judged on a subjective standard. See Farnsworth, supra note 101, at 671-73. "Surely the test is not whether one party actually believed that he was acting decently, fairly or reasonably. Surely he must do more than form an honest judgment. Otherwise no more than knowing and deliberate unfairness, maliciousness, trickery and deceit would be forbidden." Id. at 672. Indeed, if nothing more than an honest heart was required of our directors, it would be very difficult for shareholders to ever vindicate any sort of mismanagement. See Kevin S. Shmelzer, Comment, The Door Slammed Shut Needs to be Reopened: Examining the Pleading Requirements Under the Private Securities Litigation Reform Act, 78 TEMP. L. REV. 405, 426 (2005) (discussing the difficulty of pleading scienter and its effect on corporate governance and accountability). By enacting the higher hurdle of needing to plead deliberate recklessness for a securities fraud claim ... it appears as though investor confidence in corporate entities will continue to erode as investors will encounter an even more difficult burden before being allowed to enter a courthouse. Congress should take note of the current corporate atmosphere and realize that the heightened inference requirement has resulted in making it more difficult to bring all securities fraud suits, including meritorious cases. Id. Recognition of the historical evolution of the phrase "good faith" is useful in developing more a context within which to define good faith. Recognizing the original role of good faith in the context of the law gives at least a hint for determining what specifically good faith could mean. To that end, good faith has long been a way to legalize conscience. See J.F. O'CONNOR, GOOD FAITH IN ENGLISH LAW 8 (1990). To the extent that law and morality are tied together in a form most recognizable as equity, good faith was the common thread tying together law and equity. As moral law and cannon law merged and morphed, good faith remained as the vestige of a quasi-moral obligation. Id. Professor O'Connor discusses the evolution from a conscience based jurisdiction to one based on equity by saying that there was an "increasing awareness of the distinction between individual conscience and rules operating in foro conscientie and the general conscience of the realm and rules operating in foro externo." Id. This shift makes more understandable the fact that good faith might well obligate a director to act in his own subjective good faith, but review will be conducted on an objective good faith standard. Id. at 53. Professor O'Connor says: Directors must act "bona fide in what they consider-not what a court may consider-is in the best interests of the company and not for any collateral purpose", [sic] What is required is that the directors must do what they honestly believe to be right-i.e. subjective good faith-and here, as in other areas of the law where subjective good faith is required, they will normally succeed in satisfying this test unless it can be shown (objectively) that they have not behaved in accordance with the standards expected of honest and reasonable men .... Id. (footnotes omitted)(emphasis removed).
195. Conduct in the best interests of the shareholders certainly must have a reasonableness threshold or materiality, otherwise directors would be obligated to act as super-officers, essentially repeating the job done by the officers in managing the corporation and constructing disclosure documents. If the director knows how to read financial statements and has a sense of what red flags look like, it is likely that the director has acted in the best interest of the shareholders by doing nothing more than that which he has done. Good faith cannot possibly require obsessive behavior, perfection, or double verification by the directors of each numerical item of financial disclosure. Good faith should perhaps be defined as conduct that is in the best interests of shareholders, given the context and circumstances, and reflects the fact that directors are not (and are not required to be) forensic accounting experts. In the case of In re Caremark Int'l. Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996), the court recognized that there is a contextual element to the meaning of an action in the best interest of shareholders: The vocabulary of negligence while often employed, is not well-suited to judicial review of board
196. Remember from Part I that a director will not receive the benefit of the statutory exculpation from personal liability for acts "not in good faith." DEL. CODE ANN. tit. 8, § 102(b)(7) (2001). Moreover, note from Part IV that, while good faith is presumed to exist under the business judgment rule presumption, if a plaintiff can show that the director did not act in good faith, the business judgment rule protection will be stripped from the director, subjecting the director's complained of actions to the more rigorous "reasonable and fair" standard of review.
197. In a forthcoming article, Not In Good Faith, I address this issue in full. Elizabeth A. Nowicki, Not In Good Faith, 60 SMU L. Rev. (forthcoming 2007).
198. Most recently, in the Disney derivative litigation, Chancellor Chandler of the Delaware Court of Chancery offered two definitions on two different occasions for acts not in good faith. First, in 2003, in denying the motion of the Disney directors to have the claims against them dismissed, the Chancellor said: 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. In re Walt Disney Co. Derivative Litig., 825 A.2d 275, 289 (Del. Ch. 2003). In 2005, in the post-trial memorandum, Chancellor Chandler said: Upon long and careful consideration, I am of the opinion that the concept of intentional dereliction of duty, a conscious disregard for one's responsibilities, is an appropriate (although not the only) standard for determining whether fiduciaries have acted in good faith. Deliberate indifference and inaction in the face of a duty to act is, in my mind, conduct that is clearly disloyal to the corporation. It is the epitome of faithless conduct. In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 755 (Del. Ch. 2005). Both of these definitions say nothing about bad faith, yet the Delaware Supreme Court, in affirming the lower court and specifically sanctioning this language, refers to the language and standard as definitions of "bad faith." In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 63 (Del. 2006).
199. I say "and worse, the academics" because the courts might have somehow viewed themselves bound to certain definition. Academics have the luxury of not being bound to any misinterpretation of the law.
200. BLACK'S LAW DICTIONARY 149 (8th ed. 2004).
201. Brittingham v. Bd. of Adjustment of Rehoboth Beach, No. 03A-08-002, 2005 WL 1653979, at *2 (Del. Apr. 26, 2005) (unpublished opinion).
202. Desert Equities, Inc. v. Morgan Stanley Leveraged Equity Fund, II, L.P., 624 A.2d 1199, 1208 n.16 (Del. 1993).
203. White v. Panic, 783 A.2d 543, 554 n.36 (Del. 2001).
204. Id. (quoting In re J.P. Stevens & Co. S'holders Litig., 542 A.2d 770, 780-81 (Del. Ch. 1988)).
205. DEL. CODE ANN. tit. 8, § 102(b)(7) (2001) (emphasis added).
206. See, e.g., Idaho v. Prestwich, 783 P.2d 298, 302 (Id. 1989) (Bistline, J., concurring) ("The trial judge did not find good faith; he only found lack of bad faith. I submit that the two are not synonymous." (citation omitted)); Art Form Interiors, Inc. v. Columbia Homes, Inc., 609 A.2d 370, 375 (Md. Ct. App. 1992) ("We view with considerable consternation the disturbing lack of good faith . . . but we are not prepared to hold that the appellants' actions constituted bad faith . . . ."); Zdravkovich v. Bell Atlantic-Trion Leasing, Corp., 592 A.2d 498, 403 (Md. Ct. App. 1991) ("The District Court's finding that Zdravkovich 'has not shown good faith' is not the equivalent of a finding of 'bad faith' and cannot be the basis for the imposition of sanctions."); Commonwealth v. Belcher, No. F88-140, 1988 WL 619393, at *1 (Va. Cir. Ct. 1988) ("Although the court finds no bad faith, the court does not find good faith here either."). As well, there might be another opinion regarding "good faith," "not in good faith," "bad faith," and "not in bad faith." The "no faith" option was discussed in Thomas v. W. World Ins. Co., 343 So. 2d 1298, 1304 (Fl. Dist. Ct. App. 1977), when the court analyzed an insurance company's refusal to defend an insured against the insurer's fiduciary obligation to exercise good faith in defending or settling claims against an insured. "In the case before us, there is no threshold question of 'good faith' vs. 'bad faith.' For here, the company exercised no faith at all." Id. Richard Rector describes the distinction found in some cases between the violation of the duty of good faith and fair dealing and an affirmative finding of bad faith as "noteworthy, if slightly metaphysical." Richard Rector, Infotech and the Law: Good Faith, Bad Faith in Government Contracts, WASH. TECHNOLOGY, (Apr. 17, 2000), available at http://www.washingtontechnology.com/print /15_20/16188-1html. Mr. Rector further observes that this suggests that "good and bad faith are not mirror images of one another . . . the government can fail to act in good faith without necessarily acting in bad faith." Id. (quoting an Armed Services Board of Contract Appeals case in which the board observed that "[t]he mere absence of bad faith . . . does not mean the government met its obligation ... to negotiate in good faith").
207. See, e.g., In re Lukens Inc. S'holders Litig., 757 A.2d 720, 728 (Del. Ch. 1999) (dismissing shareholder claim for breach of the duty of good faith because "[l]ittle or nothing in the Complaint speaks in terms of bad faith misconduct or disloyalty"); McGowan v. Ferro, 859 A.2d 1012, 1036 (Del. Ch. 2004) (discussing a plaintiffs attempt to plead that directors acted "not in good faith" as the phrase is used in DGCL § 102(b)(7), the court said "[b]ad faith is 'not simply bad judgment or negligence,' but rather 'implies the conscious doing of a wrong because of dishonest purpose of moral obliquity ... it contemplates a state of mind affirmatively operating with furtive design or ill will'" (quoting Desert Equities, Inc., 624 A.2d at 1208 n. 16)).
208. The Delaware Supreme Court itself recently defined "bad faith" when assessing whether the lack of good faith had been pled, completely ignoring the fact that the application of DGCL § 102(b)(7), which was at stake in the case, hinged on an assessment of whether the acts or omissions complained of were taken '"not in good faith.'" In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 65 (Del. 2006).
209. See Rosenberg, supra note 46, at 512 ("Fiduciary duties are substantive obligations which must be honored in good faith in the same way that contractual obligations must be honored in good faith.").
210. Some might worry that this analysis means that the directors will no longer be automatically given the protection of the business rule presumption. That worry is not merited; the directors will still receive the benefit of the presumption. If the plaintiffs cannot rebut the presumption of good faith by showing that, actually, good faith acts-acts in the best interests of the shareholders-were lacking or the acts at issue do not fit within the phrase "in the best interests of the shareholders," a director will forever hold the protection in that case. I had an interesting debate on the internet about a point related to this topic with Benjamin Nelson. See Elizabeth Nowicki, The Disney Opinion and "Not in Good Faith," Concurring Opinions, http://www.concurringopinions.com/archives/2006/06/ the_disney_opin.html (June 9, 2006) (my initial posting); Benjamin Samuel Nelson, Prototypes and Negations: One Interpretation of Nowicki's Intuition, Law & Society Blog, http://www.lawsocietyblog.com/archives/ 208 (June 10, 2006) (Nelson's response); Elizabeth Nowicki, Benjamin Nelson and "Good Faith," Concurring Opinions, http://www. concurringopinions. com/archives/2006/06/benjamin_nelson.html (June 20, 2006) (my reply); Benjamin Samuel Nelson, Faith and Act (A Rejoinder to Nowicki), Law & Society Blog, http://www.lawsocietyblog.com/archives/210 (June 21, 2006) (Nelson's rejoinder).
211. It is very unlikely indeed that legislators could have gotten away with adopting a standard prohibiting directors only from "affirmatively acting in bad faith." I imagine their constituents might object mightily, were this flimsy language brought to their attention.
212. HUFFCUT, supra note 152, at § 90 (emphasis added).
213. Sale, supra note 139, at 493.