Stone V. Ritter and the expanding duty of loyalty

Fordham Law Review

Volumn 76, Issue 3, 2007, Pages 1769-1796

  Hill, Claire A ^a   McDonnell, Brett H ^a  

^a UNIVERSITY OF MINNESOTA LAW SCHOOL   (United States)

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EID: 39349105422     PISSN: 0015704X     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Conference Paper

References (166)

1. 911 A.2d 362, 370 (Del. 2006).
2. 698 A.2d 959 (Del. Ch. 1996).
3. Stone, 911 A.2d at 370.
4. Del. Code Ann. tit. 8, § 102(b)(7) (2001).
5. See Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993) ("A director is considered interested where he or she will receive a personal financial benefit from a transaction that is not equally shared by the stockholders. Directorial interest also exists where a corporate decision will have a materially detrimental impact on a director, but not on the corporation and the shareholders." (citations omitted)).
6. See Jesse H. Choper et al. Cases and Materials on Corporations 74-179 (6th ed. 2004);
7. William A. Klein et al. Business Association: Cases and Materials on Agency, Partnerships and Corporations 328-412 (6th ed. 2006);
8. D. Gordon Smith & Cynthia A. Williams, Business Organization: Cases, Problems, and Case Studies 395-524 (2004).
9. See Principles of Corporate Governance: Analysis and Recommendations pt. IV (duty of care), pt. V (duty of loyalty) (1994);
10. Model Bus. Corp. Act § 8(C), (F) (2005).
11. See Unocal Corp. v. Mesa Petroleum Co, 493 A.2d 946, 955 (Del. 1985).
12. See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1986).
13. See Zapata Corp. v. Maldonado, 430 A.2d 779, 781 (Del. 1981).
14. Several other statutory provisions, beyond that discussed in the text, are notable for their use of the good faith concept as well. These include Del. Code Ann. tit. 8, § 141(e) (2001) (good faith reliance on records and opinions), Del. Code Ann. tit. 8, § 144 (good faith board or shareholder approval of interested transactions), and Del. Code Ann. tit. 8, § 145 (indemnification allowed for liability incurred as a result of actions in good faith, thus apparently disallowing indemnification for liability incurred as a result of actions lacking good faith).
15. Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).
16. 488 A.2d 858 (Del. 1985).
17. In this regard, Van Gorkom has been disparaged as encouraging directors to formalistically follow and document "due procedure," without regard to, and perhaps at the expense of, critical and rigorous decision making. On Delaware corporate law's emphasis on process, see Claire A. Hill & Erin Ann O'Hara, A Cognitive Theory of Trust, 84 Wash. U. L. Rev. 1717, 1789-90 (2006).
18. Section 102(b)(7) quickly became part of the story told by the many corporate law scholars who thought director liability had no teeth-as some said, an outside director has more chance of being hit by lightning than being found liable for breaching his fiduciary duty. See Bernard Black, Brian Cheffins & Michael Klausner, Outside Director Liability, 58 Stan. L. Rev. 1055, 1139-40 (2006);
19. Margaret M. Blair & Lynn A. Stout, Trust, Trustworthiness, and the Behavioral Foundations of Corporate Law, 149 U. Pa. L. Rev. 1735, 1791 (2001). Interestingly, Delaware Chancellor Leo Strine and Professor Lynn Stout now think directors are too responsive to pressures from public shareholders, and that firms are therefore increasingly going private.
20. See Leo E. Strine, Jr., Toward Common Sense and Common Ground? Reflections on the Shared Interests of Managers and Labor in a More Rational System of Corporate Governance, 33 J. Corp. L. 1 (2007);
21. Lynn Stout, Investors Who Are Too Bolshy for Their Own Good, Fin. Times, Apr. 23, 2007, at 9.
22. See Del. Code Ann. tit. 8, § 102(b)(7)(i).
23. See id. § 102(b)(7)(ii).
24. See Christopher M. Bruner, Good Faith, State of Mind, and the Outer Boundaries of Director Liability in Corporate Law, 41 Wake Forest L. Rev. 1131, 1155 (2006).
25. See Emerald Partners v. Berlin, 726 A.2d 1215, 1221 (Del. 1999);
26. Malone v. Brincat, 722 A.2d 5, 10 (Del. 1998);
27. Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993).
28. Cede, 634 A.2d at 361.
29. See Guttman v. Huang, 823 A.2d 492, 506 (Del. Ch. 2003);
30. Nagy v. Bistricer, 770 A.2d 43, 48 n.2 (Del. Ch. 2000).
31. Guttman, 823 A.2d at 506 n.34 (citations omitted).
32. Emerald Partners v. Berlin, 726 A.2d 1215, 1223 (Del. 1999).
33. 780 A.2d 1075, 1092-96 (Del. 2001).
34. See supra note 11.
35. In recent years a number of scholars have written articles considering the meaning and implications of Delaware's growing good faith jurisprudence. In addition to the sources cited elsewhere in this Essay, these include 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 (2005);
36. Matthew R. Berry, 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);
37. Carter G. Bishop, A Good Faith Revival of Duty of Care Liability in Business Organization Law, 41 Tulsa L. Rev. 479 (2006);
38. Sarah Helene Duggin & Stephen M. Goldman, Restoring Trust in Corporate Directors: The Disney Standard and the "New" Good Faith, 56 Am. U. L. Rev. 211 (2006);
39. 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);
40. Sean J. Griffith, Good Faith Business Judgment: A Theory of Rhetoric in Corporate Law Jurisprudence, 55 Duke L.J. 1 (2005);
41. Sean J. Griffith & Myron T. Steele, On Corporate Law Federalism: Threatening the Thaumatrope, 61 Bus. Law. 1 (2005);
42. 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);
43. John L. Reed & Matt Neiderman, "Good Faith " and the Ability of Directors to Assert § 102(b)(7) of the Delaware Corporation Law as a Defense to Claims Alleging Abdication, Lack of Oversight, and Similar Breaches of Fiduciary Duty, 29 Del. J. Corp. L. 111 (2004);
44. David Rosenberg, Making Sense of Good Faith in Delaware Corporate Fiduciary Law: A Contractarian Approach, 29 Del. J. Corp. L. 491 (2004);
45. Hillary A. Sale, Delaware's Good Faith, 89 Cornell L. Rev. 456 (2004);
46. C.G. Hintmann, Note, You Gotta Have Faith: Good Faith in the Context of Directorial Fiduciary Duties and the Future Impact on Corporate Culture, 49 St. Louis U. L.J. 571 (2005);
47. Filippo Rossi, Making Sense of the Delaware Supreme Court's Triad of Fiduciary Duties (June 22, 2005) (unpublished manuscript), available at http://ssrn.com/abstract=755784.
48. In re Walt Disney Co. Derivative Litig, 906 A.2d 27, 62 (Del. 2006) (quoting the Chancery Court opinion).
49. Id. at 67 (quoting the Chancery Court opinion).
50. Id. at 72. We consider in the text accompanying note 109, infra, whether 'not in good faith' and 'bad faith' are, or should be, equivalent.
51. In re Walt Disney Co. Derivative Litig, 825 A.2d 275 (Del. Ch. 2003).
52. In re Caremark Int'l, Inc. Derivative Litig, 698 A.2d 959 (Del. Ch. 1996).
53. Id. at 960-61.
54. Id. at 965 ("No senior officers or directors were charged with wrongdoing in the Government Settlement Agreement or in any of the prior indictments.... [T]he United States stipulated that no senior executive of Caremark participated in, condoned, or was willfully ignorant of the wrongdoing. . . .").
55. Id. at 964.
56. Id. at 967.
57. Id.
58. Id.
59. Id. at 968.
60. Id. at 969 (emphasis added).
61. Id. at 971 (emphasis added).
62. William T. Allen, Reinier Kraakman & Guhan Subramanian, Commentaries and Cases on the Law of Business Organization 282-92 (2d ed. 2007).
63. E.g., Caremark, 698 A.2d at 967 ("[Compliance with a director's duty of care can never appropriately be judicially determined by reference to the content of the board decision that leads to a corporate loss, apart from consideration of the good faith or rationality of the process employed." (emphasis omitted));
64. id. at 968 ("Indeed, one wonders on what moral basis might shareholders attack a good faith business decision of a director as 'unreasonable' or 'irrational.' Where a director in fact exercises a good faith effort to be informed and to exercise appropriate judgment, he or she should be deemed to satisfy fully the duty of attention." (emphasis omitted));
65. id. ("Learned Hand correctly identifies the core element of any corporate law duty of care inquiry: whether there was good faith effort to be informed and exercise judgment.");
66. id. at 970 ("[A] director's obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists ....").
67. Stone v. Ritter, 911 A.2d 362, 364 (Del. 2006) (quoting the Chancery Court opinion).
68. Id. at 365.
69. Id. at 365-66.
70. Id. at 364.
71. Id. at 365, 369.
72. See, e.g., BusinessAssociationsBlog, http://www. businessassociationsblog.com/lawandbusiness/comments/stone_v_ritter_director s_caremark_oversight_duties/ (Jan. 3, 2007);
73. Posting of Gordon Smith to Conglomerate, http://www.theconglomerate.org/ 2007/01/good_faith_care.html (Jan. 3, 2007).
74. See supra notes 23-24 and accompanying text.
75. Stone, 911 A.2d at 369-70.
76. Id. at 370.
77. Id.
78. Id. (quoting Guttman v. Huang, 823 A.2d 492, 506 n.34 (Del. Ch. 2003)).
79. Claire A. Hill & Brett H. McDonnell, Disney, Good Faith & Structural Bias, 32 J. Corp. L. 833, 855 (2007).
80. Black's Law Dictionary 658 (8th ed. 2004) (defining "fiduciary" as "[a] person who is required to act for the benefit of another person on all matters within the scope of their relationship; one who owes to another the duties of good faith, trust, confidence, and candor"). The doctrine comes from agency law. See Restatement (Third) of Agency § 1.01 cmt. e (2006). This doctrine has been put to use not only in corporate law, but in many other areas as well, most notably in trust law. Some legal relationships are considered fiduciary relationships and are governed by some general common law doctrines that essentially reflect the Black's Law Dictionary's definition.
81. See generally Tamar Frankel, Fiduciary Duties, in The New Palgrave Dictionary of Economics and the Law 127 (Peter Newman ed., 1998).
82. And of course, after the Delaware legislature enacted section 102(b)(7), allegations that simply amounted to generic inattention became rarer still.
83. Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).
84. For an argument that loyalty should be broadly conceived to include an element of affirmative devotion to the well-being of the corporation, see Lyman Johnson, After Enron: Remembering Loyalty Discourse in Corporate Law, 28 Del. J. Corp. L. 27 (2003).
85. Hill & McDonnell, supra note 54, at 852.
86. See Julian Velasco, Structural Bias and the Need for Substantive Review, 82 Wash. U. L.Q. 821 (2004).
87. Brehm v. Eisner, 746 A.2d 244 (Del. 2000).
88. 918 A.2d 341 (Del. Ch. 2007).
89. Id. at 358.
90. Id.
91. Zapata Corp. v. Maldonado, 430 A.2d 779, 781 (Del. 1981).
92. We coined this term to describe directors who are also officers of other corporations who defer in their capacities as directors because, as officers, they would want a deferential board. Hill & McDonnell, supra note 54, at 838.
93. For more on structural bias, see Velasco, supra note 60.
94. See, e.g., Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).
95. 506 A.2d 173 (Del. 1986).
96. Id. at 177-79, 182-83.
97. Id. at 177.
98. Id. at 178.
99. Id.
100. Id. at 182.
101. Id. at 181.
102. Id. at 182.
103. See generally Lawrence A. Hamermesh, Calling off the Lynch Mob: The Corporate Director's Fiduciary Disclosure Duty, 49 Vand. L. Rev. 1087 (1996) (discussing the duty generally).
104. See id. at 1146 (discussing another type of case, in which a director is acquiring stock from an outside, public stockholder). We do not discuss this type of case because no action even purportedly on behalf of the corporation is involved.
105. 919 A.2d 563 (Del. Ch. 2007).
106. Id. at 597-98.
107. One interesting recent case involves the severance payment made to Carly Fiorina, former chief executive officer, when she left Hewlett Packard (HP). In Indiana Elec. Workers Pension Trust Fund, IBEW v. Dunn, HP was sued by shareholders who claimed that Fiorina's severance payment was more than the 2.99-times-salary-and-bonus threshold above which HP's severance policy stated HP would seek shareholder approval. No. C-06-01711 RMW, 2007 WL 1223220 (N.D. Cal. Mar. 1, 2007). One claim made by the shareholders rested on the duty of disclosure-that "defendants breached their fiduciary duty to disclose because HP did not disclose in its 2004, 2005, and 2006 proxy statements that it never intended to honor the Severance Policy or provisions of the Severance Program." Indiana Elec.
108. Id. at * 11. The case was dismissed, but the plaintiffs were granted leave to amend their pleadings, and they have done so.
109. Id. at *12.
110. Shareholders have also brought suits criticizing corporate disclosure alleging that the action at issue was disclosed but not properly characterized-paradigmatically, that directors took some questionable action and did not characterize it as such. Courts have rejected those sorts of claims, saying boards do not have to engage in self-flagellation. See, e.g., In re Walt Disney Co. Derivative Litig., 731 A.2d 342 (Del. Ch. 1998). In Disney, the Chancery Court stated, The Plaintiffs in this action attempt to convert their flawed derivative claim against Disney for paying Ovitz severance benefits to a disclosure claim. First, they claim that the information was germane to shareholder consideration of the five directors' re-election because shareholders would consider important within the total mix the fact that these directors approved such extravagant waste. That assertion runs afoul of the rule against self-flagellation: Delaware law does not, however, require a proxy statement to impugn a director's character or draw negative inferences from his past business practices. It only requires a summary of his credentials and his qualifications to serve on the board as well as a description of any conflicts of interest. Nothing in our law requires a masochistic litany of management minutiae.
111. Id. at 377 (quoting Wolf v. Assaf, No. C.A. 15339, 1998 WL 326662, at *5 (Del. Ch. June 16, 1998)). It is interesting to consider whether a good faith framework might be able to revive some of these claims where the disclosure was drafted, as legal disclosures frequently are, to convey the fact of what was done while somewhat obscuring the spirit.
112. 507 F.2d 759 (3d Cir. 1974).
113. Stephen Bainbridge has made this point in criticizing Stone. Stephen M. Bainbridge et al. The Convergence of Good Faith and Oversight 36-38 (UCLA Sch. of Law, Law & Economics Research Paper Series, Research Paper No. 07-09, 2007), available at http://ssrn.com/abstract=1006097.
114. Note that whether the corporation's interest is parochial or general depends on the context and what it is being compared to: it is more general than one individual's interest but more parochial than society's interests.
115. A related reason could be that fiduciaries are classically supposed to be honest and honorable, and simply breaking the law could be seen as running afoul of that characterization. See Frankel, supra note 55, at 129 ("Fiduciary law vests in entrustors the legal right to rely on the honesty of their fiduciaries by imposing on fiduciaries a corresponding duty of loyalty and other specific duties to deter dishonesty.").
116. There is one line of cases suggesting that damages from illegal conduct would only be the amount by which the company suffered from the conduct net of what it gained. But that damage formula is based on a New York decision that has subsequently been criticized. See Principles of Corporate Governance: Analysis and Recommendations § 7.18(c) cmt. e (1994) ("In effect, derivative actions seeking to hold corporate officials accountable for fines imposed on the corporation as a result of knowing criminal antitrust violations were dismissed because the plaintiff could not prove that the crime did not pay. The continued authority of these decisions is questionable after the New York Court of Appeals' subsequent decision in Diamond v. Oreamuno, 24 N.Y.2d 494 (1969), which stressed that the deterrent role of the derivative action excused the necessity of proving a loss to the corporation and also held that an intangible loss to the corporation might arise from adverse publicity and stigmatization.").
117. 770 A.2d 43, 48 n.2 (Del. Ch. 2000).
118. In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 754 n.453 (Del. Ch. 2005).
119. Lyman Johnson also suggests that good faith can provide doctrinal support for the duty to affirmatively devote oneself to the corporation's interest, something Johnson calls the "affirmative" or "devotion" side of loyalty. See Johnson, supra note 58, at 69 n.245.
120. See generally Stephen M. Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 Vand. L. Rev. 83 (2004).
121. Disney, 907 A.2d at 760 n.487.
122. See supra notes 8-10 and accompanying text.
123. See Bainbridge et al., supra note 83, at 34;
124. see also 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).
125. Bainbridge et al., supra note 83, at 28-31.
126. Id at 31.
127. Id. at 28-31.
128. Weinberger v. UOP, Inc., 457 A.2d 701, 714 (Del. 1983).
129. Restatement (Second) of Agency § 407 (1957).
130. See generally Bainbridge, supra note 90.
131. See Melvin A. Eisenberg, The Duty of Good Faith in Corporate Law, 31 Del. J. Corp. L. 1, 30-31 (2006).
132. 383 N.Y.S.2d 807 (App. Div. 1976).
133. Id. at 809.
134. One of us wrote an article discussing this debate. See generally Claire A. Hill, Why Financial Appearances Might Matter: An Explanation for 'Dirty Pooling ' and Some Other Types of Financial Cosmetics, 22 Del. J. Corp. L. 141 (1997).
135. Id. at 145-46 n.12 (discussing the AT&T/NCR transaction).
136. Kamin, 383 N.Y.S.2d at 811-12.
137. This being said, we should note that, in Hill & McDonnell, supra note 54, at 860 n.135, we argue that Kamin may not actually have been a straightforward care case. The alternative explanation invokes structural bias, suspect motives, and/or even straightforward self-interest: the directors were motivated by a compensation measure, applicable to the compensation of four of the twenty-member board, based on accounting earnings rather than the report by market experts as to the likely effect of the accounting loss.
138. See Del. Code Ann. tit. 8, § 144 (2001).
139. Hill & McDonnell, supra note 54, at 855.
140. On the distinction between lack of good faith and bad faith, see id. at 856-57.
141. See also Elizabeth A. Nowicki, The Unimportance of Being Earnest: Reflections on Director Liability and Good Faith (Aug. 1, 2006) (unpublished manuscript), available at http://www.ssrn.com/abstract=921668.
142. See supra notes 27-30 and accompanying text.
143. Bainbridge voices concern about the consequences of Stone in instances where a board has adopted no compliance system whatsoever. He believes it may inappropriately let boards off where they are unaware of the duty to have such a system, and that it may inappropriately find boards liable where they have carefully weighed the costs and benefits and decided such a system is not worth it. Bainbridge et al., supra note 83, at 42-48. We doubt that in this day and age any public corporation board can plausibly fit into the former, uninformed category-the duty to have a compliance system is simply too pervasive, particularly post-Sarbanes-Oxley. As for the latter category, a consequence of Stone is indeed that any board will feel it must have some sort of legal compliance system in place-and that is presumably an intended effect, and one that is defensible, as we argued above.
144. See supra notes 82-90 and accompanying text. Moreover, the need for intentional behavior may be muted as the good faith doctrine develops; an additional ground for finding the totally unaware board liable may therefore come to exist.
145. 591 A.2d 194 (Del. 1991).
146. See, e.g., Alford v. Shaw, 358 S.E.2d 323 (N.C. 1987).
147. See, e.g., Grimes v. Donald, 673 A.2d 1207 (Del. 1996).
148. Hill & McDonnell, supra note 54, at 859.
149. See, e.g., Desimone v. Barrows, 924 A.2d 908 (Del. Ch. 2007);
150. In re Tyson Foods Consol. Shareholder Litig., 919 A.2d 563 (Del. Ch. 2007);
151. Ryan v. Gifford, 918 A.2d 341 (Del. Ch. 2007).
152. See supra notes 8-9 and accompanying text.
153. See supra note 10 and accompanying text.
154. See supra note 10 and accompanying text.
155. 564 A.2d 651 (Del. Ch. 1988).
156. State of Wis. Inv. Bd. v. Peerless Sys. Corp., No. Civ. A. 17637, 2000 WL 1805376, at * 12 (Del. Ch. Dec. 4, 2000).
157. Id. at *1.
158. A recent case refines, and arguably somewhat alters, the Blasius standard. See Mercier v. Inter-Tel., 929 A.2d 786 (Del. Ch. 2007). Blasius seemed to suggest that it would be very hard to postpone a shareholder vote to stop a result the management did not like; Mercier suggests that such a postponement may be not quite so hard.
159. Johnson also stresses the interplay between the judicial loyalty rhetorical and extrajudicial norms. See Johnson, supra note 58, at 29.
160. See E. Norman Veasey & Christine T. Di Guglielmo, What Happened in Delaware Corporate Law and Governance From 1992-2004? A Retrospective on Some Key Developments, 153 U. Pa. L. Rev. 1399, 1406 (2005) (describing "an important genre of Delaware decision making" that "raises questions or teaches without imposing liability" thereby providing "guidance to the corporate world to conform to best practices without the downside of actually imposing personal liability").
161. In re Walt Disney Co. Derivative Litig., 907 A.2d 693 (Del. Ch. 2005).
162. Id. at 763.
163. 594 A.2d 48 (Del. 1991).
164. Id. at 51-52.
165. Id. at 58 n.23
166. (citing Sullivan v. Hammer, CIV. A. No. 10823, 1990 WL 114223, at *4 (Del. Ch. Aug. 7, 1990), aff'd sub nom, Sullivan, 594 A.2d 48).