Duty of Good Faith
The ubiquity of exculpation provisions in charters as well as precedent like Malpiede v. Townson have made it extremely difficult – if not impossible – for shareholder plaintiffs to succeed on claims that simply allege violations of the duty of care. In response to foreclosing that litigation avenue, shareholder plaintiffs have brought other theories to court in attempts to generate monetary liability for otherwise disinterested directors when their decision-making process has fallen short of the mark. Duty of good faith claims are one such theory. In the good faith claims, plaintiffs argue that otherwise disinterested directors' inaction or decision-making was so poor such that it exceeds gross negligence – the standard of a duty of care claim – and rises to the level of a violation of the nonexculpable duty of good faith.
The object of these theories is to work around the limitations of exculpation provisions. To the extent they are successful, such theories might be able to generate monetary liability against disinterested directors. The Delaware Supreme Court took up these various theories of good faith in In re Disney Stockholder Litigation (2006). The court distilled the various theories of good faith put forward by plaintiffs as they attempted to generate monetary liability for directors. The court evaluated these various theories and provides us with guidance with respect to what makes up a valid good faith and what types of facts fall short.
In re Walt Disney Co. Derivative Litigation, 906 A. 2d 27 - Del: Supreme Court 2006
The precise question is whether the Chancellor's articulated standard for bad faith corporate fiduciary conduct — intentional dereliction of duty, a conscious disregard for one's responsibilities — is legally correct. In approaching that question, we note that the Chancellor characterized that definition as “an appropriate (although not the only) standard for determining whether fiduciaries have acted in good faith.” That observation is accurate and helpful, because as a matter of simple logic, at least three different categories of fiduciary behavior are candidates for the “bad faith” pejorative label.
The first category involves so-called “subjective bad faith,” that is, fiduciary conduct motivated by an actual intent to do harm. That such conduct constitutes classic, quintessential bad faith is a proposition so well accepted in the liturgy of fiduciary law that it borders on axiomatic. ...
The second category of conduct, which is at the opposite end of the spectrum, involves lack of due care — that is, fiduciary action taken solely by reason of gross negligence and without any malevolent intent. In this case, appellants assert claims of gross negligence to establish breaches not only of director due care but also of the directors' duty to act in good faith. Although the Chancellor found, and we agree, that the appellants failed to establish gross negligence, to afford guidance we address the issue of whether gross negligence (including a failure to inform one's self of available material facts), without more, can also constitute bad faith. The answer is clearly no. …
That leaves the third category of fiduciary conduct, which falls in between the first two categories of (1) conduct motivated by subjective bad intent and (2) conduct resulting from gross negligence. This third category is what the Chancellor's definition of bad faith — intentional dereliction of duty, a conscious disregard for one's responsibilities — is intended to capture. The question is whether such misconduct is properly treated as a non-exculpable, non-indemnifiable violation of the fiduciary duty to act in good faith. In our view it must be, for at least two reasons.
First, the universe of fiduciary misconduct is not limited to either disloyalty in the classic sense (i.e., preferring the adverse self-interest of the fiduciary or of a related person to the interest of the corporation) or gross negligence. Cases have arisen where corporate directors have no conflicting self-interest in a decision, yet engage in misconduct that is more culpable than simple inattention or failure to be informed of all facts material to the decision. To protect the interests of the corporation and its shareholders, fiduciary conduct of this kind, which does not involve disloyalty (as traditionally defined) but is qualitatively more culpable than gross negligence, should be proscribed. A vehicle is needed to address such violations doctrinally, and that doctrinal vehicle is the duty to act in good faith. The Chancellor implicitly so recognized in his Opinion, where he identified different examples of bad faith as follows:
The good faith required of a corporate fiduciary includes not simply the duties of care and loyalty, in the narrow sense that I have discussed them above, but all actions required by a true faithfulness and devotion to the interests of the corporation and its shareholders. A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. There may be other examples of bad faith yet to be proven or alleged, but these three are the most salient.
Those articulated examples of bad faith are not new to our jurisprudence. Indeed, they echo pronouncements our courts have made throughout the decades.
Second, the legislature has also recognized this intermediate category of fiduciary misconduct, which ranks between conduct involving subjective bad faith and gross negligence. Section 102(b)(7)(ii) of the DGCL expressly denies money damage exculpation for "acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law." By its very terms that provision distinguishes between "intentional misconduct" and a "knowing violation of law" (both examples of subjective bad faith) on the one hand, and "acts ... not in good faith," on the other. Because the statute exculpates directors only for conduct amounting to gross negligence, the statutory denial of exculpation for "acts ... not in good faith" must encompass the intermediate category of misconduct captured by the Chancellor's definition of bad faith.
Following Disney there were three viable avenues for successful good faith claims against disinterested directors: 1) where a director intentionally acts with a purpose other than that of advancing the best interests of the corporation; 2) where the fiduciary acts with the intent to violate applicable positive law; and 3) where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. Of these, the third, so-called oversight claims, have been the most hotly litigated.
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