The Disney Opinion and “Not in Good Faith”
As I noted earlier today, I thought, upon first read, that the Delaware Supreme Court’s Disney opinion from yesterday dealt a fatal blow to my “not in good faith” director liability argument. For those who missed it the first dozen times, I maintain that a complaining shareholder who is suing her directors, alleging that the directors failed to act in good faith, does not *have* to go so far as to prove “bad faith” acts by her directors, but, rather, she can point to the absence of good faith acts on which to pin liability. The phrase “not in good faith,” I maintain, does not mean (only) “bad faith.” Under my “not in good faith” theory of liability, directors who basically abdicate their duty or bury their heads – which are acts arguably short of bad faith acts – have violated their fiduciary obligation to act “in good faith.” And I thought that when I read the Disney opinion yesterday that the Delaware Supreme Court was boxing me in by maintaining narrowly that “not in good faith” only meant “bad faith.” Not so, it seems.
I had forgotten, when I first read yesterday’s opinion, that sometimes Delaware opinions take a second or third read before one can glean their full import. Such was the case with Disney. While I *thought* that the Disney opinion supported the position that my broad “not in good faith” category had no place in Delaware fiduciary jurisprudence, I was very wrong. More clearly, despite frequently invoking the phrase “bad faith” in the actual holding of the case, the Delaware Supreme Court in Disney did not say that a plaintiff shareholder who was trying to establish that a director acted without good faith in violation of her fiduciary obligations must prove “bad faith.” Quite the opposite: when the court discusses (in what I would call “dicta”) three categories of troublesome director behavior, the third category discussed appears to be almost exactly the same as the Nowicki Not-In-Good-Faith category! And that third category is (a) a category distinct from the court’s “bad faith” category (see below) and (b) a category that deals with liability-meriting behavior!
Allow me to explain in more detail:
On page 65 of the slip op., the court tells us that, “[b]cause of the increased recognition of the importance of good faith, some conceptual guidance to the corporate community may be helpful.” The court then gives us three categories of fiduciary behavior that we should distinguish among when discussing “the ‘bad faith’ pejorative label.” The first category deals with “subjective bad faith,” which the court defines as “fiduciary conduct motivated by an actual intent to do harm.” Category one merits no discussion. I think all scholars likely agree that “subjective bad faith” fits within the DGCL 102(b)(7) and the business judgment rule presumption “not in good faith” language.
Category two of questionable director conduct involves the lack of due care. The Disney court defines this category as “fiduciary action taken solely by reason of gross negligence and without any malevolent intent.” The court queries whether “gross negligence (including a failure to inform one’s self of available material facts), without more, can also constitute bad faith,” and the court answers itself with a resounding no. (Slip. Op. at page 66). (Interestingly, I might well agree with that statement, but only because the court uses the phrase “bad faith.”)
The third category of questionable director conduct is where things get interesting. The court says, with respect to our third category of questionable “fiduciary conduct,” that it falls between “conduct motivated by subjective bad intent and. . . conduct resulting from gross negligence.” Page 70. The court continues:
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. . . .
The court then goes further to say several other things that make more clear to me that the “not in good faith” category of liability-creating behavior as I would roughly define it (meaning, not as purely/only “bad faith”) is still alive! The Disney court, on pages 70-73, defines their “third category” in a way that roughly accords with my “not in good faith” category:
** The court, on pages 70-73, talks about conduct somewhere between “gross negligence” and “disloyalty.” Good, the “not in good faith” definitional theory covers such conduct!
** The court is not talking about “simple inattention.” Good, me neither.
** The court is not talking about “failure to be informed of all facts material to the decision.’’ Right, right – I agree.
** The court IS, however, proscribing with the second category “fiduciary conduct of this kind, which does not involve disloyalty. . . but is qualitatively more culpable than gross negligence.” ME TOO! The belief that “not in good faith” means “not in good faith” deals with exactly this kind of conduct.
** The court says “[a] vehicle is needed to address such violations doctrinally, and that doctrinal vehicle is the duty to act in good faith.” To that, I say a wholehearted “amen.”
(As if all of that definitional work were not enough, the court winds down by cementing the “not in good faith” qua “third category” discussion: The court retreats from its seeming refusal to cite sources, and it offers a citation. . . to a 1929 case on page 72, footnote 111, of the Slip op. As we all know, decades of old common law make clear that “not in good faith” is not properly defined (meaning, limited in scope) by “bad faith,” so God bless the clerk who drafted that footnote. (Note that the court then goes on to discuss the fact that 102(b)(7), by its very terms, distinguishes between intentional conduct and “acts. . . not in good faith.” That is just icing on the “not in good faith” cake.))