Essay: Stone v. Ritter and the Expanding Duty of Loyalty
31 Pages Posted: 23 Aug 2007
Date Written: August 22, 2007
After the latest Disney decision, good faith seemed poised to take on a new and prominent role, either as an independent duty or as a component of one of the traditional fiduciary duties, loyalty or care. In the next case to arise, Stone v. Ritter, the Delaware Supreme Court quite specifically characterized the duty of good faith as part of the duty of loyalty. The Court also characterized Caremark, until then a paradigmatic duty of care case, as a duty of loyalty case. In our view, the court in Stone v. Ritter got it right, and indeed, should have gone further. It should have expanded more on the analytic underpinnings of the duty of good faith and better set the stage for a broader use of the doctrine in addressing the many cases involving problematic conduct by directors and officers that don't implicate the duty of loyalty as that duty has traditionally been conceived.
In our essay, we propose a way of understanding how good faith fits within the broader context of Delaware fiduciary duty cases. We see potential cases as arrayed along a continuum. At one end are traditional care cases; in these cases, the only conflict between directors and the corporation arises from the natural human tendency to not work as hard or carefully as one might when one is not reaping all the fruits of one's labors. At the other end are the traditional loyalty cases, where a decision-maker has a material pecuniary interest that directly conflicts with that of the corporation - for instance, where a director or officer is selling land to the corporation. In between are cases where director or officer objectivity is impaired, but less so than in traditional loyalty cases. The emerging law of good faith helps courts deal with such cases. We suggest that this law is developing at two levels of abstraction. Particular clusters of cases develop detailed guidance for certain recurring problematic situations - the adoption of takeover defenses, board responses to shareholder derivative suits, the approval of executive compensation, and so on. At the same time, a more general doctrine of good faith is emerging that helps courts deal with more unique circumstances or with emerging problematic business practices; the more general doctrine provides an expressive handle on which to ground future holdings and encourage the development of appropriate norms.
Keywords: corporate governance, good faith, fiduciary duty, duty of loyalty, duty of care
JEL Classification: D21, G30, K22
Suggested Citation: Suggested Citation