A Good Faith Revival of Duty of Care Liability in Business Organization Law
36 Pages Posted: 17 Sep 2006 Last revised: 12 Mar 2008
The core fiduciary duties of care and loyalty have long been the most important and controversial theories of director liability in corporate law. The Delaware response to exploding director care liability has been a robust business judgment rule eroding the duty of care itself coupled later with statutory complete exculpation for duty of care liability. Shareholder efforts to circumvent those director protections have placed increasing pressure on the express exceptions to statutory exculpation in general and good faith in particular. The anti-exculpatory role of good faith arguably expanded by a narrow self benefit conceptualization of the duty of loyalty. That pressure is most recently expressed in the 2006 release of In re The Walt Disney Company Derivative Litigation, a nearly ten-year saga testing the conceptual limits of good faith while concluding Disney directors were not liable. While the Disney directors were arguably negligent, the shareholder plaintiffs failed to prove the directors acted in bad faith and thus absent actionable personal benefit, the directors' decisional conduct was protected by the business judgment rule as well as statutory exculpation. In this Article, Professor Bishop canvases the modern contours of the core corporate fiduciary duties of care and loyalty to challenge conventional wisdom and demonstrate that the peripheral duty of good faith is a distinct concept but not a separately actionable fiduciary duty. Delaware statutory exculpation and indemnification law as well as its business judgment rule lean heavily on a requirement of conceptual good faith as the minimum price of protected director conduct. Professor Bishop argues, properly conceived, bad faith operates to deconstruct those protections, a more proper and limited role for a duty extremely difficult to define and prove. Moreover, confining good faith to this role allows it to serve a justified policy goal designed to increase liability for unjustifiable behavior bordering on intentional misconduct. By stripping away exculpation, indemnification and business judgment rule protections, bad faith reinvigorates the core duty of care to an ordinary negligence standard requiring only proof of a breach of the ordinary negligence duty, corporate harm, and causation. Professor Bishop argues that the good faith reinvigoration of duty of care liability requires further re-examination of the 1993 Delaware Supreme Court opinion in Cede II, a case that conflated liability standards for a breach of the fiduciary duties of care and loyalty by allowing directors to escape care liability, like loyalty liability, by showing that the director conduct was "entirely fair" to the corporation and its shareholders. The "entire fairness standard" more appropriately addresses the fairness of director personal benefit and conflict of interest transactions. While statutory exculpation makes this error irrelevant in most cases, statutory exculpation is not available upon proof of bad faith thus mandating judicial correction of Cede II to avoid using an irrelevant entire fairness test to shield care liability. Given these corporate fiduciary duty missteps and the trend to adopt statutes approving ex ante contractual elimination of the duties of care and loyalty in unincorporated business organizations including limited liability companies, Professor Bishop concludes that careful attention is required to prevent these corporate errors from invading unincorporated law, particularly in Delaware.
Keywords: fiduciary duty, good faith, limited liability company, corporation, partnership, business judgment rule, duty of care, duty of loyalty, entire fairness test, Disney
JEL Classification: K10, K19, K22, K39
Suggested Citation: Suggested Citation