New Developments

Delaware Supreme Court on good faith and the duty of loyalty in a Revlon setting

The Delaware Supreme Court, sitting en banc, has held that the Court of Chancery erred when it ruled that liability for breach of the duty of loyalty in a bad faith context could be imposed without a showing of intent.

 

In Lyondell Chemical Co. v. Ryan, Lyondell received an unsolicited all cash all shares offer at a substantial premium to the market. Lyondell had made no effort to sell itself or seek a strategic partner and the company was economically viable. The board delegated much of the negotiating work to its board chair and CEO, Smith. The final agreement did not contain a go-shop provision but did include several deal protective measures. Ryan, a Lyondell shareholder, brought the required shareholder suit challenging whether the board met its Revlon duties. The board was independent and not interested and Lyondell’s Certificate of Incorporation contained a 102(b)(7) exculpatory clause.

 

Justice Berger, speaking for a unanimous court, first described the Disney case on bad faith and Stone’s adoption of Caremark’s duty to monitor and its imposition of an intent requirement to a finding of a breach of the duty of good faith. She then held that the Vice Chancellor erroneously applied Revlon before the board actually decided to sell the company. Thus, many of the facts showing the directors did nothing to maximize the company’s value were irrelevant to the Revlon claim because Revlon did not yet apply. Justice Berger held that when one focused on the board’s actions after it decided to sell the company, it could not be accused of nearly complete inaction. In my earlier post on the Court of Chancery opinion in this case I said I thought the Vice Chancellor was clearly right about Revlon’s application. However, I didn’t consider the timing question and Justice Berger may well be correct on this point. All agree that Revlon applied at some point and that plaintiff’s claim is that Revlon wasn’t met but it’s obviously important to determine when Revlon applied before looking at facts that show whether the board complied with its Revlon duties.

 

She then held that the Vice Chancellor took too narrow a view of the ways in which Revlon can be satisfied and that, on these facts, the Supreme Court would be inclined to hold that the directors met Revlon. However, that inclination is irrelevant, Justice Burger says, because the directors’ failure to take any particular actions could not demonstrate a conscious disregard for their known duties, which is required for a finding of breach of the duty of loyalty via bad faith. There being no evidence of an intentional disregard for their fiduciary duties, the directors cannot be liable.

 

This result is definitely correct and I’m happy to see that the court has, in a relatively succinct and well written opinion, gotten the law right. I have one small (I hope) concern, however, that Justice Berger may have been slightly imprecise and may open the door to being misunderstood.

 

One of the questions in Caremark, as it stood for ten years before Stone transmogrified it, was what the standard of review for liability would be. Chancellor Allen, Caremark’s author, used extreme language, suggesting that nothing short of a complete failure to implement a monitoring system or to monitor would be enough to impose liability. When Stone made Caremark a duty of care loyalty case, it held that the directors could only be liable for intentionally disregarding their fiduciary duties. Here in Ryan, Justice Berger brings back some of Chancellor Allen’s language about utter failure and I worry that such a standard might work its way into the standard for duty of loyalty liability in bad faith cases.

 

For example, when she first mentions the standard she writes (p.11), “We adopted the standard articulated . . .  in In re Caremark . . . [now she quotes from Caremark:] only a sustained or systematic failure . . . such as an utter failure to attempt to assure a reasonable information and reporting system exists – will establish the lack of good faith that is a necessary condition to liability.” Likewise, she later writes (p.18), “Only if they knowingly and completely failed to undertake their responsibilities would they breach their duty of loyalty”. Note the phrase, “and completely”. Further on that page she quote a Chancery Court opinion that could lend support to this analysis: “[an] extreme set of facts [is] required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties”. Does an extreme set of facts equate with a requirement that the plaintiff show that the directors not only intended to disregard their duties but did absolutely nothing? Finally (p.19) “[T]he inquiry should have been whether those directors utterly failed to attempt to obtain the best sales price.” Note the words, “utterly failed”. All this language might be seen as imposing liability for breach of the duty of loyalty via bad faith only when there is intent and when the directors completely fail to meet their duty or perhaps completely fail to take action.

 

This can’t be the law. Intent is surely a requisite for finding bad faith and hence a duty of loyalty violation but there’s no case law authority and no policy reason to impose an additional test of utter failure to meet the duty or take action. Surely a director is liable who intends not to meet the duty of loyalty by only a little bit.

 

Justice Berger has much language, though, that suggests the correct rule, as well, and I’m hopeful that courts will pick up on that language and not on the looser formulations quoted above. For example, she writes in the introduction (p.3), “There is no evidence, however, from which to infer that the directors knowingly ignored their responsibilities, thereby breaching their duty of loyalty.” Later (p.17), she writes, “[B]ad faith will be found if a ‘fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.’ ” Shortly thereafter (p.18) she writes, “Thus, the directors’ failure to take any specific steps during the sale process could not have demonstrated a conscious disregard of their duties.” No mention here of anything more than that as a requisite for liability.

Delaware Court of Chancery on good faith and the duty of loyalty in a Revlon setting again

The Delaware Court of Chancery has erroneously held that it was correct in its earlier decision to permit a case to survive summary judgment under Stone v. Ritter without facts indicating that the defendants intended to violate a known duty.

 

In Ryan v. Lyondell Chemical Co. (Ryan II) (letter opinion dated August 29, 2008) (HT Francis Pileggi here), Vice Chancellor Noble took 26 pages to decide defendants’ motion for certification of an interlocutory appeal of his earlier decision in the litigation (Ryan I here) (read my post on Ryan I here). The core problem with Ryan I, in my view, was that the Vice Chancellor did not explicitly hold that the defendants knew that they were not discharging their fiduciary duties. I’m guessing that no evidence was presented to him or that the parties did not highlight that element for him in their briefs. In any event, the Vice Chancellor now asserts that Ryan I was correct although he does say that in Ryan I, “the Court perhaps did not expound in sufficient detail. . .” and “. . . the Court was not as clear as it might have been in this regard”.

 

The Vice Chancellor might simply have declared that Ryan I was correct but proceed in Ryan II to fix the errors of the earlier opinion. Had he done so, he wouldn’t have been the first jurist to take that rhetorical approach. However, Ryan II doesn’t correct the problem with Ryan I. Vice Chancellor Noble starts by emphasizing that the directors may well have violated their Revlon duties and then declares (emphasis original), “it is possible to draw the reasonable inference, at least for purposes of denying summary judgment on the current record, that the directors may have consciously disregarded their known fiduciary obligations. . . .” and that “the Defendants may have exhibited a ‘conscious disregard’ for their known fiduciary obligations. . . .”

 

He then “digresses briefly” (if 13 pages can be called brief) to assure us that Ryan I correctly defined “bad faith” per Disney. In this he is definitely correct. Ryan I certainly set out the correct standard, per Stone v. Ritter. I’m assuming that the reason Ryan II dwells on Disney is that the moving papers now argue that he misstated the definition of bad faith in Ryan I. He didn’t. He also correctly fits Disney with Stone and recognizes that to find a duty of loyalty violation via bad faith requires, as it were, specific intent. What he doesn’t do in Ryan II, and didn’t do in Ryan I, was point to any fact establishing director intent other than the undisputed fact that the directors knew Revlon applied, knew what their Revlon obligations required, and did nothing, which arguably (but not definitely) violated Revlon.

 

I don’t think that can be enough for plaintiff to survive summary judgment. The troubling part of Ryan II is that the Vice Chancellor makes much of the fact that this is a motion for summary judgment and, apparently, the motion was made on a record created for litigation in Texas. The defendants surely have the burden of showing that no genuine issue of material fact exists and that they’re entitled to judgment as a matter of law. The court must make every inference against the movants. Without having seen the briefs or, obviously, the underlying record, it seems to me that plaintiff hasn’t put forth any fact from which the court could legitimately infer that the defendants knew they were violating their fiduciary duties. Had there been such a fact, Ryan I would have mentioned it. Even accepting the Vice Chancellor’s explanation that he didn’t feel the need to go into great detail in an opinion denying summary judgment, that doesn’t explain why such a fact wouldn’t have been the centerpiece of Ryan II. The only conclusion I can draw is that the Vice Chancellor is making what is in my view an impermissible inference from the record. I’m guessing the defendants have canvassed the record and demonstrated that nothing therein raises a genuine issue of their intent to violate fiduciary duties. That is, the record does not show that the directors intended their inaction to violate their fiduciary duties. So, the Vice Chancellor has to fall back on the same facts he relied upon on Ryan I but now has to say explicitly, and erroneously, that those facts can support an inference of intent. They can’t.

 

I hadn’t focused on this aspect of the litigational posture, but Ryan I also denied plaintiff’s motion for additional discovery, essentially on the ground that he’d had plenty of time to develop his record. This strikes me as pretty strong circumstantial evidence that the Vice Chancellor didn’t appreciate the importance of defendants’ intent when he wrote Ryan I. Had he had the requisite appreciation, I suspect he would have permitted Ryan to take discovery at least on that point. He didn’t do so. I don’t see any motion by plaintiff to reopen that question but I would think such a motion would be well taken if the Vice Chancellor has any hope of being affirmed should the Supreme Court take the case.

 

Larry Ribstein has a post (here).

Delaware Court of Chancery on good faith and the duty of loyalty in a Revlon setting

The Delaware Court of Chancery has erroneously permitted a case to survive summary judgment under Stone v. Ritter without showing facts indicating that the defendants intended to violate a known duty.

In Ryan v. Lyondell Chemical Co., (HT Francis Pileggi here) Lyondell received an unsolicited all cash all shares offer at a substantial premium to the market. Lyondell had made no effort to sell itself or seek a strategic partner and the company was economically viable. The board delegated much of the negotiating work to its board chair and CEO, Smith. The final agreement did not contain a go-shop provision but did include several deal protective measures. Ryan, a Lyondell shareholder, brought the required shareholder suit challenging whether the board met its Revlon duties. The board was independent and not interested and Lyondell’s Certificate of Incorporation contained a 102(b)(7) exculpatory clause.

Vice Chancellor Nobel concluded, on a motion for summary judgment, that Ryan might show that the board’s actions were not reasonably designed to secure the highest value reasonably obtainable, thus violating Revlon. The Vice Chancellor then held that the deal protective measures (termination fee, matching rights, no-shop, and pill), in the aggregate, might be preclusive (especially the no-shop) and thus violate the enhanced scrutiny required under Omnicare.

The more interesting part of the opinion is next (see p. 54, et seq.) in which the Vice Chancellor had to face the argument that, even if the Revlon and Omnicare claims were viable, the 102(b)(7) provision will negate any recovery. This, of course, squarely raises Stone. Vice Chancellor Noble noted that the board “made no discernible effort at salesmanship either before or after the Merger was announced” and that the board hadn’t, at this stage, proved that it had adequate information about the company’s market price. Because the current record did not show that the directors discharged their Revlon duties, they might not have acted in good faith. If they did not act in good faith, then they have violated their duty of loyalty, which negates the 102(b)(7) protection.

I think Vice Chancellor Noble has been insufficiently attentive to Stone’s requirement of intent. To be liable under Stone, the plaintiff must show that the defendants knew they were not discharging their fiduciary duties. Vice Chancellor Noble does not address that requirement. Instead, he focuses on a salient aspect of Revlon, which is that its duties are quite clear. Revlon certainly applies to these facts and, presumably, the board knew it. The Vice Chancellor held that, at this stage, the board can’t show that its actions met the Revlon standard. However, what the court doesn’t address, and what is absolutely key, is whether there’s any evidence that the directors intended not to comply. Assuming (and I think it must almost certainly be true) that the board knew it was under Revlon duties and knew what those duties required, where is the evidence that they intended not to comply with Revlon? Is there any evidence other than that they arguably didn’t meet the standard? That surely can’t be enough to impose liability and without that possibility, summary judgment should be entered for defendants.

Stone was decided in a case involving a Caremark claim; this case is a Revlon claim. The theories of Caremark and Revlon are quite different but these facts present one critical similarly: liability is predicated on the board’s inaction. Caremark claims are always posited against a board’s inaction, either in not establishing an appropriate monitoring system or in not adequately monitoring. Revlon cases typically involve, inter alia, challenges to the board’s actions, which are usually many; in most Revlon cases the board has been anything but inactive. It is quite unusual to see a Revlon claim (especially where Revlon’s application was clear) predicated on board inaction. Regardless of whether a Revlon claim is based on board action or inaction, if the claim is one of duty of loyalty rather than duty of care, a plaintiff must show either that the directors were interested, or not independent, or that they intended their actions (or lack of actions) to violate a known duty. It is that analysis that is missing here and that, ultimately, leads Vice Chancellor Noble into error. See my earlier post on Stone (here).

This could be taught in Chapter 11 after Stone v. Ritter.

In addition to Francis Pileggi, Jeff Lipshaw (here), Larry Ribstein (here), and Dale Oesterle (here) have good comments on the case.

Delaware Court of Chancery on stock options, Stone v. Ritter, and Caremark

In Desimone v. Barrows, Sycamore Networks, Inc., issued stock options to certain non-executive employees, certain officers, and the four outside directors. Desimone, a shareholder, brought a derivative suit to recover from the recipients and the two inside directors on the ground that the board breached its fiduciary duties. Vice Chancellor Strine dismissed the complaint on the grounds that plaintiff lacked standing to challenge some of the options because he was not a stockholder when some of the option grants were made, had not shown demand futility as to some claims, and did not state a claim upon which relief can be granted as to the remaining claims.

The pedagogical value of this opinion lies in Strine, VC’s discussion of the current options litigation and his discussion of the effect of Stone v. Ritter on Caremark claims. He quite lucidly describes backdating and distinguishes it from spring loading and bullet-dodging practices. But more importantly, he gives his view of Stone. I don’t read the Vice Chancellor as differing from my own interpretation of Stone (here) though he claims that my reading is not “entirely consistent” with Stone:

In this same vein, the importance and utility of the Delaware Supreme Court’s recent decision in Stone v. Ritter, reinforcing the vitality of this court’s decision in In re Caremark Int'l Inc. Deriv. Litig. should not be ignored. Some respected scholars seem to fear that Stone opens directors to new kinds of claims foreclosed by Caremark, while others read it as taking away a non-scienter based claim Caremark supposedly seemed to suggest. Neither position seems entirely consistent with the decision itself. Stone clarified one of the most difficult questions in corporate law — when directors with no motivation to injure the firm can be held responsible if the corporation incurs serious harm as a result of its failure to obey the law. What Stone makes clear is that Caremark and its progeny, such as Guttman v. Huang, are still good law. For reasons Caremark well-explained, to hold directors liable for a failure in monitoring, the directors have to have acted with a state of mind consistent with a conscious decision to breach their duty of care. Caremark itself encouraged directors to act with reasonable diligence, but plainly held that director liability for failure to monitor required a finding that the directors acted with the state of mind traditionally used to define the mindset of a disloyal director — bad faith — because their indolence was so persistent that it could not be ascribed to anything other than a knowing decision not to even try to make sure the corporation’s officers had developed and were implementing a prudent approach to ensuring law compliance. By reinforcing that a scienter-based standard applies to claims in the delicate monitoring context, Stone ensured that the protections that exculpatory charter provisions afford to independent directors against damage claims would not be eroded. Stone has obvious implications for cases like this, when a plaintiff seeks to hold directors accountable for failing to prevent backdating by corporate officers.

Professors teaching Desimone could do so at page 400 of the casebook at the end of section 4. Alternatively, one could summarize this case in the Notes and Questions following Stone, which is inserted at page 394. Both Stone and Desimone are included in the casebook Supplement.

Francis Pileggi has a characteristically good discussion of Desimone (here). Larry Ribstein also has a very good post on this case (here).

Maryland Court of Appeals on duty of loyalty when director sues corporation

The Court of Appeals of Maryland has held that a director did not breach his fiduciary duty when he remained silent after he knew that the corporation had no actual knowledge that he had taken a default judgment against the corporation and attached the corporation’s bank account. In Storetrax.com, Inc. v. Gurland, (watch oral argument here), Gurland was a board member and officer of Storetrax.com, Inc (Storetrax), a Delaware corporation. His employment was terminated, though he remained as a director. After a series of letters between the parties, Gurland filed an action for breach of contract. After filing, Gurland visited the corporate offices twice but did not mention the lawsuit. Service was effected on the corporation’s registered agent. Through a concatenation of errors by the registered agent and its independent contractor, neither notice of the lawsuit nor notice of default reached the corporation. Gurland took a default judgment and obtained a writ of attachment on the corporation’s bank account. When the corporation discovered the facts, it sought relief from the judgment over Gurland’s objection. The appellate court ordered the judgment vacated and a jury returned a $150,000 verdict for Gurland. Storetrax filed an action against Gurland alleging breach of fiduciary duties.

Judge Harnell held that directors are not prohibited from suing their corporations or from becoming creditors. Thus Gurland’s actions in filing suit, taking a default judgment, obtaining a writ of attachment, declining to relinquish the writ, and opposing Storetrax’s efforts to seek relief from the judgment did not violate his fiduciary duties. Storetrax’s principal argument was that Gurland breached his duties by remaining silent after it became apparent to him that Storetrax did not know of the lawsuit or default. Finding a complete absence of caselaw, Judge Harnell analogized the situation to director conflict of interest safe harbor statutes, such as DGCL §144. Thus he held that a director must notify his or her corporation of an intention to file a lawsuit against the corporation. This requirement appropriately balances the director’s right to pursue a claim against the corporation with the director’s fiduciary duty to act in the best interest of the corporation.

On these facts, Judge Harnell held that Gurland met his duties because the letters between the parties put Storetrax on notice that Gurland might sue and they set a clear timeline for filing an action. Further, it was clear that Storetrax anticipated and was preparing for litigation. The court noted that no evidence suggests that Gurland knew that the corporation had no actual knowledge of his lawsuit and default. Only circumstantial evidence, i.e. the corporation’s failing to file an answer, might have suggested to Gurland that Storetrax had no actual knowledge of his lawsuit.

The court’s analogy to CoI safe harbor statutes is obviously misplaced. Those statutes are non-exclusive safe harbors. That is, they provide one avenue by which directors can insulate self-dealing transactions from attack. Moreover, under common law as well as under the statutes, a self-dealing transaction can be approved, even in the absence of disclosure by the director, if the director can show entire fairness. Nothing in the court’s discussion suggests that any action other than disclosure to the corporation of concrete litigation plans, will suffice to meet the duty of loyalty.

I think this case is actually quite difficult. A director with a colorable claim against the corporation can surely act in his or her own interest in filing suit. In the vast majority of instances the director and corporation will have had preliminary discussions before litigation, but I don’t believe that actual knowledge by the corporation that the director has a colorable claim is a prerequisite to the director’s filing suit. The more difficult setting is, as here, where the corporation acts toward the dispute or litigation in a way that seems not to be in the range of rational responses. Does the director’s obligation to act in the corporation’s best interest include a duty to seek to have the corporation act rationally or at least to provide facts that the corporation either may not possess or of which it may not recognize the significance? In answering that question, does the director’s duty of care require him or her to obtain reasonably available facts surrounding the corporation’s non-rational behavior? My sense is that the conflict of interest results in the director being disabled from taking any action qua director apropos the litigation. That would preclude any investigation by the director as to the corporation’s actions and would also preclude the director from providing information to the corporation except qua litigant. Thus I would agree that Gurland did not violate his fiduciary duty but not because he sufficiently informed the corporation of his intentions.

Washington State Court of Appeals on duty of good faith

The Washington State Court of Appeals has held that a director who converts corporate property breaches the duty of good faith. In Lang v. Hougan, Lang and Hougan incorporated and equally owned Lang Property Management, Inc (LPM), which was a property management and real estate investment company. Each was an officer and director. About six years later the parties began to have a falling out. They were unable to negotiate a mutually agreeable division of their business and Hougan formed another corporation, Premier. She sent letters to every LPM client telling them that her relationship with LPM was ending and soliciting them to transfer their accounts to Premier, which most of them did. The parties did not have non-competition agreements. Lang brought suit seeking dissolution of LPM and asserting that Hougan breached her fiduciary duties.

Judge Penoyar held, with no discussion, that Hougan’s actions converted LPM’s assets in violation of the duty of good faith in MBCA 8.30 and 8.42. Presumably this case more precisely fits a traditional duty of loyalty analysis. That is, Hougan could not have believed that her actions were in the best interest of LPM. If Washington were to adopt Delaware’s understanding of the duty of loyalty and the obligation to act in good faith, the court would not have conceived of Hougan’s actions as not being in good faith. They were more culpable than that.

Delaware Court of Chancery on Caremark duty of loyalty

The Delaware Court of Chancery has held that two directors breached their duty of loyalty by failing to meet their Caremark obligations. In ATR-Kim Eng Financial Corp. v. Araneta, Araneta controlled 90% of a corporation and was one of the three directors. After a falling out with his childhood friend Arnaiz, who’s ATR owned the remaining 10%, Araneta transferred the corporation’s assets to his own children for no consideration.

Vice Chancellor Strine had no difficulty finding Araneta liable. The interesting part of the opinion concerns the other two directors, Berenguer (Araneta’s niece and the CFO) and Bonilla. They were completely overborne by Araneta and readily admitted that they did nothing as directors. It appears that no board meetings were held. Vice Chancellor Strine found that they violated their duty of loyalty by failing to implement a reporting or monitoring system as required by Caremark. It has several characteristically Strinian phrases.

Pedagogically, this case and Stone v. Ritter will probably replace Caremark (casebook pp. 410, 426-27, 443-44). Between them they show that the duty to monitor is a loyalty issue and they also discuss the standard of review. The facts of Araneta are more accessible and interesting than those of Caremark. Since Stone v. Ritter torques Caremark rather considerably, it would be hard to keep Caremark itself as a teaching case. Perhaps it will be less confusing to students if we refer to the duty to monitor as the Loyaltymark duty.

Francis Pileggi (here), Steve Bainbridge (here), and Gordon Smith (here) all have discussions of Araneta.

Delaware Supreme Court on good faith (again) and the duties of care and loyalty

For the second time in five months the Delaware Supreme Court has spoken, en Banc, about the duty of good faith. In June 2006 the court, in In re The Walt Disney Company Derivative Litigation (New Developments discussion here), defined bad faith, and by implication good faith. The court left open the question whether a breach of the duty of good faith is a viable claim for relief separate from a breach of the duty of care or loyalty. Now, in Stone v. Ritter (listen to the oral argument here), the court has held that the duty of good faith is a component of the duty of loyalty, not a separately litigable claim. It also changed the framework for analyzing a Caremark claim and may presage a constriction of the duty of care. Gordon Smith, Francis Pileggi, and Elizabeth Nowicki all have posts on Stone.

The plaintiffs in Stone brought a derivative suit against the directors of AmSouth Bancorporation. AmSouth had paid $50 million in fines and penalties for failing to file suspicious activity reports. The branch employees who should have filed the reports not only did not do so but did not report the facts upward in the corporation. The directors did not know, and had no reason to know, that reports should have been filed. The plaintiffs sought relief on a Caremark theory (casebook page 410): that the defendants utterly failed to implement a monitoring system. The Chancellor dismissed the complaint, and the Supreme Court affirmed, on the ground that no basis for a Caremark claim existed thus the directors could not be personally liable so demand on the board was not futile.

Justice Holland noted that AmSouth has a § 102(b)(7) exculpatory provision so the directors’ liability must be predicated on a breach of either the duty of good faith or the duty of loyalty. He looked at Caremark, and Disney to understand a claim of lack of oversight. Justice Holland focused on the many references to “good faith” in Caremark and asserted that they were consonant with Disney’s understanding of the definition and role of good faith. Then he answered the question Disney left open:

[A] failure to act in good faith is not conduct that results, ipso facto, in the direct imposition of liability. The failure to act in good faith may result in liability because the requirement to act in good faith ‘is a subsidiary element[,]’ i.e., a condition, ‘of the fundamental duty of loyalty’. … [A]lthough good faith may be described colloquially as part of a ‘triad’ of fiduciary duties that includes the duties of care and loyalty the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. … [T]he fiduciary duty of loyalty is not limited to cases involving a … conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith.

Finally, Justice Holland affirmed what had been generally assumed: Caremark, including the standard of review (casebook page 426-27), governs the board’s duty to monitor. However, he went on to say that Caremark liability “requires a showing that the directors knew that they were not discharging their fiduciary obligations”. That’s a significant change in Caremark jurisprudence.

This case is surprising. It was argued in July, just after Disney came down, before Holland, Berger, and Jacobs, JJ. At some point it was referred to the court en Banc, but I haven’t been able to find the order doing so. The oral argument contains no hint that a discussion of good faith or Disney was involved.

This case essentially reverses Disney’s conception of good faith. Where Disney all but held that good faith is a separate fiduciary duty, Stone makes clear that good faith is a component of the duty of loyalty. This is what the Court of Chancery (and several commentators, including me) has been saying for years, in the face of the Supreme Court’s insistence that good faith is a separate part of a triad of good faith, loyalty, and care.

Another important aspect of Stone is that Caremark is reconceptualized. Chancellor Allen decided Caremark, and discussed a board’s obligation to monitor, strictly as an aspect of the duty of care. That is, it is part of a board’s duty to be informed. A few Court of Chancery opinions, notably Guttman v. Huang by Strine, VC, suggest that the standard for finding liability under Caremark is so high that only intentional actions will suffice, which transmutes Caremark into a duty of loyalty claim. Stone, without any acknowledgment that it was choosing to redefine a Caremark claim from care to loyalty, did so. This has the effect of removing Caremark claims from the ambit of § 102(b)(7) provisions.

Let me dilate a moment on the connection between good faith and the duty of loyalty. The traditional incantation of the fiduciary duties of care and loyalty in Delaware is that a director must act, “on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the corporation”. In 1993, the Delaware Supreme Court first indicated that good faith might be a duty coequal to care and loyalty. Vice Chancellor Strine joined the issue in In re Gaylord Container Corp. in 2000. In footnote 41 he asserted that good faith was a subsumed under the duty of loyalty, citing to two law review articles, the main one of which was by me. He reinforced that view in later cases, most notably in Guttman at footnote 34. Disney made clear, at least in my view, that good faith was a separate duty (see my discussion of Disney earlier on this site). I thought footnote 112, which left open the question Stone answers, was a way for the pro-Chancery justices (including Justice Jacobs, Disney’s author, and a pro-Chancery justice) to satisfy the colleagues who insisted that good faith is a separate duty while at the same time eviscerating that holding by hinting that a claim for breach of the separate duty of good faith isn’t a valid claim for relief. It seems that now the court is prepared to be even bolder. It is clear that Stone is a capitulation to Vice Chancellor Strine and other Court of Chancery judges who saw good faith as an aspect of the duty of loyalty.

Pedagogically, what does this mean? First, my casebook, on pages 400-402 asks whether there is a separate duty of good faith. The answer now is clearly no. Good faith is part of the duty of loyalty. Second, Caremark, casebook page 410, needs to be moved from Chapter 12 (Duty of Care), to Chapter 11 (Duty of Loyalty), probably to page 394. This is so not because Caremark itself is different but because Stone has shifted the focus in a Caremark inquiry from board information to board intent. Third, the duty of care is becoming increasingly constricted. The casebook at page 421 asks whether there is a duty of care. When I wrote that I was being provocative, picking up on an idea Chancellor Allen floated. After Stone, though, and its approval of Guttman, it is clear to me that the duty of care may, in fact, be or become chimerical. Fourth, Note 1 on page 426 needs to be rewritten to reflect the change in conceiving Caremark and moved perhaps to page 437.

I worry that the court’s approach in Disney and Stone will make matters worse. In my view, the Delaware preference for stability may impede a clear understanding of the law. Over 20 years ago the court got itself into serious problems because, in my view, it refused to acknowledge that it had recently misspoken. Back then, the error was Pogostin v. Rice, which held, without much discussion, that the business judgment rule applied in takeovers. The next year the court faced Unocal and, rather than admit that Pogostin was ill advised, it hewed to the position that the BJR, rather than entire fairness, applies in takeovers. That forced the court to invent intermediate scrutiny, which has been somewhat protean, but basically has wavered between being essentially entire fairness and being the business judgment rule. I wish the court in Stone had simply said, we were wrong in Disney, good faith is simply a part of the duty of loyalty. I hope the court’s circumlocution will not generate as much misunderstanding as Unocal has done.

Virginia Supreme Court on corporate opportunity

The Supreme Court of Virginia has held that a corporate officer who did not disclose a corporate opportunity to the corporation did not violate her duty of loyalty because she did not form an intent to accept the opportunity until after her termination. In Today Homes, Inc. v. Williams, Williams was Vice President of Operations for Today Homes, Inc., a property developer doing business under the name of Chesapeake Homes. Another officer made Williams aware of the Sinclair Property, which the company could purchase and develop. About three months later Williams was terminated and formed Majestic Homes, Inc. Majestic then purchased the Sinclair Property, developed it, and realized about $4.5 million in profit. Chesapeake Homes sued for breach of fiduciary duty and sought a constructive trust on the profits.

Justice Agee, writing for a unanimous court, held that Williams could not be liable for usurping a corporate opportunity. He noted that an officer’s fiduciary duty continues after resignation or termination only for transactions that began during, or that were founded on information gained during, the fiduciary relationship. Williams did not have a duty to disclose the Sinclair Property opportunity because, while she was a fiduciary, she did not intend to purchase it for herself. Only after she was terminated did she decide to buy the land but by then she was not a fiduciary.

The implication is that simply possessing information about a corporate opportunity does not trigger a duty to disclose. The duty is triggered by possessing such information and intending to take the opportunity for oneself. It is not immediately apparent to me that this is correct. Surely the information about the corporate opportunity came to Williams in her official capacity. Assume she knew of ten such properties (or a hundred). Was she entitled to accept any or all of them after her termination without breaching a duty, assuming she did not form an intent to accept them for herself until after she was terminated? Shouldn’t Williams’ fiduciary duty continue to prohibit her from accepting opportunities that she became aware of in her fiduciary capacity (in the absence of permission from the corporation)?

This opinion seems to illustrate a kind of tunnel vision that is not infrequent in analyzing fiduciary duty cases. Even if Williams did not usurp a corporate opportunity, didn’t she breach her duty of loyalty by not alerting her employer to the possibility of acquiring the Sinclair Property?

New York trial court on director duties to other directors and officers

The Supreme Court of New York has held that a corporate director does not have a duty of care or duty of loyalty that runs to the corporation’s other directors or officers. In New York v. Grasso, Grasso, an officer of the New York Stock Exchange, Inc., a not for profit corporation, was sued by the Attorney General for receiving improper compensation. Grasso impleaded McCall, a director and the chair of the compensation committee. One of Grasso’s theories was that any improper compensation was caused by McCall’s negligent misrepresentation to Grasso. Grasso alleged that McCall, as director and compensation committee chair, had a special relationship of trust and confidence with him.

Justice Ramos held that predicates for a negligent misrepresentation claim include a duty of care owed by defendant to plaintiff and a special relation of trust and confidence between the two. McCall had an arm’s length relationship with Grasso concerning Grasso’s compensation, not a special relationship of trust and confidence.

This is clearly correct and might best be seen as a reminder to directors and officers that their loyalty and care obligations run to the entity and not to other directors and officers.