Loyalty's Core Demand: The Defining Role of Good Faith in Corporation Law

70 Pages Posted: 27 Feb 2009 Last revised: 9 Mar 2012

See all articles by Leo E. Strine, Jr.

Leo E. Strine, Jr.

Wachtell, Lipton, Rosen & Katz; University of Pennsylvania Carey Law School; Harvard Law School Forum on Corporate Governance

Lawrence A. Hamermesh

Widener University Delaware Law School; Institute for Law and Economics

R. Franklin Balotti

Richards, Layton & Finger

Jeffrey M. Gorris

Friedlander & Gorris, P.A.

Date Written: February 26, 2009

Abstract

The duties owed by independent directors of large corporations to monitor the corporation's affairs have never had more political salience. Given the Enron-era debacles, the recent meltdown in our nation's financial sector, the dependence of workers on equity investments to secure their retirements, the globalization of American corporate law principles, and the complexity of managing corporations with international operations, the legal standards used to evaluate whether directors have complied with their fiduciary duties will be a subject of growing international policy interest. This article addresses an important dimension of that issue by examining the role of good faith in corporate law, and its use as the definition of the state of mind with which a director must act to comply with the fiduciary duty of loyalty. In particular, this article employs an historical, etymological, and policy-oriented analysis to address the question of whether the obligation of directors to act in good faith is a separate, free-standing fiduciary duty, or a fundamental aspect of the core duty of loyalty.

We conclude, consistent with the Delaware Supreme Court's recent decision in Stone v. Ritter, that in the American corporate law tradition, the basic definition of the duty of loyalty is the obligation to act in good faith to advance the best interests of the corporation. What this article also shows is that the duty of loyalty has traditionally been conceived of as being much broader than the duty to avoid acting for personal financial advantage. The duty of loyalty also precludes acting for unlawful purposes, and affirmatively requires directors to make a good faith effort to monitor the corporation's affairs and compliance with law.

Finally, we highlight a critical policy implication resulting from Stone v. Ritter, which is that an independent director who is accused of having failed in her monitoring duties may only be held liable if a court finds that she breached her duty of loyalty by consciously failing to make a good faith effort to comply with her duty of care. By requiring a finding of bad faith before imposing liability on an independent director, the corporate law, as explicated by Stone, protects the policy interests underlying the business judgment rule from erosion.

Keywords: Good faith, Loyalty, Fiduciary duties, Corporate governance, Directors, Boards, Shareholders, Director liability, Monitoring

JEL Classification: D70, G30, G32, G34, G38, K22

Suggested Citation

Strine, Jr., Leo E. and Hamermesh, Lawrence A. and Balotti, R. Franklin and Gorris, Jeffrey M., Loyalty's Core Demand: The Defining Role of Good Faith in Corporation Law (February 26, 2009). Georgetown Law Journal, Vol. 93, p. 629, 2010, Widener Law School Legal Studies Research Paper No. 09-13, Harvard Law and Economics Discussion Paper No. 630, Available at SSRN: https://ssrn.com/abstract=1349971

Leo E. Strine, Jr.

Wachtell, Lipton, Rosen & Katz ( email )

51 W 52nd St
New York, NY 10019
United States
212-403-1178 (Phone)

University of Pennsylvania Carey Law School ( email )

Philadelphia, PA
United States

Harvard Law School Forum on Corporate Governance ( email )

1563 Massachusetts Avenue
Cambridge, MA 02138
United States

Lawrence A. Hamermesh (Contact Author)

Widener University Delaware Law School ( email )

4601 Concord Pike
Wilmington, DE 19803-0406
United States
302-477-2132 (Phone)
302-477-2257 (Fax)

Institute for Law and Economics

3501 Sansom Street
Philadelphia, PA 19104
United States

R. Franklin Balotti

Richards, Layton & Finger ( email )

One Rodney Square
PO Box 551
Wilmington, DE 19899
United States
302-651-7710 (Phone)
302-658-6548 (Fax)

Jeffrey M. Gorris

Friedlander & Gorris, P.A. ( email )

222 Delaware Avenue, Suite 1400
Wilmington, DE 19801
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
3,154
Abstract Views
16,065
Rank
7,222
PlumX Metrics