The Merck Directors and the Vioxx Debacle: A Good Chance to Revisit the Phrase “In Good Faithâ€?

Elizabeth Nowicki —  19 May 2006

Have we already discussed the In re Merck & Co. opinion (2006 WL 1228595 (D.N.J. May 6, 2006)), wherein we find a curious demand futility discussion regarding the Vioxx debacle? Please tell me that someone out there in the blogosphere has already dissected the opinion at length. No?

On May 5, 2006, Federal District Court Judge Chesler (D.N.J.) dismissed the consolidated federal derivative lawsuits brought by shareholders of Merck & Co. against former and current Merck officers and directors for claims related to the Vioxx situation. (As we all know, Vioxx is a non-steroidal anti-inflammatory drug that was recalled by Merck on Sept. 30, 2004, due to concerns related to Vioxx’s potential link to cardiovascular problems. It is maintained by some that Merck executives/researchers knew about the potential causal relationship between Vioxx and an increased risk of heart attacks and sudden cardiac deaths, but nobody from Merck made timely disclosure of this relationship. In this period of intentional silence, many users of Vioxx suffered serious cardiovascular complications, including heart attacks and death.)

The Merck shareholders maintained in their lawsuit that the directors and officers of Merck breached their fiduciary duties to the corporation and its shareholders (among other claims) by doing numerous improper things – things such as threatening academics who publicly questioned the safety of Vioxx, concealing Vioxx’s potential link to increased cardiovascular risks, and touting in a misleading fashion Vioxx’s safety – after it became clear to the directors and officers that Vioxx might well be linked to cardiovascular problems. Judge Chesler granted the defendant’s motion to dismiss the complaint for failure to make a demand on the directors as required by Federal Rule of Civil Procedure 23.

The plaintiff shareholders had conceded that they did not make demand on the Merck Board, but the plaintiffs predictably maintained that such a demand should be excused as futile. I do not yet have the complaint, but, based on the District Court opinion, it seems that the plaintiffs made their demand futility argument in large part on the “disinterested� aspect of the demand futility analysis. Under Aronson v. Lewis (looked to by NJ courts when dealing with demand futility), demand is excused if a reasonable doubt is created that “(1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.� Judge Chesler concluded that the Merck shareholders did not establish that the Merck directors conceded demand futility or were interested under the first prong of Aronson, and the Judge noted that the second Aronson prong was technically unavailable to the plaintiffs because the shareholders were complaining about “alleged inaction.� Slip op. at 8.

Notwithstanding that last point, which strikes me as odd, Judge Chesler still seemed willing to consider that second prong of Aronson, as he offered that “the conclusory allegations before this Court are insufficient to demonstrate that Defendants’ participation in the alleged wrongdoing creates a risk of substantial personal liability that excuses demand.� Slip op. at 13. The Judge seemed to view the plaintiffs’ allegations that the defendant directors promoted Vioxx and authorized further efforts to promote Vioxx despite mounting evidence that Vioxx was seriously linked to cardiac problems as weak an/or boilerplate. The Judge said “Plaintiffs fail to allege facts establishing that any of the outside directors were involved in the research, development, manufacturing or sale of Vioxx.� Further, the Judge wanted a showing from the plaintiffs of “a substantial likelihood of liability� (for breaching the duty of care, it seems), as opposed to the plaintiffs merely showing that there was a threat of personal liability.

The Judge said many other interesting things in his opinion, but what I note above covers what was most interesting to me. In an unsurprising turn of events, I see this case as boiling down to yet another “good faith� case. Despite the Judge’s incomprehensible (forgive me) “inaction� position, it seems that the Judge would have accepted a showing of demand futility based on clear lack of independence or, more importantly, an almost proven case of a breach of the duty of care. Phrased differently, ignoring the independence point, our plaintiffs seemed to have needed to point to facts strong enough to create a substantial likelihood that the directors either (a) acted “not in good faith� or (b) were grossly negligent in becoming informed, such that they were outside the BJR presumption’s protection.

Setting aside my criticism of the Judge’s “inaction� position, and setting aside the whole “independence� discussion (after the Martha Stewart travesty from the SDNY, I cannot discuss “independence� without feeling. . . dirty), my biggest question about Judge Chesler’s opinion comes from his determination that the plaintiffs did not establish facts sufficient to show a substantial likelihood of liability. What was he looking for, given that we were not yet at discovery? I guess I cannot fault him for sending the plaintiffs back to at least make the demand, but I cannot help but feel that that is just a wasted effort. . . . That said, before I complain about Judge Chesler’s unwillingness to do a complete “good faith� analysis under that second Aronson prong, I suppose I need to see the plaintiffs’ complaint, to see what Judge Chesler was served up, in terms of facts and law.

As a warm-up to what might later follow as my monologue on good faith in the Vioxx context, consider reading read my prior opining on how the judiciary (among others) keeps going wrong on the “good faith� aspect of director liability: http://www.theconglomerate.org/2006/04/where_is_disney.html#comments http://www.theconglomerate.org/2006/01/not_in_good_fai.html#comments http://busmovie.typepad.com/ideoblog/2006/04/is_disney_about.html

For those of you who are too busy to click on the links, I offer the two-pronged nutshell version of “Nowicki on Good Faith:�

First, “good faith� in the context of director conduct is a “positive duty� (an active duty, an affirmative duty) that requires the director to act in a way that is in pursuit of the best interest of the shareholders/corporation. The definition of “good faith� in the fidcuairy context does not merely prohibit a director from acting in bad faith, in a way that is venal toward or fraudulent regarding the corporation/shareholders.

Second, acts that are “not in good faith� (such that they are beyond the protection of the BJR or DGCL § 102(b)(7)) do not need to reach the level of bad faith. The “not in good faith� universe is larger than the “bad faith� universe; the phrases “bad faith� and “not in good faith� are not interchangeable. A plaintiff/shareholder can show that a director acted “not in good faith� by showing something much more “Caremark-esque� than “Enron-esque.� A director does not need to affirmatively act in bad faith (fraud, lying, deceit) in order to violate his obligation to act “in good faith.� She just has to. . . fail to act in good faith.

9 responses to The Merck Directors and the Vioxx Debacle: A Good Chance to Revisit the Phrase “In Good Faithâ€?

  1. 

    A puzzling idea. I think Kate has more grounds for her position from a classical logical standpoint — “not good” and “bad” are synonymous.

    However, Elizabeth is entirely correct in her interpretation from the standpoint of *natural language*, which includes fuzzy in-between categories whether we like it or not. Entirely respectable fields in semantics and logic have grown over the past century that may be able to accomodate Elizabeth’s position (one variety of them are called “intuitionists”).

    Incidentally, Elizabeth’s interpretation is one which I share quite strongly and independently, though my approach is from the standpoint of the philosophy of language and not law.

    And, further, if we were to define precisely this third-way middle option, then that would actually be an exercize in *reducing* vagueness, not increasing it. So I don’t sympathize with that objection.

  2. 
    Elizabeth Nowicki 22 May 2006 at 3:08 pm

    Dear Delaware,
    Thanks for your kind words. Interestingly enough, I am likely one of the most “sensitive” folks on the planet. I am able to grit my teeth and walk into the wind on many issues only because (a) I would rather *have* exchange on important issues than not, even if it means I end the day by going home and muttering Stuart Smalley-esque things to myself, and (b) I worked for a judge who used to say “I’d rather be hung for a sheep than a lamb.”

  3. 

    I meant to say Elizabeth, note Kate!

  4. 

    So, if “not in good faith” does not necessarily mean “in bad faith,” (i.e., you can fail to act in good faith but that does not mean you are acting in bad faith) are you contemplating a faithless no-man’s land of indemnification-free director liability? If that’s the thesis, then it seems to me that (a) a CONSCIOUS decision to be faithless obviously is a decision in bad faith (semantics) and/or (b) an UNconscious failure to act in good faith looks like a negligence/Caremark situation.

    BTW, Kate–you, more than any other blogger, seem to throw your ideas out there for everyone to see, and I, for one, really appreciate your thoughts, even though I disagree with many of them.

  5. 
    Elizabeth Nowicki 20 May 2006 at 10:07 pm

    Ok, Kate, let me try again to see if I can be more responsive. The answer to your question is in my point “2” below. I am including two other points (1 & 3) because I am enjoying the discussion. They are not necessarily responsive to your query, but I thought I’d include them anyway. Feel free to skip them:

    1. You said “in my limited English, “not goodâ€? actually means “badâ€? – rather than “neither good nor badâ€? as you suggest.”
    I actually do not think that your point is relevant – that is to say, “not good” versus “bad” is not quite parallel to “not in good faith” versus “bad faith.” But given your comment on “limited English,” I will offer that “not good” is often not the same as “bad.” I disagree with you in that regard.

    Example:
    Elizabeth: Kate, does this outfit look good?
    Kate: Ahhhhh…. Well, it doesn’t look *bad,* but I can’t say that it looks *good,* either.
    Elizabeth: Well, I’m going to dinner with a bunch of judges who want to hear about my “not in good faith” article, so I want to look *good,* not just. . . passable.
    Kate: Ok. Got it. Then wear some brown. It brings out your eyes. That will look good! Brown always looks good on you. The black that you are wearing doesn’t look *bad,* but it does not do anything for you.

    So, if you were asking what the difference between “bad” and “not good” is, it seems that the difference is one of degree. Interestingly, Merriam-Webster Online does not use “not good” to define “bad” nor does it do the opposite. Good is defined first as “of a favorable character or tendency,” such that it seems that “not good” would include the “neutral” or decent or satisfactory categories.

    2. The paper has not been workshopped beyond the four walls of Richmond. At Richmond, given that I am essentially the only corp. law scholar on the faculty, the reaction was predictable: “Right. Not in good faith dose not mean bad faith.” (That is to say, this curious corporate law unwillingness to define good faith and let it stand as its own measuring stick seems to have struck my colleagues as a bit odd.)
    **** Let me take this opportunity to say that, if any generous reader is affiliated with a law school that has a workshop series and is in need of warm bodies (or is willing to take a warm workshop-seeking body), please let me know. I would be grateful for any chances to present this paper anywhere.

    That said, the limited audiences who have heard about my position have responded as follows:
    Reactions from the bench to my proposal have been shockingly good. I have yet to have a jurist react as you and Gordon have. Indeed, the reaction has often been exactly the opposite. For example, one jurist admitted that she/he wished a plaintiff had served the argument up as I did when the chance arose. Another jurist went so far as to sigh and say something akin to “I have been saying this for years.” An additional jurist was . . . initially leery but seemed open to considering the idea (not convinced, by any stretch, but willing to consider the idea). Just to be clear, the “not in good faith” verus “bad faith” discussion comes up now and again in various published opinons in different contexts, and every time (except one) that I have so far found the discussion being had directly, my argument carries the day or at least holds ground (setting aside the corporate governance or corporate law realm in general, b/c the issue has come up only in garbled fashion, in my view).
    The bar: I have only discussed my position with two practitioners. One just did not understand it. The fellow was a plaintiffs’ lawyer, with the PERFECT opportunity to make the argument, but he *just* *did* *not* *get* *it.* Sad. The other practitioner agreed with me. I imagine that conversations with the defense bar would be predictable and negative – I have not yet had them, however.
    Other Academics: You and Gordon are the only two I have yet come across who thought my idea was “bizarre” or, in Gordon’s view, “a nightmare.” The few other academics who have heard the argument have been either in agreement, neutral, or skeptical of how far I will get with the argument but willing to concede that it has merit. I will be presenting this paper at Cornell in the fall – I will report back.

    Just so we are clear, I *know* that my position is very unlikely to carry the day. I agree that it is common, in various opinions, for the parlance to automatically run between good faith and bad faith. I know that the defense bar would *hate* to lose the cushion that “bad faith” affords. I agree that it has historically been the habit to shorthand “bad faith” for “not in good faith.” But, just because it is done, does not make it intellectually defensible (not to metion right) in the few cases where it actually MAKES a difference. As one jurist said, “your argument would make a difference with the Caremark sorts of cases.” Bingo!

    3. As I describe in point one, above, I think I can dispose of your “plain English” argument by using. . . the dictionary, case law, examples, etc. There is a huge gap in terms of pure dictionary definition between “not in good faith” and “bad faith.” (If you were to line up the defintion of good faith with the definition of bad faith, you would immediately see that they are *not* definitional opposites!) As far as your utilitarian argument, if two things do *not* mean the same thing (and I maintain that “not in good faith” and “bad faith” do not), it probably is not helping the discussion to make a vague situation . . . just plain *wrong* from a “plain English” standpoint. That said, I am sure your view and that of Gordon will be shared by many, if I am lucky enough to get chances to workshop the paper. And I have to believe that, at the end of the day, the defense bar would never let the tide turn. Let’s be honest: They convinced the legislature in the 1980’s that there was an insurance crisis such that the Delaware legislature adopted 102(b)(7). There was no crisis – please. But that is another post entirely.

    Thanks for the question, Kate.

  6. 

    Elizabeth, I was not debating your idea here. Rather, I was wondering whether you took it on the workshopping tour and what people said. Especially the people who actually litigate these things. Did they think they could sell it to the judge? Did they say they’ve already thought of it, but were afraid to put in their briefs?

    I in fact dislike your proposal, partly for statutory interpretation reasons (in my limited English, “not good� actually means “bad� – rather than “neither good nor bad� as you suggest), and partly for utilitarian reasons (I see no reason to think up yet another vague category in the world that needs more clarity and predictability; the fact that this area of law is already polluted by vagueness doesn’t mean we should add more vagueness or that more vagueness won’t cause more harm).

    But again, I am mostly curious about the reactions from the bar and the bench.

  7. 
    Elizabeth Nowicki 20 May 2006 at 5:31 pm

    Kate, good evening, and thanks for the comment!

    I am delighted to be gaining ground with you. You initially observed that my position (that “not in good faith” should mean “not in good faith”) was bizarre; now your opinion of my position has graduated to “stillborn.”

    Please tell me more about why you continue to disagree. Your colorful comments do not give me the best understanding of why you prefer to define “not in good faith” as meaning the same thing as “bad faith” as opposed to just defining “not in good faith” to mean “something other than affirmative good faith.” I recall that you had mentioned earlier that you thought my definition would be unfriendly to business and unclear. As to the latter concern, I think we agree that we are already in the land of the unclear. That, to me, is not necessarily a good reason to give up the struggle to well-define “good faith” in the affirmative (such that the meaning of “not in good faith” is more clear, if not even close to obvious!) in favor of mis-defining “not in good faith” as shorthand for “bad faith.” I guess you disagree? Or is it more that your first concern is an overwhelming (in your view) concern? I understand the argument that we do not want to freeze the pool of potential directors – obviously I strongly disagree with the merits of the argument. But is that concern what is underpinning your disagreement with my position?

    I appreciate your willingness to engage in the discussion. This will be a good distraction from the very sad recent events at today’s Preakness. In case you missed it, Barbaro, the favorite for today’s race, was pulled up about ten strides into the race, as he snapped his ankle in two places. To see that poor animal’s lower-leg wobble, to see him holding up his leg in obviously serious distress, and to see him try to kick away whatever it was that was “hurting him” was gut-wrenching. Michael Matz, Barbaro’s trainer, is an incredible trainer and horseman, in addition to being a very big-hearted guy, and, as best I could tell, Barbaro was ready to make that track his. (Barbaro broke through the starting gates before the bell, and he was full of himself in the warm-up.) It was very sad to see what should have been a wonderful day for Michael and his horse end in tragedy. God bless the jockey for being able to stop Barbaro quickly – hopefully the jockey’s excellent response saved the animal from turning a broken ankle into a terminal injury.
    So, Kate, I am glad you are giving me something less troubling to think about, and I thank you.

  8. 

    Just wondering: does _ANYBODY_ like your “not in good faith doesn’t mean in bad faith” idea? Feels completely stillborn to me, but perhaps I am in the minority.

Trackbacks and Pingbacks:

  1. TRUTH ON THE MARKET » Lay *and* Skilling Found Guilty - May 25, 2006

    [...] 1.  He said something about the verdict proving that a CEO cannot just *not* ask questions.  (Forgive the double negative, but one of the compelling points for the jury, in the prosecutor’s eyes, was that Lay failed, in part, by not pushing for information – not asking questions – ignoring the red flag information that was right in his lap – not acting in good faith!   See here and here for my “Not in Good Faith” manifesto.  Who would have thought that the same sort of the fundamental failings that trouble me about director behavior would translate so well (relatively speaking) to the criminal context when dealing with officers?) [...]