In November of 2006, the Delaware Supreme Court issued an opinion in Stone v. Ritter dealing with a directorâ€™s fiduciary duties in cases where the complaining plaintiff-shareholder is maintaing that her directors did not sufficiently monitor their corporate charge. (I refer to these “oversight” cases loosely as “asleep at the wheel” cases.) There has been some excellent blogging on the topic by Eric Chiappinelli, Gordon Smith, andÂ Steve Bainbridge.Â Though I was in the middle of moving such that I could not blog in the middle of that wonderful Ritter blog-fest,Â I am now ready to stake my blogging ground on Ritter.
Stone v. Ritter was an oversight case, in which the complaining shareholders maintained that the directors of AmSouth failed to maintain a sufficient monitoring and reporting program such that red flags (in this case pertaining to banking law violations) could be detected by the board. This, the shareholders maintained, was a violation of the directorsâ€™ fiduciary duties. The chancery court dismissed the plaintiff-shareholdersâ€™ claims, and the Delaware Supreme Court affirmed, saying “In the absence of red flags, good faith in the context of oversight must be measured by the directorsâ€™ actions â€˜to assure a reasonable information and reporting system existsâ€™. . . .”
What the court also says about the duty of loyalty, however, is more interesting to me that the good faith references.Â The en banc panel says: “[T]he fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. As the Court of Chancery aptly put it in Guttman, “[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporationâ€™s best interest.”
Enter Lyman Johnson and his article “After Enron: Remembering Loyalty Discourse in Corporate Law,” 28 Del. J. Corp. L. 27 (2003). In that article, Professor Johnson takes the position that “loyalty” in the context of a directorâ€™s “duty of loyalty” should be interpreted the same way the word is interpreted in daily life. Being loyal, as that term is normally used, covers conduct that we corporate law folk have always tried to finagle under the “duty of care.” We should expect directors to be loyal in the same way we expect others be loyal. That is to say, if I ask my loyal friend, Monica,Â to vote for me for state senate, I envision that Monica, my loyal friend, would march to the polling place and vote for me. How loyal is my friend if, after work, she decides on the spur of the moment and with no prior plans instead to go to “happy hour” somewhere? Â Can I say “Monica is a loyal friend?” She is not a loyal friend, is she? It is not that she is a traitor. Rather, she is just not loyal.Â I cannot look at Monica up on her stool at the bar for happy hour, not having voted for me,Â and say “Now THERE is a loyal friend.Â ThatÂ Monica is loyal.”
In his article, Lyman references “Christâ€™s famous charge to His apostle Peter to â€˜take care of my sheep.â€™” If Peter is the loyal apostle, he will affirmatively care for the flock. If he is loyal. Not if he is “acting in good faith” or “acting with due care.” If he is truly a loyal disciple, he will affirmatively doÂ whatever is needed to “take care of [the] sheep.” That, Lyman Johnson maintains, is what loyalty means.Â Loyalty is that broad.Â Asking if the actor is loyal subsumes the care and good faith inquiries.
Back to Ritter:Â “[T]he fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. As the Court of Chancery aptly put it in Guttman, “[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporationâ€™s best interest.”
With that language, it is almost as though the Delaware Supreme Court taking a position thatÂ is totally consistent with Professor Johnsonâ€™s very broad position on what “loyalty” in the phrase “duty of loyalty” should mean. To breach the duty of loyalty, the actor does not need a conflict of interest. Simply failing to act in “the good faith belief that her actions are in the corporationâ€™s best interest” is enough. Simply failing to be “loyal,” as that term is used in common parlance, is enough.
I like that.