Benjamin Nelson and “Good Faith”

posted by Elizabeth Nowicki

Benjamin Nelson (who appears to be a lawyer *and* philosopher) from Law & Society Blog fortuitously took an interest in my “not in good faith” theory and my “good faith” debate with others. (**In a great addition to Mr. Nelson’s comments, law professor Steven L. Winter from Wayne State sent Mr. Nelson an e-mail, with permission to post the e-mail on lawsocietyblog.com. See here.) Before I say anything about “not in good faith,” let me thank Mr. Nelson and everyone else who has commented on my posts here, on truthonthemarket, and on theconglomerateblog. Commenting on posts (posting in general) takes time, and I appreciate the generosity folks have shown me in commenting. Those comments and criticisms allow me to look for new ways to bolster my arguments, modify my arguments, or consider disgarding them.

Luckily, Mr. Nelson was able to support my “not in good faith argument.” He does it, however, with a super diagram that is different from the one that I would have drawn. Upon reading his post and seeing his incredible color diagram, I undertook to draft a responsive diagram with my new “Visio” software. Easier said than done. When I finally completed my pathetic diagram (after days of effort, while on vacation, nonetheless), I could not upload the diagram as a pdf. So I am trying now to upload it below as a text document. Hopefully this will work.

My theory is that, when assessing whether a director acted “not in good faith,” such that he should be stripped of the business judgment rule presumption *and* his conduct should not be protected under a DGCL § 102(b)(7) provision, it is appropriate to do two things:

(a) list out the complained of acts (e.g. “inattention to the hiring of a $140 M President,” “failure to aggressively follow-up when it became clear that something was going wrong at the executive operation level of at Disney,” “failure to at least attempt to touch based in a conference call or something with the entire board on some ‘big ticket’ items”)

then

(b) ask “are those acts that represent – that manifest – good faith? Are those acts that we can say are ‘in good faith’ if we define a director acting in good faith as an actor who ‘is trying to act in the best interests of the corporation/shareholders’?” If we affirmatively define good faith as “an attempt to act in the best interests of the corporation/shareholder,” how do the acts listed in “(a)” gauge/assess/line-up against that definition?

All me to break this down more:

1. All acts of directors have to be characterized as something – with some “faith”-based label – good faith, bad faith, not-in-good faith, [something-else-faith].

2. Good faith acts are acts in the best interests of the corporation/shareholders.

3. It follows that acts “not in good faith” include acts that cannot be described as “acts in the best interests of the corp./sh.”

4. Bad faith acts include fraud, willful misconduct, attempts to harm the corporation, lying to other

directors about material matters, etc.

5. If an act is neither a good faith act nor a bad faith act, what is it?

If an act is neither in the best interests of the corp./sh. nor affirmatively against the corporation, what is the act? How do we label it?

6. Such acts – which cannot be credibly called “good faith acts” nor do they rise to the level of “bad

faith acts” – are best referred to as acts “not in good faith.” The act does not rise to the level of bad faith, but we most certainly cannot call the act a “good faith act.”

Therefore, for purposes of my discussion, there are three categories of labels for a director’s acts:

Good Faith Acts - Acts that manifest an attempt to act for the best interests of the corporation/sh.

Bad Faith Acts – Acts of fraud, attempts to harm the corp., willful misconduct, etc.

Acts “Not in Good Faith” – Acts that we cannot, in good faith, label “good faith” acts (See “donut” in circle-based diagram above)

Let’s go back to my test above, with the two-step “a” and “b” process. Here are some examples of how my test would work:

1. Director steals from the corporation.

Is this an act affirmatively in the best interests of the corp./sh.? NO. So this cannot be a GOOD FAITH ACT. This is an act broadly noted as an act NOT IN GOOD FAITH.

Is this an act of fraud or other attempt to harm the corporation? YES.

Label: BAD FAITH ACT (sub-category within the “not in good faith” category)

2. Director reads press release saying that President of company is leaving the company. This press release comes on the heels of rumors that the President and CEO were at odds. The director calls (a) the CEO/President/GC and/or (b) several other directors on the board to discuss.

Is this an act affirmatively in the best interests of the corp./sh.? YES.

Label: GOOD FAITH ACT

3. Director signs-off on President’s pay package because President is a good friend.

Is this act affirmatively in the best interests of the corp./sh.? NO. This is, at the very least, an act NOT IN GOOD FAITH.

Is this willful misconduct? I THINK SO. Label: BAD FAITH ACT

If reasonable minds differ, however, as to whether this act rises to the level of “BAD FAITH,” we can all agree that it is, at the least, an act “not in good faith,” as noted above, such that it is outside the business judgment rule presumption and DGCL 102(b)(7).

4. When hiring a new President for a large sum of money, Director asks for an Exec. Comp. expert to explain how the new President’s salary compares to salaries of other Presidents with backgrounds like that of the new President.

Is this an act affirmatively in the best interests of the corp./sh.? YES.

Label: GOOD FAITH ACT

5. Director asks if the $140 million pay package to be awarded to the new, not-yet-intereviewed President sits well with the Comp. Committee directors. Upon being told “yes,” Director signs off on the package without question or discussion.

Is this act affirmatively in the best interests of the corp.? No. So it cannot be a GOOD FAITH act.

Is this an affirmative attempt to harm the corporation? No. So it is not what we would traditionally label a “bad faith” act.

Label: NOT IN GOOD FAITH ACT (or “an act ‘not in good faith’”)

6. Director reads in newspaper about strained relationship between President and CEO. Director realizes CEO has fired President without authorization. Director realizes that stock price has been stagnant for the decade since the last long-term President died a decade ago. Director sees in the newspaper how various large investors are outraged at the exiting-President’s large termination package. Director realizes that CEO, who is friends with President, has negotiated a new termination package that is oddly (absurdly?) generous. Despite all of these factors, Director makes no move to call CEO to task, Director does not call for a director teleconference, Director does not informally confer with his peers about the CEOs behavior.

Is this in the best interests of the corp.? No. So it cannot be a GOOD FAITH act.

Is this an attempt to harm the corporation? No. So it is not an act of affirmative BAD FAITH.

Label: NOT IN GOOD FAITH ACT

7. Director reads in newspaper about strained CEO-President relationship, and director does nothing. Director knows that CEO has had trouble in the past retaining other senior execs. b/c CEO is noxious. Director does not e-mail fellow directors, does not call CEO, does not call President, does not informally ask around (other folks in the CEO’s suite or the GC). Director just lets the information pass.

Is this in the best interests of the corp.? No. So it is not a GOOD FAITH act.

Is this an attempt to harm the corporation? No. So it is not an act of affirmative BAD FAITH.

What is left? Label: NOT IN GOOD FAITH ACT

 June 20, 2006 at 2:17 pm   Posted in: Sociology of Law    Print This Post

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