One of the most important aspects of Delaware Supreme Court Justice Jack Jacobs' opinion in the Disney case is his analysis of the directors' duty of good faith. My friend Wisconsin law professor Gordon Smith suggests that Jacobs' definition of what constitutes bad faith likely includes "intentional violations of law." I have not seen anything in the opinion squarely so stating and, upon reflection, I think Gordon ought to be wrong - at least insofar as he may be suggesting that intentional law violations per se constitute bad faith. (Note carefully that I said ought; I did not say is.)
The analysis that follows is adapted from my Corporation Law and Economics treatise.
The business judgment rule will not insulate from judicial review decisions tainted by fraud or illegality. See, e.g., Shlensky v. Wrigley, 237 N.E.2d 776, 778 (Ill. App. 1968); see also Cottle v. Storer Communication, Inc., 849 F.2d 570, 575 (11th Cir. 1988) (holding that the business judgment rule protects directors “from liability absent a clear showing of fraud, bad faith or abuse of discretion”).
The key issue in this context thus is whether the board has a duty to act lawfully, such that an intentional violation of the law constitutes a breach of the board's duties of care and/or good faith. (Note that the issue here is distinct from the problem of board oversight. In oversight cases, corporate employees have committed some criminal act and the board is charged with having failed to prevent those acts. Here we ask a different question; namely, what happens when the board affirmatively instructs its subordinates to violate the law?)
In the oft-cited Miller v. American Telephone & Telegraph Co. decision, the Third Circuit held that directors have such a duty. AT&T failed to collect a debt owed it by the Democratic National Committee for telecommunications services provided during the 1968 Democrat Party’s convention. Several AT&T shareholders brought a derivative suit against AT&T’s directors, alleging that the failure to collect the debt violated both federal telecommunications and campaign finance laws. Ordinarily, a board decision not to collect a debt would be protected by the business judgment rule. Citing a 1909 New York precedent, however, the Third Circuit held that the business judgment rule did not insulate defendant directors from liability for illegal acts “even though committed to benefit the corporation.” Miller v. AT&T Co., 507 F.2d 759, 762 (3d Cir. 1974) (diversity case arising under New York corporation law).
Assuming a duty to act lawfully exists, operationalizing it is a nontrivial task. Should there be a de minimis exception? If a package delivery firm told its drivers to illegally double-park, so as to speed up the delivery process, for example, it is hardly clear that liability should follow. Should the business judgment rule be set aside only where the board ordered violations of criminal statutes or should it also be set aside where the board authorized violation of some civil regulation? The criminal law long has distinguished between crimes that are malum in se and those that are merely malum prohibitum. The latter are acts that are criminal merely because they are prohibited by statute, not because they violate natural law. It is said that “misdemeanors such as jaywalking and running a stoplight are mala prohibita, as are most securities-law violations.” Black’s Law Dictionary 401 (pocket ed. 1996) (emphasis supplied). Individuals routinely make cost-benefit analyses before deciding to comply with some malum prohibitum law, such as when deciding to violate the speed limit. Is it self-evident that directors of a corporation should be barred from engaging in similar cost-benefit analyses?
And, yet, still more questions must be answered if a duty to act lawfully is to be imposed. If neither the corporation nor the board was convicted or even indicted, for example, should plaintiff have to make out the elements of the criminal charge? If so, to what extent does the criminal law concept of reasonable doubt come into play? Is a knowing violation of criminal law a per se violation of the duty of care unprotected by the business judgment rule? How are damages to be measured and is causation an issue? And so on.
The point is not that corporations should be allowed to break the law. They should not. If a corporation breaks the law, criminal sanctions should follow for the entity and/or the responsible individuals. The point is only that fiduciary obligation and the duty to act lawfully make a bad fit. If the question is one of reconciling authority and accountability, it is not self-evident that corporate law should hold directors accountable simply for deciding that the corporation’s interests are served by violating a particular statute. After all, “[a] business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end.” Dodge v. Ford Motor Co., 170 N.W. 668, 684 (Mich. 1919).
Put another way, the point of the business judgment rule is that shareholders should not be allowed to recover monetary damages simply because the directors made the wrong decision. Allowing shareholders to sue over a decision made with the intent of maximizing corporate profits is nothing less than double-dipping, even if the decision proves misguided. This claim is further supported by the realities of shareholder litigation. Shareholder lawsuits alleging that directors violated the purported duty to act lawfully will be brought as derivative actions. The real party in interest in derivative litigation is the plaintiff’s attorney, not the nominal shareholder-plaintiff. In most cases, the bulk of any monetary benefits go to the plaintiffs’ lawyers rather than the corporation or its shareholders. In practice, such litigation is more likely to be a mere wealth transfer from corporations and their managers to the plaintiff bar than a significant deterrent to corporate criminality.
Accordingly, the illegality of a board decision—standing alone—should not result in liability. And this is true whether the challenge is mounted as one involving a breach of the duty of care or of good faith.
