Here in Ryan, Justice Berger brings back some of Chancellor Allen’s language about utter failure and I worry that such a standard might work its way into the standard for duty of loyalty liability in bad faith cases.
For example, when she first mentions the standard she writes (p.11), “We adopted the standard articulated . . . in In re Caremark . . . [now she quotes from Caremark:] only a sustained or systematic failure . . . such as an utter failure to attempt to assure a reasonable information and reporting system exists – will establish the lack of good faith that is a necessary condition to liability.” Likewise, she later writes (p.18), “Only if they knowingly and completely failed to undertake their responsibilities would they breach their duty of loyalty”. Note the phrase, “and completely”. Further on that page she quote a Chancery Court opinion that could lend support to this analysis: “[an] extreme set of facts [is] required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties”. Does an extreme set of facts equate with a requirement that the plaintiff show that the directors not only intended to disregard their duties but did absolutely nothing? Finally (p.19) “[T]he inquiry should have been whether those directors utterly failed to attempt to obtain the best sales price.” Note the words, “utterly failed”. All this language might be seen as imposing liability for breach of the duty of loyalty via bad faith only when there is intent and when the directors completely fail to meet their duty or perhaps completely fail to take action.
This can’t be the law. Intent is surely a requisite for finding bad faith and hence a duty of loyalty violation but there’s no case law authority and no policy reason to impose an additional test of utter failure to meet the duty or take action. Surely a director is liable who intends not to meet the duty of loyalty by only a little bit.
Justice Berger has much language, though, that suggests the correct rule, as well, and I’m hopeful that courts will pick up on that language and not on the looser formulations quoted above.
The use in recent bad faith opinions of terms like "completely" and "utter" does suggest that bad faith requires a showing of an intentional and utter failure on the board’s part. It’s hard to imagine sufficiently “egregious” facts to satisfy that standard. (AIG suggests that, in oversight cases, culpable participation may be necessary.)
Yet, that does appear to be the emerging standard. In his recent Citigroup decision, Chancellor William Chandler explained that "a plaintiff must also plead particularized facts that demonstrate that the directors acted with scienter." 964 A.2d 106, 125 (Del Ch 2009). As I explained in Caremark and Enterprise Risk Management, Chandler hewed closely to the "utter" and "completely" position.
In effect, bad faith may be in the process of becoming the functional equivalent of the so-caled egregious or irrational decision exception to the business judgment rule; i.e., a theoretical claim that in practice is an empty set.
