Corporate Governance, Director Liability, and Good Faith

Corporate directors are obligated to act “in good faith,” and directors face personal monetary liability to their shareholders for acts “not in good faith.” Yet no modern court has imposed liability accordingly. Every time the issue of a director’s good faith comes up in court, the court forces the complaining shareholder to prove that her directors acted affirmatively in bad faith as opposed to merely in the absence of good faith. The judiciary completely misses the point that acts lacking good faith are not always the same as acts affirmatively taken in bad faith. A director can act in the absence of good faith without going so far as to be affirmatively acting in bad faith. More troubling, the academics who write in the area of corporate law also completely miss the distinction between acts showing a lack of good faith—acts “not in good faith”—and bad faith acts. This wordsmith failure changes the entire nature of a director’s duty to her shareholders, and it renders impotent a director’s obligation to act in good faith. This becomes most evident when reviewing allegations of director inattention. For example, if a director votes on her CEO’s compensation package without actually reading the compensation agreement because it is not finalized in time for the board meeting, that director is not acting in good faith. Yet she is also not affirmatively acting in bad faith—she is not deliberately trying to hurt the corporation. Her vote is simply an inattentive act, an act not in good faith. Given the judiciary’s use of a bad faith standard when reviewing whether a director acted in good faith, the inattentive or half-hearted director will never face liability. This paper exposes in detail the problems that stem from this careless linguistic substitution, and this paper argues for a sea change among the judiciary and members of the academy who insist on bastardizing a director’s obligation to act in good faith. The erosion of a director’s obligation to act in good faith does not bode well for the modern corporation and the economy, and a meaningful interpretation of “not in good faith” is necessary to help halt that erosion. Visiting Associate Professor of Law, Washington & Lee Law School. Many thanks to Professors Lyman Johnson, Stephen Bainbridge, Mel Eisenberg, and Harvey Goldschmid, and Dean Lance Liebman for their philosophical input regarding “not in good faith.” Outstanding research assistance was provided by Jennifer Jennings, Justin Curtis and Kristin Watts.