2006 • Volume 31 • Number 1

The Duty of Good Faith in Corporate Law (Part 1)(Part 2)

Melvin A. Eisenberg

An important development in corporate law is the recent explicit recognition, in a series of Delaware cases, that corporate managers owe afiduciary duty of good faith in addition to their traditional duties of care and loyalty. The duty of good faith was not created by those cases. On the contrary, the duty has long been explicit under the statutes-for example, in statutory provisions that require directors to act in good faith, and in provisions concerning indemnification. The duty of good faith has also long existed implicitly in the case law-for example, in the formulation of the business judgment rule and in fiduciary obligations that can only be explained by that duty, such as the duty not to knowingly cause the corporation to violate the law. Nevertheless, the explicit recognition of the duty of good faith in recent Delaware cases shines a spotlight on that duty and therefore makes it especially important to develop the contours of the duty and to examine the duty from a normative perspective.

Briefly, the duty of good faith in corporate law is comprised of a general baseline conception and specific obligations that instantiate that conception. The baseline conception consists offour elements: subjective honesty, or sincerity; nonviolation of generally accepted standards of decency applicable to the conduct of business; nonviolation of generally accepted basic corporate norms; and fidelity to office. Among the specific obligations that instantiate the baseline conception are the obligation not to knowingly cause the corporation to disobey the law and the obligation of candor even in non-self-interested contexts.

Turning to the normative issue, there are several basic reasons why the duty of good faith is desirable. To begin with, the duties of care and loyalty do not cover all types of improper conduct by managers, because certain kinds of managerial misconduct fall outside the spheres of those duties, and most of these types of misconduct fall within the duty of good faith. Furthermore, various rules limit a manager’s accountability under the duties of care and loyalty, and these limiting rules should be and are inapplicable to conduct that violates the duty of good faith. Moreover, the duties of care and loyalty characteristically (although not invariably) function as plaiforms for liability rules, while the duty of good faith characteristically (although not invariably)functions as a condition to the application of rules that do not in themselves impose liability. This difference in characteristic function makes it desirable to treat good faith separately from care and loyalty. Finally, the duty of good faith provides a principled basis for the courts to articulate new specific fiduciary obligations that come to be seen as appropriate in response to changes in social and business norms, and in the general understanding of efficiency and other policy considerations, but that cannot be easily accommodated within the duties of care or loyalty.