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Supreme Court Interprets The "Duty" To Act In Good Faith

Stone v. Ritter,  C.A. No. 93, 2006 (Del. Supr. November 6, 2006).

The Supreme Court has issued the latest Delaware decision to interpret the duty to act in good faith. Indeed, it is possible to read Stone as holding there is no separate duty of directors to act in good faith. While that would be a mistake, the implications of this decision may be far reaching. At the very least, Stone upholds the conventional wisdom in Delaware that under Caremark the directors' duty to act is most easily triggered when there are red flags indicating something is wrong with the way the entity is being operated. A complaint that fails to plead those red flags has a good chance of being dismissed.

Stone states it will "clarify" some "doctrinal" issues that are now being debated over what is the extent and the implications of holding that directors must act in good faith. First, it holds that the duty to act in good faith is really just a part of the duty of loyalty. This is illustrated by the examples of bad faith that it takes from the Disney opinion.

Second, Stone notes that a violation of the duty of good faith does not "directly result in liability".  Exactly what this means is not clear, but may mean that liability will depend on a showing that the directors knew that they were not fulfilling their fiduciary duty.

Third, the Court holds violations of the duty of loyalty are not limited to instances of "financial or other cognizable fiduciary conflict of interest". This seems to refer to cases of personal gain so that there may be a violation of the duty of loyalty even when the directors themselves do not thereby obtain some economic benefit.

This decision by the full Supreme Court will lead to much debate over what it means. While it seems fair to say it does not change the law of Delaware as most of us understand it, that may be wrong.



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