Corporate Oversight and Disobedience

By Pollman, Elizabeth | Vanderbilt Law Review, November 2019 | Go to article overview

Corporate Oversight and Disobedience


Pollman, Elizabeth, Vanderbilt Law Review


Introduction

In the corporate law canon lies the promise of powerful accountability. Decades ago, the potential for the fiduciary duty of care to be the source of this accountability for corporate directors was lost. It was stripped of its sting just after its bite in Smith v. Van Gorkom.1 Nearly as soon as the Delaware Supreme Court ruled in the 1985 case that the directors had acted with gross negligence in corporate decisionmaking, the state legislature enacted section 102(b)(7) of the General Corporation Law.2 The outcry from corporate America demanded this response-corporations were given the freedom to put exculpatory provisions in their charters eliminating the personal liability of directors for monetary damages for breach of the duty of care.3 Corporate directors could thereafter rest easy knowing that absent fraud, bad faith, or self-dealing, they would rarely, if ever, pay out of pocket for harming the corporation, even if their service had been far less than perfect.4

But the potential for corporate accountability through fiduciary duty law was not entirely extinguished. Setting aside traditional duty of loyalty issues such as self-dealing, the duty of good faith remained as a potential mechanism for accountability that could not be exculpated. Two aspects of the duty of good faith-obedience and oversight-soon came into sharper focus through a series of cases that joined Smith v. Van Gorkom in the corporate law canon: In re Caremark International Inc.;5 In re Walt Disney Co.;6 and Stone v. Ritter.7

Through these cases, the Delaware courts established a claim for what became known as Caremark liability, which involves an utter failure to implement an information and reporting system to allow the board to monitor the legal compliance of the corporation or a conscious failure to monitor its operations.8 A successful claim requires showing that "the directors knew that they were not discharging their fiduciary obligations"-that is, a "conscious disregard" of their oversight responsibilities, which implicates the duty of good faith.9 Further, the Delaware Supreme Court clarified that a breach of the duty of good faith can also be shown in any instance in which the fiduciary acts with a purpose other than advancing the best interests of the corporation, intentionally disregards duties, or intends to violate positive law.10 As part of the fiduciary duty of loyalty, claims of bad faith cannot be exculpated.11

Over a decade has passed since these landmark decisions, and with virtually no cases going to trial and resulting in liability, scholars have puzzled over whether Caremark oversight responsibility is a "practical irrelevance"12 or only "soft law."13 And, despite a constant stream of media headlines exposing corporate illegality, shareholder suits successfully holding directors liable for breaking the law are extremely rare.14 This state of affairs raises the question of what it means to have the potential for corporate accountability lodged within the duty of good faith but almost never brought to fruition in terms of trial liability.

This Article offers a two-fold answer to this question-a descriptive theory of the purpose of the obedience and oversight duties in corporate law, and a functional account of how they are applied in practice. First, this Article argues that the fidelity to external law required by the duty of good faith largely serves a legitimizing role for corporate law.15 Shareholders cannot be counted on to police corporate illegality, and oversight failures may rarely rise to the level of conscious disregard. The fiduciary duty of good faith is neither irrelevant nor toothless, however-it embeds a safety valve for public policy in the obligations of fiduciaries that cannot be eliminated. Expressing legal compliance and oversight obligations within corporate law acknowledges societal interests in the rule of law and preserves the ability of courts to flexibly respond to particularly salient and egregious violations of public trust, should they arise, without upending case law developed over decades. …

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