Galactic Stupidity and the Business Judgment Rule - College of Law

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310 The Journal of Corporation Law [Winter judgment rule.” 52 However, although courts do engage in such review, they rarely hold directors liable for even such decisions like the one by the Disney directors to approve Michael Ovitz’s compensation package. The Court of Chancery’s decision in Disney IV exemplifies such substantive review. Virtually every formulation of the business judgment rule under Delaware law contains a requirement that the directors act honestly or in good faith. 53 But that is merely the starting point. It is difficult to come up with a definition of the business judgment rule that does not beg the question, “what do we mean by ‘good faith’?” For example, former Chancellor Allen described the bounds of the business judgment rule in the following way in an influential decision: [W]hether a judge or jury considering the matter after the fact, believes a decision substantively wrong, or degrees of wrong extending through “stupid” to “egregious” or “irrational” provides no ground for director liability, so long as the court determines that the process employed was either rational or employed in a good faith effort to advance corporate interests. 54 Stephen Bainbridge usefully points out that, in an earlier decision, Chancellor Allen said that rationality and good faith are essentially the same thing: “such limited substantive review as the rule contemplates (i.e. is the judgment under review ‘egregious’ or ‘irrational’ or ‘so beyond reason,’ etc.) really is a way of inferring bad faith.” 55 And Bainbridge himself does not dispute that rationality is necessary for an action to receive business judgment rule protection. 56 Despite the abundance of such formulations of the business judgment rule, we are still left to define “good faith” and “rational” on our own. Most students of corporate law are extremely reluctant to suggest that the concept of the reasonable person that pervades other areas of law (such as torts) should be applicable to corporate directors. We hesitate to speak of what a reasonable director might do in a given situation because, unlike in a situation involving everyday torts, a reasonable director might have chosen many different paths for the corporation he oversees. 57 The 52. Brehm v. Eisner, 746 A.2d 244, 264 (Del. 2000). 53. Courts and commentators must take as their starting point, the Delaware Supreme Court’s definition in the highly problematic Aronson v. Lewis, 473 A.2d 805 (Del. 1984), which held that the business judgment rule presumes “that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” Aronson, 473 A.2d at 812. The body of literature criticizing that decision on various grounds is voluminous and continues to grow. 54. In re Caremark Int’l Derivative Litig., 698 A.2d 959, 967 (Del. Ch. 1996) (emphasis in original). 55. STEPHEN BAINBRIDGE, CORPORATION LAW AND ECONOMICS 274 (2002) (quoting In re RJR Nabisco, Inc. S’holders Litig., No. 10289, 1989 WL 7036, at *13 n.13 (Del. Ch. 1989)). Interestingly, in the same discussion, Bainbridge then goes on to equate irrationality with self-interest alone, a position that seems to be unique to him. Id. Numerous other commentaries have equated rationality with good faith, including one by the then-Chief Justice of the Delaware Supreme Court. E. Norman Veasey, Musings on the Dynamics of Corporate Governance Issues, Director Liability Concerns, Corporate Control Transactions, Ethics and Federalism, U. PA. L. REV. 1007, 1009 (2003) (“Although the concept of good faith is not fully developed in the case law, an argument could be made that reckless, irresponsible, or irrational conduct but not necessarily self-dealing or larcenous conduct could implicate concepts of good faith.”). 56. BAINBRIDGE, supra note 55, at 274; see also Bainbridge, supra note 46 (“[A]n essential precondition for application of the business judgment rule long has been the absence of irrationality.”). But he is not willing to say that an inquiry into the rationality of a decision would constitute substantive review of the merits of the decision. BAINBRIDGE, supra note 55, at 274. 57. William T. Allen et al., Realigning the Standard of Review of Director Due Care With Delaware
2007] Galactic Stupidity 311 “reasonable” director standard seems too strict because the very term carries with it the suggestion that only one—or perhaps a few—courses of conduct were reasonable under any given set of circumstances. Since the “reasonable director” standard is disfavored, some other standard, not too strict and not utterly lacking in teeth, must prevail. Rather than asking whether a director acted “reasonably,” courts often asked whether she acted “rationally.” Former Chancellor Allen and Chancellors Jacobs and Strine argue that “a rationality standard gives directors greater freedom to make risky decisions than a reasonableness standard.” 58 And they attempt to draw a distinction between these two standards (reasonable and rational) by defining an irrational decision as one “that is so blatantly imprudent that it is inexplicable, in the sense that no well-motivated and minimally informed person could have made it.” 59 But it is not obvious how much broader this standard really is than a reasonable director standard. What kind of behavior does not pass the reasonable director standard that would pass the rationality test as described above? Neither the requirement of prudence, good motivation, nor minimal information seems to allow much behavior that would not already be permissible under the requirement that a director act reasonably. It is not clear, then, how the widely accepted rationality standard differs in reality from the much-shunned reasonableness standard. Indeed, application of the rationality standard often sounds a lot like an application of the reasonableness standard, and therefore an inquiry into the substance of the directors’ decision. In a well-known case in which a board of directors was accused of breaching its fiduciary duty to accept the highest price available in a tender offer, Chancellor Allen allowed the directors business judgment rule protection. 60 Though he explicitly rejects the idea that he has engaged in substantive review of the directors’ action, much of his language sounds very much like an inquiry into its substance: it was not beyond the range of reasonable responses, in the circumstances in which the overall objective was to get a committed deal at $64 per share cash from [the bidder] . . . . These are precisely the sort of debatable questions that are beyond the expertise of courts and which the business judgment rule generally protects from substantive review for wisdom . . . . Certainly, the decision... in these circumstances does not fall so far afield of the expected range of responses to warrant an inference that [they] must have been motivated by a concern other than maximizing the value of shareholders’ interest. 61 Here, Chancellor Allen appears to be asking whether the proverbial “reasonable” director might have done the same thing under the circumstances; whether the director’s Public Policy: A Critique of Van Gorkom and its Progeny as a Standard of Review Problem, 96 NW. U. L. REV. 449, 454 (2002). The authors (two Delaware chancellors and a former chancellor) use the case of automobile accidents as an example. They point out that in that context, “only one decision is reasonable in a given set of circumstances, so decisions that turn out badly almost invariably turn out to have been bad decisions.” Id. In contrast, if the business judgment rule stands for anything at all, it is that decisions that turn out badly are not necessarily bad decisions. Id. 58. Id. at 452. 59. Id. at 452 (emphasis added). 60. In re J.P. Stevens & Co., Inc., 542 A.2d 770 (Del. Ch. 1988). 61. Id. at 783 (emphasis added).
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