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  • Duty of loyalty and good faith

    David Skeel, guesting on Conglomerate, posts on the distinction between the duty of good faith and the duty of loyalty. He says, in part:

    At least one Delaware judge has suggested that the good faith duty is part of the duty of loyalty, while several academics (including Hillary Sale and Mel Eisenberg) have characterized it as a separate duty. Is this a difference that matters? I think it does. If the good faith duty becomes part of the duty of loyalty, the duty of loyalty will no longer be limited to conflicts of interest– the problems that arise when a director or officer is on both sides of the table. The result will be a serious loss of clarity in one of the few areas of corporate governance that has remained relatively clear.

    I agree with both the general need to separate out the good faith duty, and with the need for “clarity.” Indeed, the latter is the main point of my paper, Are Partners Fiduciaries?forthcoming in the University of Illinois Uncorporation Symposium, 2005 University of Illinois Law Review (latest draft here).

    Here’s an excerpt from what I have to say about the good faith/fiduciary duty distinction (footnotes omitted):

    The most difficult aspect of defining fiduciary duties involves distinguishing these duties from the general obligation of “good faith.” Good faith has two broad meanings. The first is a flexible way to interpret a long-term contract like a business association where the parties cannot easily foresee the circumstances in which their contract will apply. . . . .

    This view of good faith does not demand foregoing self-interested conduct, but rather only refraining from the particular sort of self-interested conduct that is proscribed by the parties’ contract, broadly construed. . . .

    Because good faith is an interpretive rule rather than a specific default term, its existence is not subject to general contractual alteration, although its application in a particular case ultimately depends on the terms of the parties’ contract.

    Good faith as a gap-filler tailors agreements to their specific circumstances without subjecting them to inappropriate standard form duties. This application of good faith is particularly useful in interpreting contractual modifications of fiduciary duties. The combination of fiduciary duties and good faith interpretation may explain why fiduciary duties and the interpretation view of good faith sometimes seem to blur at the edges.

    The second view of good faith is as a distinct set of non-fiduciary duties that are applied to people who may, or may not, also be fiduciaries. These duties differ from the strong fiduciary duty of unselfishness that requires disgorgement of gains from dealings with other parties. Good faith may, for example, include the duty to make affirmative disclosures to the extent necessary to make actual representations not misleading—an aspect of general fraud law. Good faith also has been said to be a duty of corporate directors under recent Delaware cases that extends beyond loyalty and care to encompass an assurance that transactions are based on adequate information. This closely resembles the non-fiduciary duty of care.

    Originally posted by Prof. Larry Ribstein on Ideoblog