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Leveraging Information Forcing in Good Faith

The duty of good faith and oversight, which is a branch of the duty of loyalty, has been the subject of considerable litigation in recent years, with cases revealing significant information asymmetries between directors and management. These cases are subject to the business judgment rule and strict pleading requirements, resulting mostly in dismissal at the motion to dismiss or summary judgment stages.  As a result, the “definition” of the duty of good faith and oversight has evolved from how the cases are pleaded, at least for those that are resolved with a motion to dismiss. Even cases that survive summary judgment rarely go trial — mainly because a breach is non-exculpable, non-indemnifiable, and usually non-insurable, creating a significant incentive for officers and directors to settle, which also confines our understanding of the duty of good faith to what might be a fiduciary breach.

Nevertheless, many of the recent court opinions involve information gaps between directors and officers.  Initial changes in the law to address the information gaps between company operators and company owners were largely federal and premised on disclosure regulation.  This regulatory area is the home of the information-forcing-substance theory.  Federal securities regulation requires substantial and substantive disclosures about the corporation, its financials, and its operations and choices. If it works well, discourse ensues and improves the quality and quantity of information disclosed.

This information-forcing-substance theory also has a significant role to play both in how courts decide fiduciary matters and in how active and engaged directors can add value in the boardroom.  In a new book chapter, I explore two case studies to reveal how judges can use information forcing to develop robust disclosure discourse in the good faith and oversight context.

For example, a Boeing case study examines the litigation that followed two Boeing airplane crashes. Fiduciary oversight was at the root of this claim. The questions posed were: Did the directors and officers put safety and reporting systems in place to make sure they knew of issues with planes? Did they pay attention to red flags? According to the Delaware Chancery Court, the answer was no. Boeing’s officers focused on profits, not safety, and the board was complicit.  The officers did not share safety information with the board, and the board did not monitor safety or hold management accountable for it.

A second Delaware case study provides a review of the officer side of information forcing.  In the McDonald’s litigation, the Chancery Court clarified that officers owe the same fiduciary duty of oversight as directors, albeit with some potential limits based on the scope of their remits. This move is key because, for the information-forcing-substance theory to work, both directors and officers must engage in the process and discourse. Here, the issue was sexual harassment — throughout the restaurants and corporate spaces, both by the CEO, Stephen Easterbrook, and by the chief people officer, David Fairhurst, who was the defendant in this matter.

In analyzing derivative claims against Fairhurst, the Chancery Court described the first realm of oversight as “Information-Systems Theory.”  The premise for this type of claim is that fiduciaries must create internal information and reporting systems that are calibrated to get information to senior leaders and the board so that the board can fulfill its supervisory and monitoring obligations. The obligation to share information, however, is not limited to initial monitoring systems.  It extends to a red-flag situation involving bad faith, and the Chancery Court concluded that the latter is what the McDonald’s plaintiffs pleaded successfully.  Red flag and information systems claims are connected.  For example, Vice Chancellor Laster found that Fairhurst failed to report to higher-ups sexual harassment issues of which he was aware and, in so doing, appeared to have breached his fiduciary duties. That finding is itself a standard invoking the information-forcing-substance theory.

As the case studies reveal, corporate law and the judges who create it have important roles to play — not just in developing fiduciary duties, but also in ensuring mechanisms are in place to create good disclosure discourse between management and the board. Information forcing uses disclosure requirements and mechanisms to press for the development of information that enlightens and produces substantive choices and behaviors. Judges can also create incentives for officers to share more information sooner and, thus, help to realign the asymmetry between directors and officers. That in turn, can decrease agency costs and information asymmetries and improve directors’ understanding of their oversight role as well as their ability to do their jobs and fulfill their fiduciary roles.

This post comes to us from Hillary Sale, the Agnes Williams Sesquicentennial Professor of Leadership and Corporate Governance at Georgetown University Law Center and a professor of management at Georgetown University’s McDonough School of Business. It is based on her recent book chapter, “Leveraging Information Forcing in Good Faith,” available here.

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