Over the last ten years, we have seen a marked shift from the Delaware Chancery Court chipping away at corporate board member liability claims. In a number of seminal cases involving Boeing airplane crashes (In re the Boeing Co. Derivative Litig., No. 2019-0907 (Del. Ch. Sept 7, 2021)), and deadly listeria outbreaks from tainted ice cream (Marchand v. Barnhill, 212 A.3d 805 (Del. 2019)), Delaware Courts have upheld plaintiffs’ cases against claims of failing to adequately plead violations of the standards set forth in Caremark, 698 A.2d 959 (Del. Ch. 1996), (establishing basic pleading requirements to withstand motions to dismiss).
Caremark oversight duties stem from the well-established duty of loyalty and its subsidiary duty of good faith. To plead a Caremark claim, a plaintiff is required to put forth adequate facts from which a factfinder can make a reasonable inference that the fiduciary acted in bad faith. Under Caremark, bad faith can be established when a fiduciary: “(1) utterly fail[s] to implement any reporting or information system or controls,” or (2) having implemented such a system or controls, consciously fail to monitor or oversee its operations, which results in a failure to act or attend to a risk or problem requiring their attention or response.
Last year, the Chancery Court extended so-called Caremark oversight obligations and governance requirements to senior management in the McDonald’s case. In re McDonald’s Corp. S’holder Derivative Litig., 289 A.3d 343 (Del. Ch. 2023). The Delaware Court’s decision stands as one of the most significant developments in years for those advocating for increased accountability for oversight and governance failures.
In the McDonald’s decision, the Delaware Chancery Court confirmed that corporate officers owe a duty of oversight, applying the same logic that justified application of such requirements against corporate board members. The McDonald’s plaintiffs alleged that a senior officer (responsible for Human Resources) acted in bad faith by ignoring numerous red flags of pervasive sexual harassment at the company, along with his own sexual harassment conduct.
The path now for Caremark cases will continue as a means to hold board members accountable for serious oversight and governance failures. In close cases, however, the Delaware Chancery Court has demonstrated that it remains comfortable rejecting Caremark claims lodged by plaintiffs.
The sea-change, however, continues to ensnare those companies and individual board members who fail to exercise basic fiduciary and governance obligations. In these situations, corporate boards and individual board members must act when faced with illegal conduct or face serious allegations of bad faith. Such a claim is likely to survive a motion to dismiss under the new strictures outlined by the Delaware Chancery Court.
Last year, the Delaware Chancery Court rejected motions to dismiss failed by the defendant and individual board members involving alleged governance failures at Walmart for failing to oversee the distribution of prescription opioids at Walmart stores in violation of federal law. Ontario Provincial Council of Carpenters’ Pension Tr. Fund v. Walton, No. 2021-0827-JTL, 2023 WL 3093500 (Del. Ch. Apr. 26, 2023). The Court cited plaintiff’s pleading that the majority of Walmart directors appeared to have knowingly disregarded serious compliance issues arising from Walmart’s distribution of opioids.
In its first case applying the McDonald’s standard to corporate officers, the Delaware Chancery Court sustained the dismissal of a motion in Segway Inc. v. Cai, No. 2022-1110-LWW, 2023 WL 8643017 (Del. Ch. Dec. 14, 2023).
In April 2015, Segway, a producer of personal mobility devices, was acquired by the Chinese startup Ninebot, Inc., and maintained its own board of directors and officers. Judy Cai was appointed president in 2015. After the acquisition, Segway’s business declined causing layoffs and ultimately to the closing of its corporate headquaretrs in New Jersey. Cai was terminated as President in 2020. After her departure, Segway discovered that there were discrepancies in the financial data Segway provided to Ninebot, including “an excess of $5 million in accounts receivable that were ‘not properly recorded and/or booked.’” Segway filed suit against Cai asserting a Caremark claim that she breached her fiduciary duty of loyalty to Segway by “consciously disregarding certain financial discrepancies” and “willfully ignored” issues in the Company’s accounts receivable records.
To clarify the distinction between a Caremark issue and a business-related issue, the Court emphasized that the Caremark doctrine is not a means to hold officers liable for everyday business problems. Instead, the Delaware Chancery Court explained that, “[a]t a minimum, a plaintiff pursuing an oversight claim against an officer would need to demonstrate that the officer failed to make a good faith effort to monitor central compliance risks within his/her remit that pose potential harm to the company or others.”
Cai moved to dismiss. In a brief decision, the Chancery Court granted the motion. The Delaware Chancery Court rejected plaintiff’s claims that the president of Segway ignored “financial struggles” and instead cited the need for plaintiff to plead and support a Caremark claim of a lack of good faith needed to detect “central compliance risks” within the scope of the officer’s responsibilities.
The Chancery Court’s focus appears to center on the responsibility of board members and officers to respond when faced with allegations of conduct bordering on illegality. The amount of evidence triggering a requirement to act is still developing under Delaware Chancery Court decisions, but it is clear that the trend is moving toward holding directors and officers accountable for failures to act in response to indications of potential illegal conduct. On their face, when board members and/or officers fail to act in response to such red flags, plaintiffs should be able to plead and support claims of bad faith that usually survive a motion to dismiss.
