Caremark Claim Based on Business Risks Dismissed

• The Court of Chancery continues its consideration of whether a director or officer’s oversight duties, set forth in the seminal case of In re Caremark International Inc. Derivative Litigation¹ and its progeny, apply to business risks in addition to legal compliance.
• The Court’s recent decision in Segway, Inc. v. Cai squarely concludes that an officer does not face oversight liability for alleged inattention to day-to-day business matters or routine business risks.

The Court of Chancery granted a motion to dismiss on December 14, 2023, in Segway, Inc. vs. Cai where the plaintiff, Segway Inc. (“Segway” or the “Company”), alleged a Caremark oversight claim against Judy Cai, the former president of the company.² In the Court’s succinct memorandum opinion, Vice Chancellor Lori Will forcefully rejected Segway’s theory that “everyday business problems” could constitute a fiduciary’s breach of the duty of oversight or that there is a lower pleading standard when a Caremark claim is brought against an officer as opposed to a director. Instead, the Court confirmed the “enduring principles” of the Caremark doctrine that “[l]iability can only attach in the rare case where fiduciaries knowingly disregard [their] oversight obligation and trauma ensues.”³

Segway continues an ongoing debate within the Court of Chancery over whether the duty of oversight, which historically has required directors and officers to have in place and monitor controls related to mission-critical legal compliance, can give rise to liability for a failure to oversee business risk. For example, in Construction Industry Laborers Pension Fund v. Bingle, Vice Chancellor Sam Glasscock III noted “it is possible . . . to envision an extreme hypothetical involving liability for bad faith actions of directors leading to such liability.”⁴ By contrast, in In re ProAssurance Corp. Stockholder Derivative Litigation, Vice Chancellor Will drew a distinction between business risk and unlawful conduct, explaining that “[s]o long as the challenged conduct is lawful, directors have broad discretion to advance the corporation’s interests as they see fit.”⁵ The Segway decision adds to this discussion, providing support that—even assuming oversight liability can arise from the failure to oversee business risk—the burden for a plaintiff to establish such liability should be substantial.

Background

Plaintiff Segway is a producer of personal mobility vehicles. In April 2015, Segway was acquired by the Chinese startup Ninebot, Inc., but maintained its own board of directors and officers, and largely continued operations as they had existed pre-merger. Cai became President of the Company in 2015, but also maintained responsibilities of her prior role as Segway’s in-house accountant.

After the Ninebot acquisition, Segway’s business prospects declined leading to layoffs and ultimately a closing of the Company’s headquarters in Bedford, New Jersey. Due to the decline in performance, 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.’”⁶

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.⁷ Notably, Segway did not claim that Cai breached her fiduciary duty of care. Segway further argued that officers could be found liable for a Caremark oversight breach merely for failing to recognize business risk without any allegations of bad faith.

Cai moved to dismiss. In its 12-page memorandum opinion, the Court granted the motion, wholly rejecting Segway’s arguments.

The Court’s Decision

Relating to Segway’s argument that Cai’s conduct implicated the duty of oversight, the Court held that Segway failed to plead facts that suggested Cai “consciously failed to act after learning about evidence of illegality—the proverbial ‘red flag’ within her areas of responsibility.”⁸ Indeed, the Court noted that Segway’s allegations “are an ill fit for a Caremark claim,” particularly because Segway failed to allege any “potential wrongdoing (much less within Cai’s purview).”⁹ For example, absent from the complaint were allegations that “Cai overlooked accounting improprieties, fraudulent business practices, or other material legal violations.”¹⁰ Accordingly, the accounts receivable issue constituted “generic financial matters [] far from the sort of red flags that could give rise to Caremark liability if deliberately ignored.”¹¹

The Court also highlighted the lack of allegations that Cai acted in bad faith and reiterated the heightened standard required for a Caremark claim. Quoting the Delaware Supreme Court’s seminal Stone v. Ritter decision, the Court explained that a Caremark claim is intended to address only “the extraordinary case where fiduciaries’ ‘utter failure’ to implement an effective compliance system or ‘conscious disregard’ of the law gives rise to a corporate trauma.”¹² The Court further rejected Segway’s argument that a lower standard should apply to officers, and expressly held that for officers, like directors, a Caremark claim requires a showing that “the officer failed to make a good faith effort to monitor central compliance risk within her remit that pose potential harm to the company or others.”¹³ Segway failed to make any such showing here and its complaint was dismissed in its entirety.

Takeaways

Segway confirms that a Caremark claim requires a plaintiff to establish that a director or officer must knowingly disregard their obligations to the company in a way that causes damage far beyond “unexceptional financial struggles.”¹⁴

More broadly, Segway is an important addition to the current debate within the Court of Chancery over whether Caremark oversight claims extend from matters of legal compliance and to matters of business risk. As we have previously written, extending Caremark liability to matters of pure business risk, as opposed to legal risk, could undermine the important principles at the heart of the business judgment rule and the deference given to fiduciaries in running an entrepreneurial organization. While this debate continues, Segway offers a powerful rejoinder to any argument that directors and officers should be liable for failing to oversee business risk.

1. 698 A.2d 959 (Del. Ch. 1996).
2. C.A. No. 2022-1110-LWW (Del. Ch. Dec. 14, 2023).
3. Id. at 1.
4. 2022 WL 4102492, at *7 (Del. Ch. Sept. 6, 2022).
5. C.A. No. 2022-0034-LWW, at 36 (Del. Ch. Oct. 2, 2023).
6. Segway, C.A. No. 2022-1110-LWW, at 6.
7. Id. at 9 (cleaned up).
8. Id. at 9.
9. Id. at 10.
10. Id. (emphasis added).
11. Id.
12. Id. at 11 (quoting Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006)).
13. Id. at 12.
14. Id. at 1.
15. See Bingle, 2022 WL 4102492, at *7; ProAssurance at 37.