Tag: Caremark

Boards Must Rigourously Exercise Their Oversight Function

“[T]o satisfy their duty of loyalty, directors must make a good faith effort to implement an oversight system and then monitor it.”

Marchand v. Barnhill, 212 A.3d 805 (Del. 2019)

Clovis Oncology’s stock dropped sharply in 2015 when it disclosed poor clinical trial results for Rociletinib a promising experimental drug for the treatment of lung cancer. That meant the FDA was unlikely to approve Rociletinib to enter the market. Shareholder lawsuits ensued. The claim was that board breached its fiduciary duties by disregarding red flags that reports of the drug’s performance in clinical trials were inflated.

Delaware’s Caremark line of cases impose a responsibility on corporate boards to have a compliance program, but with a great deal of discretion to design it for the corporation’s context, industry, and resources. However, that compliance obligation is heightened when the corporation operates in an area of mission-critical regulatory compliance risk.

In the recent decision of In re Clovis Oncology, Inc. Derivative Litigation, the court highlighted the two components required of corporate compliance. First, you have to have an oversight system in place. Second, you have to monitor the oversight system. In area of mission-critical regulatory compliance, board oversight responsibility is heightened.

If you fail to do either, the corporation risks fiduciary litigation when bad news comes out.

Sources:

Imposing Caremark Fiduciary Duty on Corporate Officers

I previously posted on the Midland Grange case [Delaware Imposing Same Fiduciary Duty on Officers as Directors] where the Delaware Chancery Court imposed the same obligations on officers as directors, including the duty of loyalty and the duty of care.

In Miller v. McDonald, et al., ( D. Del., Bankr., April 9, 2008), the Bankruptcy Court for the District of Delaware ruled on corporate governance issues related to the fiduciary duties of officers and directors. The Bankruptcy Court denied a motion to dismiss in the course of ruling that Caremark duties would be imposed on an officer (who was not a director), that was on the management team when the President of the company committed fraud and other actions and omissions that ultimately led to the bankruptcy filing of the company.

It is correct that Delaware law does not impose fiduciary duty on “employees” generally, but it is incorrect that it does not impose failure of oversight (fiduciary duty) as to officers. . . . While it is true that all of the cases relied upon by the Trustee involved directors’ conduct, not officers’, I believe the Caremark decision itself suggests that the same test would be applicable to officers.

The corporate entity in Miller v. McDonald is a Florida corporation, so the court is exporting this concept of similar duties between officers and directors from Delaware to Florida.

Thus, it is clear that under both Delaware and Florida law both officers and directors owe fiduciary duties to the corporation.

Thanks to the Harvard Law School Corporate Governance Blog and Francis G.X. Pileggi of Fox Rothschild LLP and the Delaware Corporate and Commercial Litigation Blog for pointing out this case: Court Imposes Caremark Fiduciary Duty on Corporate Officer.

The Implications of Stone v. Ritter

In 1996, Delaware’s Court of Chancery stated in the Caremark case that a director’s duty of good faith includes a duty to attempt to assure that a corporate information and reporting system exists, and that failure to do so may, under some circumstances, render a director liable for losses caused by the illegal conduct of employees. In 2006 the Delaware Supreme Court applied and clarified the Caremark language in the case of Stone v. Ritter.

Rebecca Walker of Walkercompliance.com wrote a summary of the Implications of Stone v. Ritter on Board Oversight of a Compliance Program.

The Stone decision formalizes the discussion that appeared in Caremark regarding potential liability of directors into a holding that directors may be liable for the damages resulting from legal violations committed by employees of a corporation, if directors fail to implement a reporting or information system or controls or fail to monitor such systems. The court places this duty of directors squarely within the duty of loyalty. The decision also provides a view of those factors that the court will use in deciding whether the board oversight of the company’s compliance program was adequate to prevent liability to the directors.