Court Explains Rigorous 'Caremark' Pleading Requirements

A recent opinion containing the report and recommendation of the magistrate judge in the U.S. District Court for the District of Delaware, In re Chemed Shareholder Derivative Litigation, C.A. No. 13-1854-LPS-CJB (D.Del. Dec. 23, 2015), well illustrates the accepted wisdom that a Caremark claim is “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment, as in In re Caremark International Derivative Litigation, 698 A.2d 959 (Del.Ch. 1996). As the Chemed case demonstrates, it is exceptionally difficult to even plead such a claim. In recommending that dismissal be granted on Rule 23.1 grounds (with leave to amend), the court carefully analyzed Delaware law and the requisite specificity necessary for a plaintiff to plead that directors “consciously failed to act after learning about evidence of illegality [such as becoming aware of] the proverbial ‘red flag.’”

BACKGROUND

A Caremark claim typically arises after a corporation suffers a major corporate trauma and resulting loss or harm. The question that frequently ensues is where was the board of directors and how did it allow this trauma to occur? Under Delaware law, the board of directors carries responsibility for the management of the corporation’s affairs, but the board may, and typically does, delegate the day-to-day management to officers and other full-time employees. With most corporations having corporate charter provisions exculpating the directors from monetary liability for violations of the duty of care, directors receive protection from personal liability for negligent oversight and management of the corporation’s affairs, as in 8 Del. C. Section 102(b)(7). Directors may be liable, however, for breach of the duty of loyalty for a Caremark claim if they fail to act when they otherwise should have done so. One way to satisfy the Caremark burden is to demonstrate the directors consciously failed to act after learning about evidence of corporate illegality. To establish a breach of the fiduciary duty of loyalty in a Caremark context requires a showing that the directors knew they were not discharging their fiduciary obligations or that they demonstrated a conscious disregard for their duties through a systematic and continuous failure to oversee and monitor over a period of time. Caremark claims asserted by shareholders against the directors are derivative in nature because they seek to vindicate harm to the corporation. The plaintiff therefore must satisfy rigorous Rule 23.1 pleading standards. These require the plaintiff to plead with specificity facts showing that at least half the board cannot disinterestedly exercise business judgment in responding to a demand to sue the board members. A mere threat of personal liability is not enough to disable a director from disinterestedly considering a demand. Plaintiffs are entitled to an inference of director interestedness only where the facts pleaded show the directors face a substantial likelihood of liability. The Chemed case demonstrates the difficulty of pleading facts that permit an inference of directorial knowledge sufficient to show the directors face a substantial likelihood of Caremark liability.

FACTS