Court Dismisses Derivative Claim for Alleged Breach of Oversight Duty

The Delaware courts encourage plaintiffs who bring derivative claims in Delaware without making demand on the board of directors to seek books and records under Section 220 of the Delaware General Corporation Law so as to be able to plead facts sufficient to demonstrate that demand is excused. Many claims have been dismissed under Delaware Court of Chancery Rule 23.1 because a plaintiff failed to utilize the “tools at hand” to obtain relevant books and records. When a plaintiff grounds its claim on directors’ alleged failure to exercise oversight, however, even receipt of books and records may not enable a plaintiff to plead facts sufficient to demonstrate that the directors knowingly ignored their duties so as to have acted in bad faith. That high standard as articulated by the Delaware Supreme Court in Stone v. Ritter makes a Caremark claim for breach of directors’ oversight duties as among the most difficult in corporate law. The Court of Chancery’s recent decision in Reiter v. Fairbank, C.A. No. 11693-CB (Del. Ch. Oct. 18), demonstrates that, regardless of the injury allegedly sustained by the subject company, a pleading based on books and records obtained from the company that at best reflects awareness of “yellow flags” is not sufficient to call into question the directors’ good faith and hence to excuse demand, thus requiring dismissal of the plaintiff’s derivative claim.

Background Facts

Capital One Financial Corp.’s business included check cashing. It was subject to certain statutory requirements under the Bank Secrecy Act and anti-money laundering laws (BSA/AML). Following investigations by state and federal agencies, Capital One entered into a consent order on July 10, 2015, in which the company agreed with the Office of the Comptroller of the Currency, without admitting to any wrongdoing, that it had “failed to adopt and implement a compliance program that adequately covers the required BSA/AML program elements due to an inadequate system of internal controls and ineffective independent testing.” It also agreed to certain remedial actions. On Nov. 10, 2015, after obtaining books and records, the plaintiff filed its complaint alleging breach of the duty of loyalty by all director defendants and seeking monetary damages based on unjust enrichment for their receipt of compensation and directors’ fees. The plaintiff alleged that the defendants “purposefully, knowingly or recklessly” failed to comply with the BSA/AML. The defendants moved to dismiss for failure to state a claim and for failure to comply with Rule 23.1 and also to stay pending completion of other ongoing regulatory investigations. As explained below, the court dismissed the complaint for failure to make demand and to allege with particularity that a majority of the board faced a substantial threat of personal liability such that they could not impartially consider a demand.

Court of Chancery’s Findings