Stockholder plaintiffs seeking to assert a non-exculpated breach of fiduciary duty claim against corporate directors arising from adverse company news frequently allege that the directors breached their duty of loyalty by failing to exercise appropriate oversight over company activities. The hallmark of the claim known under Delaware law as a Caremark claim is bad faith; director liability requires proof that the directors knowingly (1) failed to implement any board-level reporting or information system or controls; or (2) having implemented such a system or controls, consciously failed to monitor or oversee its operation. While Delaware courts have repeatedly characterized the claim as possibly the most difficult claim in corporate law to establish, a recent Delaware Supreme Court decision reversing dismissal of a Caremark claim reminds practitioners that courts will scrutinize board members’ close personal relationships with management when analyzing demand futility and that directors’ duty to monitor does have substance. In Marchand v. Barnhill, — A.3d —-, 2019 WL 2509617 (Del. June 18, 2019), the court emphasized Caremark’s “bottom-line requirement” that a board “make a good faith effort—i.e., try—to put in place a reasonable system of board-level monitoring and reporting.” While only a motion to dismiss decision, Marchand provides practical guidance on how boards may discharge their risk oversight duties.

Background

Under In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996), directors must make a good faith effort to oversee the company’s operations, including legal compliance and financial performance. A typical Caremark claim is brought by a stockholder as a proposed derivative claim, alleging that the board knowingly or recklessly caused or allowed the company to violate applicable law, resulting in money damages to the company. As developed in decisions amplifying then-Chancellor Allen’s Caremark decision, the bad faith necessary for liability is established when directors either (1) completely fail to implement any reporting or information system or controls, or (2) having implemented such measures, consciously fail to monitor or oversee the company’s operations, thereby knowingly “disabling themselves from being informed of risks or problems requiring their attention.” Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006). Under either theory, the “imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations.” Id.