In re Caremark International Inc. Derivative Litigation case brief

In re Caremark International Inc. Derivative Litigation
(698 A.2d 959 (Del.Ch. 1996))

FACTS

-Caremark employees were indicted for violations of regulations that were applicable to health care providers.  These violations eventually cost the company $250M.
-Some of the shareholders instituted derivative litigation against the directs for breach of fiduciary duty.
-Shareholders argued: directors knew (or should have known) about that which was going on in the company and they should have stopped it before the company became liable for the $250M, i.e., the directors should have been more active in monitoring corporate performance.
-The parties eventually agreed to settle, and asked the Court to approve the settlement agreement.
     -Settlement agreement gave the shareholders express assurances that Caremark woudl adopt a more centralized and active supervisory system in the future by creating compliance and ethics committees.

ISSUE
-Was the settlement agreement valid?

HOLDING

-Yes, the trial court approved the settlement agreement.

RULES

-As long as the directors were acting in good faith to advance corporate interests, the courts should not question the decisions of the directors.
-The standard is subjective:  directors can choose what they believe to be good corporate governance, the standard is not what a reasonable person would believe.
-Good Faith Effort: (on the part of the directors) to assure that a corporate information and reporting system exists and that it is adequate to detect activities that could put the corporation at risk of liability.
Conditions necessary for liability under the standard: 
1.  Directors failed to implement any reporting or information system/controls, or
2.  Directors did implement such a system, but consciously failed to monitor or oversee its operations, thus disabling themselves from being informed of risks or problems requiring their attention.
(Imposition of liability requires showing that directors knew that they were not discharging their fiduciary obligations)

ANALYSIS

-The court stated that if the directors were incompetent, it was the shareholders' (not the director's) fault, because the shareholders elected incompetant directors.
-Graham v. Allis-Chalmers Manufacturing Co. (held that directors did not have responsibility to institute a monitoring system means that directors can decide for themselves what sort of system that they believe will be adequate to detect wrongdoing) was construed narrowly to mean:  the court should not second guess a director who says that they believed the system they had in place was adequate.
-Courts standard made it so that the shareholders would have a tough time winning in court. 
-Settlement was modest and generally changed corporation for the better, so should be approved.

Course: Corporations
Subject: Liability, Director responsibility, Duty of Care