Caremark International Inc. Derivative Litigation

Delaware Court of Chancery · Corporations

CorporationsDirectors' duty of oversightDerivative suitsCorporate complianceduty of careoversightmonitoringgood faith

Facts

Caremark's business involved extensive financial relationships with physicians and providers in areas where reimbursement often came from Medicare and Medicaid, creating potential issues under the Anti-Referral Payments Law. After federal and state investigations, Caremark was indicted in 1994 and later entered agreements including a guilty plea to a single felony of mail fraud, with total payments of about $250 million. The record showed that before and during the investigations, Caremark had guides governing contractual relationships, internal audit efforts, board committee review, outside auditor reports, ethics policies, training, and later a compliance structure. The derivative plaintiffs sought to recover the corporation's losses from the directors, and the parties proposed a settlement centered on additional compliance-related undertakings rather than monetary recovery from the directors.

Issue

Whether the proposed derivative settlement was fair and reasonable to Caremark and its shareholders in light of the strength of the claim that the directors breached their fiduciary duty by failing to monitor corporate compliance. More specifically, whether the record showed a sufficient likelihood that the directors could be held liable for failing in good faith to assure an adequate information and reporting system.

Rule

A director's obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists. In a claim predicated on director ignorance of liability-producing misconduct, only a sustained or systematic failure of the board to exercise oversight, such as an utter failure to attempt to assure a reasonable information and reporting system exists, will establish the lack of good faith necessary to impose liability.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

Redwood Transit Systems, a Delaware corporation based in Phoenix, operates in a heavily regulated medical-transport business. For six years, its board never created any compliance committee, never required legal-compliance reports, and never adopted any internal reporting or audit system, even though operations spanned 40 locations; employees later engaged in widespread billing misconduct that led to major fines.

In a shareholder derivative suit seeking to hold the directors liable for the corporation's losses, which is the strongest argument for liability?

Explanation. Oversight liability requires far more than a bad outcome. The controlling rule is that directors must make a good-faith effort to assure that an adequate corporate information and reporting system exists. Where liability is predicated on ignorance of wrongdoing, only a sustained or systematic failure of oversight—such as an utter failure to attempt to assure a reasonable system exists—can establish the lack of good faith necessary for liability. Large fines or criminal violations alone are not enough, and the inquiry is not substantive second-guessing of business decisions. (Derived from Caremark International Inc. Derivative Litigation (n.d.).)