In re Caremark International Inc. Derivative Litigation

Delaware Court of Chancery · 2006 · Corporations

CorporationsDirectors' duty of oversightDerivative settlementsCorporate complianceduty of careoversightmonitoringgood faith

Facts

Caremark incurred approximately $250 million in fines, civil payments, and reimbursements after federal and state investigations into its relationships with physicians and other health care providers, including conduct that raised concerns under the Anti-Referral Payments Law. The derivative plaintiffs sought to recover those losses from the directors, alleging that the board failed to supervise corporate compliance. The record showed that Caremark had guides governing contractual relationships, internal audit plans, outside auditors, board committee review, revised compliance policies, an ethics manual, employee training, and later a Compliance and Ethics Committee. The proposed settlement provided additional compliance-related undertakings rather than monetary recovery.

Issue

Whether the proposed derivative settlement was fair and reasonable in light of the strength of the claims that Caremark's directors breached their fiduciary duty by failing to monitor and supervise corporate compliance with law. In assessing that question, the court also addressed what standard governs director liability for failure to monitor corporate operations.

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 the oversight context, 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 for liability. To show liability for failure to control employees, plaintiffs would have to show that directors knew or should have known that violations of law were occurring, that they took no steps in a good faith effort to prevent or remedy the situation, and that the failure proximately resulted in the losses complained of.

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

Summit Biologics, a Delaware corporation based in Denver, operates through dozens of regional sales offices. Its board never creates any compliance process, never asks for reports about legal compliance, and never establishes any channel for employees to report suspected misconduct. After years of unlawful billing practices by lower-level employees, the company pays massive civil penalties.

In a shareholder derivative suit against the directors, which argument most strongly supports oversight liability?

Explanation. Oversight liability requires more than corporate wrongdoing or large losses. The key inquiry is whether there was 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. Massive penalties by themselves do not establish a breach, and employee misconduct does not automatically become director liability.