McCall v. Scott

United States Court of Appeals for the Sixth Circuit · 2001 · Corporations

Corporationsdirector fiduciary dutiesdemand futilityDelaware law§ 102(b)(7) exculpationduty of caregood faithgross negligence

Facts

The claims concerned Columbia's board's failure to act in the face of allegedly illegal corporate activity, placing the case in the Caremark category of unconsidered board inaction. Columbia's Restated Certificate of Incorporation included a Delaware § 102(b)(7) provision eliminating directors' personal monetary liability for breach of fiduciary duty except, among other things, for acts or omissions not in good faith or involving intentional misconduct. Plaintiffs alleged the directors engaged in intentional ignorance, willful blindness, and conscious disregard of red flags signaling fraudulent practices throughout Columbia. Defendants argued those allegations stated only duty-of-care claims for which the charter provision provided exculpation.

Issue

Whether plaintiffs' allegations that Columbia's directors intentionally ignored or were willfully blind to red flags of fraudulent corporate practices were barred by Columbia's Delaware § 102(b)(7) charter exculpation provision. More specifically, the question was whether such allegations should be treated as mere gross-negligence duty-of-care claims or as bad-faith misconduct outside the protection of the waiver.

Rule

Under Delaware law, director oversight liability based on board inaction requires a sustained or systematic failure to exercise oversight, such as an utter failure to attempt to assure a reasonable information and reporting system exists. A valid § 102(b)(7) charter provision may exculpate directors from monetary liability for duty-of-care violations based on gross negligence, but it does not protect acts or omissions not undertaken in good faith or involving intentional misconduct. Allegations that directors consciously disregarded known risks, including intentional ignorance or willful blindness to red flags, are properly treated as alleging a breach of the duty of good faith and therefore are not precluded by such an exculpation provision.

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Lake Harbor Medical Systems, a Delaware corporation headquartered in Cleveland, has a charter provision eliminating directors' personal monetary liability to the fullest extent permitted by Delaware law, including for duty-of-care violations. Shareholders file a derivative suit alleging the board carelessly failed to monitor billing compliance, but the complaint alleges only that the directors were inattentive and grossly negligent; it does not allege they knew of any warning signs or consciously ignored reports.

If the directors move to dismiss the monetary claims based on the charter provision, what is the strongest argument for dismissal under the governing rule?

Explanation. A valid Section 102(b)(7) provision may be applied when its validity is uncontested and the pleaded facts implicate only a duty-of-care claim based on gross negligence. The majority drew a line between mere sustained inattention or gross negligence, which may be exculpated, and conscious disregard of known risks amounting to bad faith, which may not be exculpated.