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Corporate Governance Update

Board Oversight in Light of COVID-19 and Recent Delaware Decisions

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In times of crisis, the risk of shareholder derivative litigation rises as boards of directors face heightened scrutiny of their actions. While business judgment protection applies to good faith board efforts to navigate a crisis, boards and their advisors should be mindful of guidance that the Delaware courts have issued in the past year, including in a Delaware Chancery Court case decided on April 27, regarding the circumstances in which a claim can move forward seeking to hold directors personally liable for a failure of oversight.

The 1996 Delaware Chancery Court decision in In re Caremark Int’l Inc. Deriv. Litig. clarified that directors are responsible for overseeing that the company has in place information and reporting systems reasonably designed to provide the board and senior management with timely, accurate information sufficient to support informed judgments about compliance risk.1 Since then, shareholder plaintiffs have tried to hold directors liable for a variety of corporate missteps on the basis that directors failed in their oversight role. These claims – known as Caremark claims – have until recently typically been dismissed in early pleading stages (before discovery) for failure to state a claim. Indeed, these types of claims are regarded as among the most difficult on which to establish director liability (although Caremark claims survived motions to dismiss in a few rare cases prior to 20192). Nonetheless they are attractive to plaintiffs because an oversight failure sufficient for a Caremark claim constitutes a breach of the duty of loyalty and good faith which cannot be exculpated under Delaware law. Because most Delaware corporations provide in their charters that directors will not be held personally liable for breaches of the duty of care, this is one of the few remaining avenues to seek monetary damages from directors personally absent a conflict of interest situation.

In three cases in the past year – one involving a listeria outbreak in ice cream (Marchand), one involving a failure to follow established clinical trial protocols for a cancer drug (Clovis) and just weeks ago one involving lack of attention by an audit committee to internal control issues in the wake of a restatement (Hughes) – Delaware courts have denied motions to dismiss on demand futility and sufficiency of pleadings grounds and allowed Caremark claims to move forward. These recent cases confirm the serious nature of directors’ oversight duties regarding compliance and risk, and the litigation risks associated with failure to demonstrate in corporate records that directors are attending to important compliance and other risks facing the company.

This Sidley Update summarizes the recent Delaware case law developments and provides practical guidance for boards and their advisors to reduce the risk of derivative claims premised on a failure of board oversight.

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