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E-MailElizabeth Pollman is Professor of Law at Loyola Law School. This post is based on a paper by Professor Pollman, forthcoming in the Vanderbilt Law Review. This post is part of the Delaware law series; links to other posts in the series are available here.
Over a decade has passed since landmark Delaware decisions on corporate oversight obligations and with virtually no cases going to trial and resulting in liability, scholars have puzzled over what it means to have the potential for corporate accountability in the fiduciary duty of good faith. Recent decisions in Marchand v. Barnhill and In re Clovis Oncology have raised this question anew, adding to the small number of Delaware cases that have survived motions to dismiss with Caremark claims. In Vanderbilt Law Review’s forthcoming symposium, I offer a two-fold answer to this question—a descriptive theory of the purpose of the obedience and oversight duties in corporate law, and a functional account of how they are applied in practice.
First, state corporate law expresses fidelity to legal compliance through dual requirements of obedience and oversight that are lodged within the duty of good faith and cannot be exculpated. Each can be traced through statutory and doctrinal developments. The obligation of obedience concerns the corporation itself, which under the Delaware General Corporation Law section 101(b) must serve a “lawful purpose,” and its directors, who have fiduciary duties that prohibit them from acting with the intention of violating the law, per the Delaware Supreme Court’s Disney opinion. The obligation of oversight concerns the monitoring function of the board of directors to ensure the legal compliance of actors within the corporation, as the Court of Chancery suggested in Caremark and the Delaware Supreme Court validated in Stone v. Ritter.
Taking these two threads of corporate law and building on a related recent article, Corporate Disobedience, 68 Duke L.J. 709 (2019), that explores in-depth the obligation of legal obedience, I argue that the duty of good faith serves a legitimizing role for corporate law. Although shareholders may not perfectly police corporate illegality and oversight failures may rarely rise to the level of conscious disregard, expressing the obligations of legal compliance and oversight within corporate law acknowledges societal interests in the rule of law. Courts do not apply the business judgment rule or engage in entire fairness analysis when the issue at stake involves a potential legal violation as the fiduciary’s treatment of the corporation is not the relevant inquiry. Instead, the doctrine of good faith inquires into the intent or conscious disregard of the director in making decisions concerning legality or the monitoring of unlawful conduct within the corporation. The obligations of obedience and oversight cannot be met by a showing that the fiduciary was acting to maximize profits for the corporation.
Lodging these expressions of fidelity to external law within the duty of good faith amplifies the foundational statutory requirement of lawful conduct and allows for judicial review. The duty of good faith therefore serves as a public-regarding safety valve, allowing courts to flexibly respond to particularly salient corporate violations of trust without upending case law developed over decades.
Second, the article examines the body of Delaware law concerning the Caremark oversight obligation and argues that through stringent judicial review of pleadings it has become functionally linked with the duty of legal obedience. There are currently just over one hundred Delaware opinions citing Caremark—some of these cite the case for propositions other than the oversight obligation, many involve dismissals of Caremark claims, and a handful involve Caremark claims that survived motions to dismiss.
Reviewing these cases reveals that corporate law takes legal obedience as a strict requirement, and the Caremark doctrine creates a mandate for the board to put in place and monitor some system of compliance, but beyond this minimal threshold courts have not policed the effectiveness of oversight. Rather, the potential for oversight liability through fiduciary duty doctrine arises in the limited context of pleadings that allow for an inference of an utter failure to implement a board-level monitoring and reporting system (as in the recent Marchand decision) or that fiduciaries flouted, violated, or ignored laws with a level of scienter that rises to conscious disregard or intent (as in cases such as AIG, China Agritech, Fuqi, Massey, Pyott, and Clovis).
In practice, Delaware courts have seemingly prioritized giving directors broad latitude to take business risk by drawing a line at legal risk, despite the possibility that both types of activity could create social value or harm depending on the circumstances. The approach taken in the case law suggests, for example, that a distinction might be drawn between a financial institution that takes massive amounts of business risk—which would not give rise to oversight liability—and an innovative startup that knowingly flouts laws—which could potentially result in liability if the resulting corporate trauma relates to the illegality. Notably, the social value or harm created by each of these activities—for shareholders and stakeholders—is arguable and context specific, but corporate law does not enter that debate. Corporate law instead seeks to preserve the legitimacy of broad business discretion by setting minimal process thresholds for compliance and otherwise drawing a strict prohibition against the conscious or intentional managing of risk of legal enforcement.
Moreover, examining Delaware case law reveals that courts have stringently reviewed the pleadings for Caremark claims, requiring particularized factual allegations of conscious disregard that resembles intent to violate the law or acquiescence in misconduct. With limited exception, the handful of Delaware cases alleging Caremark claims that have survived motions to dismiss involved particularized allegations of a complete lack of board oversight or disobedience—in circumstances in which the corporation was allegedly engaged in pervasive wrongdoing, when facts supported an inference that directors were complicit in fraudulent business models or deceiving regulators, and when rogue corporations expressed disagreement with underlying laws.
Bringing together these threads of discussion, the article concludes with the observation that corporate law’s public-regarding commitment to the rule of law supports accountability in these instances of disobedience as well as more broadly when fiduciaries act with willful ignorance or an awareness that their efforts at compliance are insufficient. Although derivative litigation is often an imperfect tool for corporate accountability and drawing a line between business and legal risk is debatable from a social welfare perspective, the doctrinal foundations exist for a robust understanding of the obligations of oversight and obedience.
The complete paper is available for download here.
