Citing Thin Board Record: Delaware Court of Chancery Again Sustains Oversight Claim

William SavittRyan A. McLeod and Anitha Reddy are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Monetary Liability for Breach of the Duty of Care? by Holger Spamann (discussed on the Forum here).

The Delaware Court of Chancery has sustained another Caremark claim, pointing to the absence of documents produced in response to a stockholder’s inspection demand as evidence that the directors “face a substantial likelihood of liability” for “failing to act in good faith to maintain a board-level system for monitoring the Company’s financial reporting.” Hughes v. Hu, C.A. No. 2019-0112-JTL (Del. Ch. Apr. 27, 2020).

The case involved Kandi Technologies, a Delaware corporation headquartered in China that sells automobile parts. Kandi had a long history of inadequate internal controls, including improper insider transactions and a 2017 restatement of earnings. The stockholder plaintiff complained that the board failed to implement responsible auditing protocols notwithstanding these clear red flags.

The Court reaffirmed that Delaware directors are at risk of Caremark liability only if they “utterly fai[l] to implement any reporting or information system or controls” or, “having implemented such a system or controls, consciously fai[l] to monitor or oversee its operations.” But that high bar was met in this case, the Court ruled, because the complaint alleged that the audit committee met only infrequently and briefly, and routinely overlooked important issues—“chronic deficiencies [that] support a reasonable inference that the [board], acting through its Audit Committee, failed to provide meaningful oversight.”

Importantly, the Court observed that “[t]he Company could have produced documents in response to the plaintiff’s Section 220 demand that would have rebutted this inference.” Explained the Court: “The absence of those documents is telling because it is more reasonable to infer that exculpatory documents would be provided than … that such documents existed and yet were inexplicably withheld.”

The decision reinforces the straight line that connects good governance, good recordkeeping, books-and-records demands, and Caremark risk. It is essential that companies implement reporting systems that provide directors with timely information regarding key corporate risks. It is essential that directors react promptly when these reporting systems suggest the need for remedial action. And it is essential that these efforts are thoroughly documented to provide inspecting stockholders and reviewing courts a fair picture of the directors’ work.

Trackbacks are closed, but you can post a comment.

Post a Comment

Your email is never published nor shared. Required fields are marked *

*
*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

  • Subscribe or Follow

  • Supported By:

  • Program on Corporate Governance Advisory Board

  • Programs Faculty & Senior Fellows