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E-MailRoy Shapira is a Professor of Law at the Reichman University Harry Radzyner Law School and a Research Member at ECGI. This post is based on his recent paper forthcoming in the Indiana Law Journal.
Today, virtually every corporate fiasco is followed by an oversight duty lawsuit against the company’s directors and officers for not doing enough to prevent the debacle. But the rapid resurgence of oversight duties has created a mismatch: the doctrine has become one of the most important in corporate law yet remains underarticulated.
In a new Article I try to bridge this mismatch by conceptualizing the doctrine (often dubbed Caremark, after Delaware’s leading precedent). The standard of liability across all types of oversight duty claims is bad faith. Failure-of-oversight claims thus usually boil down to what courts can infer about directors’ mental state from external evidence about directors’ actions and the circumstances in which they took them. The Article identifies the external “markers” that courts use to infer directors’ bad faith in each type of Caremark claim. The Article then articulates the main policy arguments behind each Caremark claim, namely, combatting “willful blindness,” “cosmetic compliance,” corporate recidivism, and managerial short-termism.
But perhaps even more importantly, the recent slew of oversight duty cases has brought to the fore ostensibly procedural issues that have an outsized impact on corporate compliance. Many of these issues were addressed in rulings of first impression over the past year: from how to treat redactions due to privileges, to laches, to what weight should be given to findings of other, non-corporate law tribunals. In this blog post I want to spotlight one issue of first impression that promises to have an outsized impact on oversight duty litigation going forward, namely, what is the level of deference to Special Litigation Committees (SLCs).
Once Caremark claims started surviving motions to dismiss, it was only a matter of time until directors and officers tried to overtake and dismiss these claims by appointing SLCs. In November 2023, Chou ruled for the first time on the issue, allowing AmerisourceBergen’s (ABC) directors to dismiss well-pled allegations against them. One of ABC’s subsidiaries was pooling overfills from oncology vials, which were not intended for patient use, and repackaging them into syringes that they then sold and distributed. This behavior violated multiple regulations and ended up costing ABC hundreds of millions in criminal and civil fines. Shareholders sought inspection of internal documents and filed a detailed complaint. The court rejected defendants’ motion to dismiss, finding multiple pleading-stage indications of red flags that were ignored by ABC’s directors.
Then, a new director joined ABC’s board and was appointed as a one-man committee (…) to independently investigate the failure-of-oversight allegations. The one-man SLC concluded that pursuing Caremark claims would not be in the company’s best interests and moved to dismiss the case. Plaintiffs objected, arguing that (1) the director was not independent (due, for example, to his social ties with former directors who faced Caremark liability), and (2) his investigation was not reasonable. The court’s decision to reject plaintiffs’ objections and grant the SLC’s motion to dismiss may look ordinary to those steeped in corporate law: it applies the usual Zapata framework to credit the SLC’s independence and reasonableness and concludes that the dismissal of the claims is proper.
But from a policy perspective, it is far from clear that the usual deference to SLCs should apply to Caremark claims that survived the motion to dismiss. SLCs have two roles, namely, (1) finding out what happened and (2) deciding whether what happened merits pursuing litigation. And in both roles, SLCs’ value is more limited in Caremark claims than in other corporate law claims.
Consider fact-finding first. Proponents of SLCs note that they often produce information not otherwise available, thereby providing a better basis for directors and judges to decide whether to pursue or settle a claim. SLCs’ investigations add value by pushing “fact investigation, which usually takes places during discovery, into the prediscovery phase,” or so the argument goes. But the new mode of Caremark litigation is already front-loaded and rich in information. Even in the pre-filing stage, directors and judges can usually lean on regulatory enforcement actions to learn what went wrong with the company. Following pre-filing discovery (Section 220), directors and judges usually have a good sense of what directors knew about the problem in real time. By the time an SLC is appointed, the record usually contains encyclopedic complaints and judicial decisions on Section 220 actions and motions to dismiss. SLCs’ investigations of failure-of-oversight claims are thus likely to add less informational value than they could in other types of claims.
Once facts are gathered, SLCs decide whether it is in the best interests of the company to pursue claims based on the facts. In that respect as well, Caremark claims are different, because they often implicate broader societal interests. Other common derivative claims, such as self-dealing, revolve around agency problems and allocating money and power within the corporation. Caremark claims, by contrast, often implicate behavior that harms third parties. While it may make sense to let independent directors decide whether it is in the company’s best interests to go after those who enriched themselves at the company’s expense, it makes less sense to let directors decide whether it is in the company’s best interests to go after those who enriched the company at the expense of third parties. Caremark claims should not be treated as business decisions. If the law does not allow directors to take a business decision to violate laws, why should the law allow a committee comprised of directors to take a business decision not to pursue claims against fiduciaries who decided to violate laws?
The purported advantages of SLCs are therefore attenuated in Caremark contexts. In general, relying on SLCs trades off “superior ability to identify meritless cases ex post” for “reduced deterrence ex ante.” For Caremark claims that survived a motion to dismiss, the informational advantage is more limited, and the deterrence disadvantage is more pronounced. Recognizing this should make courts scrutinize such SLCs’ conclusions more closely. As of this writing, Chou is on appeal before Delaware’s Supreme Court. Deference to SLCs is therefore yet another area of Caremark law that could evolve quickly.
The full article is available for download here.
