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A Board's Duty to Monitor - New York Law School

A Board's Duty to Monitor - New York Law School

a Board’S dUTY To

a Board’S dUTY To MoNiTor was not good law. 90 Even though Graham did not expressly require the board to make an effort to be informed of the activities of the corporation, the court agreed with Allen that boards had a duty to be reasonably informed and to ensure that corporate information-reporting systems were in place. 91 The court also made clear, however, that the failure of a board to meet its Caremark duty was a failure to act in good faith (as opposed to a violation of the duty of care, as determined by Allen). 92 Furthermore, the court declared that the duty of good faith was a subsidiary element of the duty of loyalty. 93 Whereas in Brehm the duty of good faith appeared to be a non-exculpable violation of the duty of care, the court in Stone flatly rejected this notion and the notion that the duty of good faith was independent from the duties of care and loyalty, ending the doctrinal debate about the existence of a triad of fiduciary duties. 94 In interpreting the duty to monitor, the Delaware Supreme Court relied heavily on the reasoning of Vice Chancellor Leo Strine in Guttman v. Huang. 95 In Guttman, Strine considered a Caremark claim where a group of shareholders accused the board of failing to ensure accurate financial reporting. 96 Even though Strine recognized that “by its plain and intentional terms” the Caremark standard for the duty to monitor was about the exercise of care by directors, he recast Caremark as a case about the duty of loyalty and the responsibility of directors to meet their duties in good faith. 97 In his opinion, good faith was an essential element of the duty of loyalty—i.e., it is impossible for a director to act in bad faith and still be considered to have acted loyally to the corporation. 98 Consequently, Strine argued that Caremark, despite its intent to encourage boards to exercise greater care, in fact set a standard that “requires a showing that the directors breached their duty of loyalty by failing to attend to their duties in good faith.” 99 90. Id. at 370 (“We hold that Caremark articulates the necessary conditions predicate for director oversight liability . . . .”). 91. Id. at 369. 92. Id. (“[T]he Caremark standard for so-called ‘oversight’ liability draws heavily upon the concept of director failure to act in good faith.”). 93. Stone v. Ritter, 911 A.2d 362, 368 (Del. 2006). 94. Id. at 370. 95. See id. at 370 (citing Guttman v. Huang, 823 A.2d 492 (Del. Ch. 2003)). 96. Guttman v. Huang, 823 A.2d 492, 505–06 (Del. Ch. 2003). 97. Id. at 506. 98. Id. at 506 n.34. Strine further argued that the Delaware legislature should redraft DGCL section 102(b)(7) to make disloyal conduct the only exception to liability exculpation, eliminating once and for all any notion that good faith and legality of action were different from the duty of loyalty. See id. 99. Id. at 506. See generally Claire A. Hill & Brett H. McDonnell, Stone v. Ritter and the Expanding Duty of Loyalty, 76 Fordham L. Rev. 1769 (2007) (commenting on the awkward fit of the duty of good faith within the duty of loyalty). It is interesting to note that despite his strongly argued assertion that a breach of the duty to monitor is a breach of the duty of loyalty, Strine still recognized the connection between the duty to monitor and the duty of care even after deciding Guttman. See Teachers’ Ret. Sys. of La. v. Aidinoff, 900 A.2d 654, 668 (Del. Ch. 2006) (“[T]he most difficult task of all: demonstrating 732

nEW YOrK LaW sChOOL LaW rEViEW VOLUME 54 | 2009/10 Building upon Strine’s analysis in Guttman, the Delaware Supreme Court in Stone reformulated the Caremark standard as a two-part test where liability stems either from (a) “utterly fail[ing] to implement any reporting or information system or controls” or (b) if “having implemented such system or controls, consciously fail[ing] to monitor or oversee its operations.” 100 Most notably, the court identified a scienter requirement to prove a breach of the duty to monitor, stating, “imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations.” 101 In order to show scienter, plaintiffs must plead “particularized facts . . . that [the directors] had ‘actual or constructive knowledge’ that their conduct was legally improper.” 102 The court left unanswered how difficult it would be to satisfy that requirement. In sum, Stone, a decision that courts have interpreted as defining the appropriate scope of the duty to monitor, was in reality an attempt by the Delaware Supreme Court to end doctrinal confusion about the meaning of the duty of good faith and loyalty. However, because of its treatment by lower courts as a duty to monitor case, the decision, while clarifying one area of law, undermined the impact that the duty to monitor has on boards’ willingness to exercise oversight of corporate activities and places Delaware out of step with popular calls for more vigorous risk management by corporate boards. D. Duty to Monitor After Stone v. Ritter In the few years since Stone, courts have considered a handful of duty to monitor cases, providing some data points to consider how well the post-Stone standard encourages monitoring efforts by boards. In almost all cases, the courts reviewed duty to monitor claims as part of motions to dismiss, usually in the context of plaintiffs arguing demand futility 103 by showing that directors faced a substantial likelihood of that the outside directors had breached their duty of care, not as a result of trying to do their job . . . but because the directors’ level of indolence was so extreme that it arose to a conscious decision to take the salary of a director while intentionally failing to discharge one’s fiduciary obligations.”). 100. Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006) (emphasis added). In reformulating the Caremark standard, the court borrowed language from the definition of good faith—specifically the use of the word “conscious”—first set forth by Chancellor Chandler in Disney II as a “conscious disregard for one’s responsibilities.” Disney II, 907 A.2d 693, 755 (Del. Ch. 2005). Thus, there is an explicit connection between the duty to monitor standard set forth in Caremark and the duty of good faith standard set forth in the Disney cases. 101. Stone, 911 A.2d at 370 (citing Guttman, 833 A.2d at 506) (emphasis added); see also Wood v. Baum, 953 A.2d 136, 141 (Del. 2008) (“Where, as here, directors are exculpated from liability except for claims based on ‘fraudulent,’ ‘illegal’ or ‘bad faith’ conduct, a plaintiff must also plead particularized facts that demonstrate that the directors acted with scienter . . . .”); Desimone v. Barrows, 924 A.2d 908, 935 (Del. Ch. 2007) (discussing a “scienter-based standard” in a monitoring context). 102. Wood, 953 A.2d at 141 (citation omitted); see also Guttman, 823 A.2d at 506 (“[The Caremark standard] premises liability on a showing that the directors were conscious of the fact that they were not doing their jobs.”). 103. To initiate a derivative suit, a plaintiff makes a demand on the board to bring forward a claim on behalf of the corporation. A plaintiff may attempt to bring forward a derivative claim without the board’s 733

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