Graham v. Allis-Chalmers Manufacturing Co.
41 Del.Ch. 78, 188 A.2d 125 (Del.Supr. 1963)

  • Allis-Chalmers and four of its directors were indicted for price fixing violations of anti-trust laws. Some shareholders instituted a derivative lawsuit against the directors for breach of fiduciary duty.
    • The shareholders argued that the directors should have had knowledge of the price fixing and were liable because they didn’t have a monitoring system that would have allowed them to uncover the illegal activity.
  • The Delaware Supreme Court found for the directors.
    • The Delaware Supreme Court found that is was corporate policy at Allis-Chalmers to delegate price-setting authority to the lowest possible levels. While the directors reviewed the general financial goals of the corporation it would not have been practical for the directors to consider in detail the specific problems of the various divisions.
    • The shareholders argued that the directors should have put into effect a system of watchfulness, which would have brought the illegal activity to their attention. However, the Court found that directors are entitled to rely on the honesty and integrity of their subordinates unless there is something to raise suspicions of wrongdoing.
      • In other words, management need not create a “corporate system of espionage.”
  • This case established the Graham Standards which basically impose a duty of inquiry only when there are obvious signs of employee wrongdoing.
    • That’s an objective standard and asks whether a reasonable person would have seen the wrongdoing.
    • Alternately, under the standard set by In re Caremark International Inc. Derivative Litigation (698 A.2d 959 (Del. Ch. 1996)), directors are responsible for establishing some sort of monitoring system, but will not be held liable if that system fails.