In re Caremark International Inc. Derivative Litigation
698 A.2d 959 (Del.Ch. 1996)

  • Employees of Caremark were indicted for violations of regulations applicable to health care providers.
    • Those violations eventually cost the company $250M.
  • Some shareholders instituted a derivative lawsuit against the directors for breach of fiduciary duty.
    • The shareholders argued that the directors knew, or should have known, about what was going on in the company and stopped it before the company became liable for $250M.
      • Essentially, the directors should have been more active monitors of corporate performance.
  • The parties came to an agreement to settle the suit, and asked the Court for approval pursuant to Chancery Rule 23.1.
    • The settlement agreement gave the shareholders express assurances that Caremark will adopt a more centralized, active supervisory system in the future by creating Compliance and Ethics Committees.
  • The Trial Court approved the settlement.
    • The Trial Court found that as long as the directors were acting in good faith to advance corporate interests, the courts shouldn’t question their decisions.
      • That would be a subjective standard. The directors are held what they personally believed was good corporate governance, not what a reasonable person would believe.
      • The Court noted that if the directors were incompetent, it was the shareholders’ fault for electing incompetent directors.
    • The Court found that part of what would make a ‘good faith effort’ on the part of the directors would be to assure that a corporate information and reporting system exists and that it is (in the opinion of the directors) adequate to detect activities that could put the corporation at risk of liability.
      • The Court narrowly construed Graham v. Allis-Chalmers Manufacturing Co. (188 A.2d 125 (Del. 1963)) which held that the directors did not have responsibility to institute a monitoring system to mean that directors’ can decide for themselves what sort of system they believe will be adequate to detect wrongdoing.
        • The Court noted that they shouldn’t second guess a director who says that they believed that the system they had in place was adequate.
    • The Court found that, based on the standard they had set, the shareholders would have been unlikely to win in court. However, since the settlement was pretty modest and generally changed the corporation for the better, it should be approved.
  • The Court found that there are two conditions necessary for liability under the standard set by this case (now known as the Caremark Factors):
    • The directors utterly failed to implement any reporting or information system or controls; or
    • Having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.
    • In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations.