Caremark’s Fractured State

Delaware’s hegemony in U.S. corporate law is indisputable. Law students are taught Delaware corporate law, and corporate law practitioners are expected to be well-versed in Delaware’s doctrinal nuances. Regardless of one’s opinion about the benefits provided by Delaware incorporation, Delaware’s preeminence has created a shared corporate law language that bridges jurisdictional boundaries.

The Caremark doctrine exemplifies this state of affairs. Chancellor Allen’s novel declaration of a proactive board-level monitoring obligation, even in the absence of suspected wrongdoing, propelled it to the pantheon of influential corporate law decisions. Caremark’s framework for assessing board liability invigorated the board’s oversight role and jumpstarted the compliance industry. Nearly three decades after it was handed down, Caremark remains a common staple in corporate law casebooks, and an accepted shorthand for the board’s oversight obligation.

Yet Caremark’s ubiquitousness obscures important Delaware-specific nuances. Caremark originally situated a director’s obligation to monitor as part of the exculpable duty of care. Because of this classification, even credible allegations of suspect monitoring would be unable to overcome the impregnable liability shield that exculpation provides. Had it remained unchanged, shareholder challenges would face certain early dismissal, if filed at all. The Delaware Supreme Court’s recasting of the obligation to monitor as a subset of the non-exculpable duty of loyalty was intended to promote more vigorous monitoring. Even after this shift, however, two doctrinal appendages hamstrung plaintiffs’ efforts to successfully plead a Caremark claim. First, Caremark’s monitoring obligation was limited to illegal activities perpetrated by corporate underlings. If no law was broken, the board could not possibly be held liable for the ensuing damage. Second, Caremark liability hinges on mental culpability. As directors are not likely to admit they knowingly breached a fiduciary duty, this aspect of Caremark became a near-insurmountable pleading hurdle. Plaintiffs’ dismal success rates justified Caremark’s self-imposed moniker as “the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.”

The latest development in oversight liability has turned Caremark’s traditional tone on its head. In Marchand v. Barnhill, the Delaware Supreme Court decreed that directors are expected to demonstrate a higher degree of attentiveness while overseeing “mission critical” aspects of the enterprise. Oversight failures in those areas infer a culpable mental state, which the board will have to countermand. Marchand’s message was heard loud and clear. Formerly herculean pleading requirements gave way to an increased willingness to construe inferences against directors regarding their oversight of activities that are critical to the continued success of the business. In less than a year and a half after Marchand was decided, four additional Caremark claims survived a motion to dismiss.

Marchand’s repercussions are still being felt. The Delaware Supreme Court’s reluctance to define the contours of mission criticality thrust Caremark to the forefront of corporate law’s most divisive policy debates. No matter one’s view on the merits of the argument, Caremark is the unquestioned doctrinal rubric used to evaluate board liability for failing to ensure corporate compliance with such far-ranging issues as environmental laws, civil rights antidiscrimination laws, fair election reporting, and the dictates of the Controlled Substances Act. As Caremark represents the accepted framework for evaluating a director’s potential oversight liability, this paper examines whether non-Delaware jurisdictions have adopted the doctrine’s latest development.

Caremark’s evolution is intricately linked to Delaware’s formulation of its statutory authority to permit director exculpation. Caremark itself would have remained a dead letter if not for the doctrinal recalibration that removed the protections of Delaware’s exculpation shield from the duty to monitor. Accordingly, this paper juxtaposes the breadth of non-Delaware director exculpation provisions with those jurisdictions’ oversight caselaw. Despite Caremark’s prominence in corporate law discourse, this paper reveals substantial deviation regarding the enforceability of director oversight duties in non-Delaware jurisdictions.

To be sure, a duty to monitor the corporation is uniformly recognized. Beyond that shared starting point, Caremark functions differently outside of Delaware. Due to the scope of their exculpation provisions, nearly half of the non-Delaware jurisdictions have declared a director’s oversight obligation to be effectively litigation-proof. Additionally, the absence of Delaware’s ancillary litigation rules makes successful Caremark claims substantially less likely, even in jurisdictions with exculpation provisions similar to Delaware.

This paper reveals discrepancies that have been largely overlooked. Caremark’s historical toothlessness no doubt contributed to the lack of scholarly interest. Even after the duty to monitor was re-characterized as a subset of the duty of loyalty, Caremark’s pleading requirement meant that the threat of liability was similar to that felt in jurisdictions that do not offer exculpation carve-outs. After Marchand, that is no longer the case. The “oversight gap” uncovered in this paper produces an additional takeaway: Despite Caremark’s universal acceptance in the corporate law vocabulary, only a handful of jurisdictions are able to take part in the policy debates that have been kickstarted by Delaware’s new Caremark jurisprudence.

 

The complete paper is available for download here.