Chancellor Allen’s famous and prescient 1996 opinion in Caremark will soon be twenty-five years of age. It has more than stood the test of time. Indeed, it has become gospel as an enduring corporate governance doctrine and a dynamic driver of modern-day oversight and compliance requirements. Although it did not become enshrined as a major Delaware Supreme Court precedent until the Stone v. Ritter Delaware Supreme Court decision in 2006, Chancellor Allen’s 1996 Caremark dictum enjoyed from the outset the international respect of a precedent that had the imprimatur of a Delaware Supreme Court holding.
In this article we analyze the Caremark opinion itself, including the key and lasting importance of Chancellor Allen’s sua sponte invocation of the United States’ Organizational Sentencing Guidelines. He correctly concluded that the Sentencing Guidelines provide “powerful incentives for corporations to have in place compliance programs . . . and to take voluntary remedial efforts.” He parlayed those “powerful incentives” into the conclusion that the proper exercise of good faith requires that “a director’s obligation includes a duty to assure that a corporate information and reporting system . . . exists, and that the failure to do so under some circumstances may . . . render a director liable for losses caused by non-compliance with applicable legal standards. [But] . . . only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to liability.”
While Caremark/Stone state that there is theoretical exposure of directors to liability for violation of their duty of loyalty if they “utterly” fail in good faith to implement and monitor an internal information system (i.e., oversight protocols), such Delaware litigation liability is rare and hard to plead/prove. But recent Delaware cases at the pleading stages have framed parameters where this theoretical exposure might or might not become a real concern of the boards of directors, particularly where there is little or no board involvement and/or where “red flags” are ignored.
Moreover, there are developments at the federal and scholarly levels that flesh out the oversight obligations of corporations, alternate entities, and their governing bodies. These developments, coupled with Delaware fiduciary duty principles, tend to inform boards of directors that they need to ensure their management has a robust oversight protocol. In short, the directors need to carry out effective oversight/monitoring, including awareness of and effective addressing of red flags. The tension is that board oversight must occur without directors micromanaging the operations of the firm, which traditionally is a management responsibility.