In re Caremark Int’l – 698 A.2d 959 (Del. Ch. 1996)

Estimated Reading Time: 10 minutes

Summary

The plaintiffs in this case, the shareholders who filed the original derivative claim and the Defendant Board, presented the Delaware Court of Chancery with a settlement agreement. The deal provided for Defendants to exercise more control to ensure that company workers follow the legislation when it comes to partnerships with outside health care providers.

Rule

Where an allegation of directorial responsibility for corporate loss is based on negligence of actions that create liability within the company, the breach of good faith that is a required condition of liability would be created. The standard for determining responsibility – a director’s loss of good faith as shown by a sustained or systemic inability to practise fair supervision – is very strong. A challenging measure of responsibility in the supervision sense, as it is in the board decision context, is probably advantageous to corporate shareholders as a community, because it makes board service by competent individuals more possible, while also acting as an incentive to good faith performance of duty by those directors.

Facts

A motion to support a negotiated settlement of a combined derivative case on behalf of Caremark International, Inc. as equitable and rational is pending under Chancery Rule 23.1. The lawsuit alleges that members of Caremark’s board of directors violated their fiduciary duty of care to the company in accordance with possible violations of federal and state laws and regulations governing health care providers by Caremark employees. Caremark was the target of a four-year probe by the US Department of Health and Human Services and the Department of Justice as a result of the suspected abuses. In an indictment, Caremark was charged with various felonies. Following that, it entered into a series of settlements with the Justice Department and others. Caremark pled guilty to a single felony of postal theft and agreed to pay civil and federal charges as part of one of these deals. As a result, Caremark promised to compensate a variety of private and public entities. Caremark has been forced to make nearly $ 250 million in payments in total.

This suit was brought in 1994 with the intention of recovering these damages on behalf of the corporation from the individual defendants that make up Caremark’s board of directors. The parties have proposed that it be resolved, and a hearing on the proposal’s validity was held on August 16, 1996, after warning to Caremark shareholders.

Issue

The question is whether the Board paid enough heed to the probability of ARPL breaches.

Settlement of this Litigation

That Caremark, its staff, and agents agree not to pay any kind of compensation to a third party in return for a patient’s referral to a Caremark facility or service, or for the prescription of drugs sold or administered by Caremark for which reimbursement might be obtained from Medicare, Medicaid, or a related state reimbursement programme;

That Caremark, for itself, its employees, and agents, agrees not to pay or split fees with physicians, joint ventures, any business combination of which Caremark has a direct financial interest, or other health care providers with which Caremark has a financial relationship or interest, in exchange for a patient referral to a Caremark facility or service or a prescription of Caremark products.

That the full Board shall discuss all relevant material changes in government health care regulations and their effect on relationships with health care providers on a semi-annual basis;

That Caremark’s officers would withdraw all staff from health care facilities or hospitals who have been put there for the purpose of providing remuneration in return for a patient referral for which reimbursement from Medicare, Medicaid, or a related state reimbursement programme might be sought;

And any financial arrangement between Caremark and the health care practitioner or provider who made the referral will be disclosed in writing to each patient;

That the Board form a Compliance and Ethics Committee of four directors, two of whom will be non-management directors, to meet at least four times a year to implement these policies and track business segment compliance with the ARPL, and to report to the Board on compliance by each business segment semi-annually;

That enforcement officers, who must report semi-annually to the Regulatory and Ethics Committee and, with the help of outside lawyers, review existing contracts and obtain advanced approval on all proposed contract forms, be appointed by corporate officers responsible for business divisions.

Legal Principles

As stated at the start of this opinion, the Court must now make an educated decision on whether the proposed resolution is fair and equitable in view of all applicable considerations. On this type of application, the Court tries to secure the corporation’s and its excluded shareholders’ best interests, both of whom will be barred from further action on these grounds if the deal is accepted.

Potential liability for directorial decisions: 

In principle, director responsibility for a violation of the obligation to take reasonable care may occur in two situations. To begin, such liability can be attributed to a board decision that results in a failure as a result of the decision being ill-advised or “negligent.” Second, responsibility for a loss to the company can be said to result from the board’s hasty inability to behave in cases when due diligence would, arguably, have avoided the loss. The director-protective business judgement rule would usually apply to the first class of cases, meaning the decision was taken as the result of a procedure that was either intentionally considered in good conscience or was otherwise reasonable. What can be recognised, but may not be commonly understood by courts or journalists who are not often confronted with those issues, is that judicial conformity with a director’s duty of care should never be properly assessed by reference to the substance of a board decision that results in a corporate failure, without taking into account the good faith or rationality of the mechanism used. That is, if a judge or jury later considers a judgement to be substantively incorrect, with degrees of incorrectness ranging from “stupid” to “egregious” to “irrational,” there is no basis for director liability whether the court decides that the procedure used was either rational or used in a good faith attempt to further corporate interests. Using a separate provision that allowed for an “objective” assessment of the decision would subject directors to substantive second-guessing by ill-equipped judges or juries, which would be detrimental to investor interests in the long run.

On what moral grounds would shareholders attack a director’s good faith business decision as “unreasonable” or “irrational?” When a director makes a good faith attempt to stay updated and make sound decisions, he or she should be considered to have thoroughly fulfilled the obligation of attention. If the shareholders believed they were entitled to a higher level of judgement than that which such a director produces in the course of exercising his or her powers of office, they should have chosen other directors.

Liability for failure to monitor

The second type of situation in which director responsibility for inattention is potentially probable involves situations in which a failure occurs as a result of unconsidered negligence rather than a decision. The majority of decisions made by a company by its human agents are not, of course, the responsibility of the board of directors. Legally, the board would only be expected to approve the most important organisational acts or deals, such as mergers, financial structure changes, basic market changes, CEO appointment and pay, and so on.

Ordinary management choices taken by officers and staff further within the company will, though, have a significant impact on the corporation’s wellbeing and ability to accomplish its multiple strategic and financial targets, as the facts of this case graphically illustrate. If this situation wasn’t enough to persuade you, recent corporate history will. Consider the departure of senior management and a large portion of the board of directors at Salomon, Inc. senior management at Kidder, Peabody was replaced after major trading errors were discovered as a result of phantom trades by a highly paid trader; or Prudential Insurance sustained a significant financial loss and reputational injury as a result of its junior officers’ misrepresentations in conjunction with the distribution of limited partnership rights.

to use criminal legislation to ensure that a company complies with external regulatory standards such as environmental, financial, employee, and product protection, as well as a variety of other health and safety regulations The United States Sentencing Commission introduced Organizational Sentencing Guidelines in 1991, in accordance with the Sentencing Reform Act of 1984, which provide a significant influence on the potential impact of criminal penalties on businesses. 

The Guidelines provide a uniform sentencing framework for companies convicted of violating federal criminal statutes, with sentences that are equal to or sometimes vastly greater than those levied historically on businesses. The Guidelines provide powerful incentives for businesses today to put in place enforcement systems to track and monitor legal breaches, as well as to take prompt, cooperative remedial action when violations are detected.

In light of these developments, it would be a mistake, in my opinion, to conclude that our Supreme Court’s statement in Graham concerning “espionage” means that corporate boards can fulfil their obligation to be reasonably informed about the corporation without ensuring that information and reporting systems exist in the organisation that are reasonably designed to provide to senate committees.

Obviously, the required level of detail for such an information system is a matter of business judgement. Obviously, no rationally built knowledge and monitoring mechanism can exclude the risk that the company will break laws or rules, or that senior officers or directors will be deceived or otherwise fail to detect actions that are material to the corporation’s legal enforcement. However, it is critical that the board make a good faith determination that the corporation’s information and reporting mechanism is sufficient in principle and architecture to ensure that accurate information can be brought to the board’s notice in a timely manner as a part of routine operations, allowing it to fulfil its responsibilities.

I believe that a director’s responsibility entails a requirement to make a good faith effort to ensure the existence of a corporate information and reporting system that the board determines to be satisfactory, and that failure to do so under certain cases which render a director responsible for damages incurred by non-compliance with relevant legal requirements, at least in principle.

The Claims and conclusion 

Overall, I believe this deal is fair and equitable after examining the case’s lengthy record, which includes various records and three depositions. Given that the Caremark Board also has a working committee tasked with monitoring corporate enforcement, the reforms in corporate conduct presented as part of the resolution do not strike one as particularly important. Nonetheless, the consideration seems to be sufficient to justify dismissal of the derivative director liability claims, since such claims lack substantive evidentiary support in the record and were almost certainly vulnerable to a motion to dismiss in either case.

Plaintiffs would have to prove either (1) that the directors knew or should have recognised that breaches of law were happening and, in either case, (3) that the directors took no action in a good faith attempt to avert or mitigate the condition in order to show that the Caremark directors violated their duty of care by failing to properly monitor Caremark’s workers.

Knowing violation of statute

Concerning the likelihood that the Caremark directors were aware of legal irregularities, neither the records requested for inspection nor the deposition transcripts seem to support this theory. The Board was well aware that the organisation had entered into a number of arrangements with doctors, researchers, and health-care companies, and that some of these contracts were with people who had prescribed medications that Caremark provided. The board was told that the majority of the company’s payment for health treatment came from government funds, and that those facilities were subject to the ARPL. Experts seem to have informed the Board that the company’s policies, although questionable, were legal. There is no basis to believe that relying on those sources was irrational. As a result, there is no basis in this case to enforce the principle that intentionally leading a company to commit a criminal act is a violation of a director’s fiduciary responsibility. It’s unclear if the Board was aware of the level of specificity included, for example, in indictments related to the Company’s payments. Of necessity, the requirement to behave in good conscience to be knowledgeable cannot be construed as requiring directors to have extensive knowledge of all facets of the company’s operations. In this technical era, such a criterion would simply be incompatible with the scale and reach of an effective organisation.

Failure to monitor

Although it seems that the Board was largely ignorant of the actions that contributed to responsibility, I’ll move on to the pleadings’ other possible avenue for director liability: director inattention or “negligence.” In general, if a claim of directorial liability for corporate loss is based on the board’s ignorance of liability-creating activities within the corporation, as in Graham or this case, only a sustained or systematic failure of the board to exercise oversight — such as an utter failure to ensure a reasonable information and reporting system exists — will establish the lack of g. A high standard of liability exists where a director’s breach of good faith is shown by a sustained or systemic inability to maintain fair supervision. A challenging measure of responsibility in the supervision sense, as it is in the board decision context, is probably advantageous to corporate shareholders as a community, because it makes board service by competent individuals more possible, while also acting as an incentive to good faith performance of duty by those directors. 

The record provides no evidence that the director defendants failed to perform their supervision duty on a consistent basis. On the contrary, the corporation’s information structures seem to have represented a good faith effort to be aware of relevant evidence. The directors cannot be blamed if they were unaware of the details of the events that led to the indictments.

The responsibility that resulted in this case was enormous. However, the fact that it was the product of a criminal law crime would not automatically imply a lack of fiduciary responsibility on the part of the directors. At this point, the evidence does not support the inference that the defendants either acted in bad faith in carrying out their monitoring obligations or knowingly allowed the company to violate the statute. At this point, the arguments made against them must be considered extremely poor.

Reference 

[1] https://www.casemine.com/judgement/us/5914bca8add7b0493479dd62

[2] https://www.lexisnexis.com/community/casebrief/p/casebrief-in-re-caremark-int-l-526890181

[3] https://law.justia.com/cases/delaware/court-of-chancery/1996/13670-3.html

[4] https://h2o.law.harvard.edu/cases/5773

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