When I teach Caremark in Business Associations, I tell my students that there is a critical difference between cases in which the board fails to consider the desirability of law compliance programs and cases in which the board makes an informed decision not to adopt such a program. In an earlier post on the Delaware Supreme Court's opinion in Stone v. Ritter, I suggested that the Court's recharacterization of Caremark as a loyalty-based cause of action changed that result:
First, it seems clear that a conscious decision by the board of directors that the costs of a law compliance program outweigh the benefits will no longer be protected by the business judgment rule. To the contrary, such a decision might result in per se liability. See Stone, 911 A.2d at 370, in which the court stated that "Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith." I suppose this problem could be finessed by holding that a board that consciously decides on the basis of an informed process not to adopt a law compliance program will escape liability because such a board had no "duty to act," but notice how such a solution guts the business judgment rule. The whole purpose of the business judgment rule is to prevent the court from asking whether the board made a reasonable decision. See, e.g., Brehm v. Eisner, 746 A.2d 244 (Del. 2000) ("Courts do not measure, weigh or quantify directors' judgments. We do not even decide if they are reasonable in this context.").
I've got a very bright student who's doing a research paper on Stone under my supervision. She pointed out a clever solution to the problem. Suppose the corporation's general counsel comes to the board and recommends that the board consider adopting a program to ensure that the company complies with law X. The board carefully considers the question and reaches a fully informed decision that the costs of implementing such a program outweigh the benefits. Unfortunately, the company ends up violating law X and is obliged to pay significant fines. Shareholders sue the board, bringing a Caremark claim. What standard of review applies? As noted in the earlier post, there is an argument for treating an informed decision not to adopt the law compliance program as a duty of care issue, such that the business judgment rule applies.
Suppose, however, a Delaware court concludes that failure to adopt a law compliance program - whether informed or not - raises issues of good faith and, per Stone, loyalty. The court would do so, presumably, by concluding that such a decision entails a failure "to act in the face of a known duty to act." If the decision was made by independent and disinterested directors, however, Puma v. Marriott, 283 A.2d 693 (Del. Ch. 1971), suggests that the standard of review ought to be the business judgment rule.
In Puma, a disgruntled Marriott Corporation shareholder brought a duty of loyalty claim based on the corporation’s purchase of six other companies from the Marriott family. At the time of the transaction, the Marriott family collectively owned 44% of Marriott Corporation’s stock. Four of the nine directors were Marriott family members. The acquisition was unanimously approved by the five disinterested directors. The court held that on those facts the business judgment rule was the applicable standard of review.
As I point out in my Corporation Law and Economics text (at page 312):
Some commentators contend the same rule applies to transactions reviewed under § 144(a)(1). Dicta in at least one Delaware supreme court decision seemingly supports this view. It also is supported by a few decisions from other jurisdictions interpreting comparable statutes. This view also is consistent with case law on the effect of shareholder approval under § 144(a)(2). Finally, this interpretation of § 144(a)(1) is consistent with the economic justification for the business judgment rule as developed in Chapter 6. If the disinterested directors have approved the transaction, courts should defer to their judgment, just as they would with respect to any other business decision. All of the economic arguments in favor of the rule of judicial abstention apply here, just as they do to any other business decision made by impartial directors.
In sum, whether the claim is characterized as one based on the duty of care or good faith (as subsumed into loyalty), a claim that the board of directors breached its fiduciary duties by making an informed decision not to adopt a law compliance program should be reviewed under the business judgment rule.
