Caremark claims are a parasitic form of shareholder litigation. As the case usually develops, the corporation is caught by the government committing some sort of regulatory crime or accounting transgression. The corporation pays a fine to resolve the matter.
Some plaintiff's attorney then free rides on the government case, filing suit against the company's directors for failing to have adequate oversight and monitoring systems in place. The claim is that the company would not have committed the underlying violation if such programs had been in place.
A new Washington Legal Foundation research paper looks at the particular issues posed when Caremark claims are based on corporate violations of federal law. Here's the summary:
A developing phenomenon in corporate litigation, known as ”Caremark claims,” threatens corporate directors with state-law fiduciary duty to monitor lawsuits based upon the corporation’s actual, or merely alleged, violations of federal law. Arising out of a Delaware Chancery Court ruling in In re Caremark, courts have accepted that fiduciary claims may be brought against corporate directors if they failed to monitor or act in good faith to protect against corporate malfeasance. Over time, plaintiffs have brought fiduciary claims against corporate directors even when the corporations are not proven guilty of violations of federal regulations or statutes. Caremark claims demand scrutiny and in the vast majority of situations, judicial rebuke, for three reasons.
First, the conflation of state-law civil liability claims with federal criminal violations and accusations is inappropriate and subverts Congressional intent. The collision between state and federal law leads to questions of preemption. Even in situations where the motivation for the state corporate law duty of loyalty and for a federal law, such as the Foreign Corrupt Practices Act, are similar, courts have properly rejected derivative shareholder lawsuits.
Second, accurately measuring the harms which alleged wrongdoing caused to a business is difficult at best, and encourages plaintiffs’ lawyers to manipulate Caremark claims and invites dangerous judicial speculation. Further complicating the measurement of damages, corporations often gain a net monetary benefit as a result of actual violations of federal law.
Third, federalized Caremark claims based solely upon announcements of federal investigations or indictments undermine important protections for corporate directors. Delaware and other states adopt such laws to ensure that qualified professionals are willing to serve on corporate boards. The plaintiffs’ bar, for instance, could bring a state lawsuit based upon unsubstantiated allegations or the commencement of federal law investigations, and could file suit again upon the completion of a federal investigation if it leads to a settlement.
In order to prevent Caremark-style derivative lawsuits from becoming vehicles for abusive litigation and violations of legislative intent, courts must closely scrutinize such claims, particularly when no court has found the defendant’s corporation guilty of any violations of federal law.
I'm not convinced by the arguments that federal law-based Caremark claims are a unique problem. The over deterrence argument is true, but applies to any situation in which both a corporate entity and its directors face liability under different theories of law arising out of the same transaction. OTOH, their argument about the practical conflict between Caremark and the Federal Corrupt Pratices Act has some merit.
In any case, as I discuss in my article, Caremark and Enterprise Risk Management, Delaware courts are doing a pretty good job of limiting Caremark claims to the handful of truly meritorious settings.
