Elon Musk and his supporters offer several explanations for his contrarian views, unfiltered speech and provocative antics. They’re an expression of his creativity. Or the result of his mental-health challenges. Or fallout from his stress, or sleep deprivation.
In recent years, some executives and board members at his companies and others close to the billionaire have developed a persistent concern that there is another component driving his behavior: his use of drugs.
Those executives and directors allegedly worry about the potential consequences for "the six companies and billions in assets he oversees."
Corporate lawyers in the audience will immediately spot the potential Caremark issue this report raises. As recently and ably summarized by VC Will, allegations that directors failed to exercise appropriate oversight of subordinates "arise from the duty of good faith, which is a subsidiary element of the duty of loyalty."
To plead a viable claim for breach of the duty of oversight, a plaintiff must allege sufficient facts to support a reasonable inference that the fiduciary acted in bad faith. Under Caremark, bad faith can be established when fiduciaries (1) “utterly fail to implement any reporting or information system or controls,” or (2) “having implemented such a system or controls, consciously fail to monitor or oversee its operations,” which disables them “from being informed of risks or problems requiring their attention.”
If the WSJ report is correct, it would seem that neither prong of the Caremark theory would be satisfied on these facts. To be sure, the WSJ reports that although "Tesla board members over the years have talked among themselves about their concerns over Musk’s alleged drug use" they "haven’t said anything formally that would end up as an official board agenda item or in meeting minutes." On the other hand, however, it sounds as though the board and executives are informed of the problem. Does Caremark require more? Does it require a formal system set of internal controls that would simply inform them of what the already know?
In other words, what liability exposure does the board have when it is aware of a problem and decides to do nothing? I think the answer should be that the board would not be held liable. Granted, a board can be held liable for acting in bad faith not only for acting with “'subjective bad faith,' that is, fiduciary conduct motivated by an actual intent to do harm" to the corporation, In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 64 (Del. 2006), "but also intentional dereliction of duty." Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 240 (Del. 2009).
At least on these facts, however, I doubt whether a board decision to do nothing would rise to the level of "intentional dereliction of duty." First, as VC will explained, The Caremark doctrine is not a tool to hold fiduciaries liable for everyday business problems. Rather, it is intended to address the extraordinary case where fiduciaries’ “utter failure” to implement an effective compliance system or “conscious disregard” of the law gives rise to a corporate trauma. ... Officers’ management of day-to-day matters does not make them guarantors of negative outcomes from imperfect business decisions." Hence, even if the board's decision not to act was "imperfect" that board cannot be held liable as "guarantors of negative outcomes."
Second, as I discussed at considerable length in my post My Pillow, Inc. and the perennial question of whether Caremark claims should lie when boards fail to monitor the CEO's personal life, the Delaware courts have held in several cases that "“directors of Delaware corporations generally have no duty to monitor the personal affairs of other directors and officers." Granted, saying there is no duty to monitor such affairs is not the same as saying that there is no duty to intervene when such affairs are brought to the board's attention, but it tends to support the proposition that the board has little liability exposure in this area.
Finally, and related to the first point, "The business judgment rule may apply to a deliberate decision not to act, but it has no bearing on a claim that directors' inaction was the result of ignorance." Rabkin v. Philip A. Hunt Chem. Corp., 547 A.2d 963, 972 (Del. Ch. 1986). This case would seem to fall into the former category rather than the latter.
