Delaware Corporate Law Update

Updates on Delaware Corporate Law by Evan O. Williford, Esq., Delaware Corporate Litigation Attorney.

Chancery Court Dismisses Caremark Claim

In Melbourne Municipal Firefighters’ Pension Trust Fund v. Jacobs (opinion available here), Vice Chancellor Montgomery-Reeves dismissed a fiduciary duty claim for failure of oversight (a so-called “Caremark claim”).  Caremark claims are well-known for being difficult to succeed on, and Melbourne further defines the limited circumstances where one is colorable.

Qualcomm, Inc. has paid more than one billion dollars for antitrust violations, including:  1) a $891M settlement for a 2005 claim by competitor Broadcom; 2) a $208M fine in 2009 by South Korea; 3) a 2010 claim by Japan still pending; and 4) a $975M fine in 2015 by China.  While these cases involved different allegations of wrongdoing, many involved Qualcomm’s market dominance in certain products used in wireless communications coupled with the same alleged failure to license its products on fair, reasonable and non-discriminatory (“FRAND”) terms.  Plaintiff alleged the first three cases were red flags that should have prompted Qualcomm’s board of directors to prevent the fourth.

Plaintiff filed its complaint after succeeding via a books-and-records case at getting some 14,000 pages of documents including board materials.  Plaintiff’s complaint pointed to board materials showing that Qualcomm’s board knew it expected to continue to face regulatory complaints and investigations in the future.   Rather than modifying its policies or prices to reduce or eliminate risk, however, Qualcomm’s board’s strategy on this issue was to educate “industry participants and government officials as to why its practices were legal” and to “pursu[e] appeals.”  Under Delaware law, “a fiduciary may not choose to manage an entity in an illegal fashion, even if the fiduciary believes that the illegal activity will result in profits for the entity.”

The Court held that plaintiffs did not state a claim.  In doing so it compared plaintiff’s claims to two cases in which Caremark claims survived.

In Massey Energy Co., a coal mining company had failed to change safety practices that later lead to the company pleading guilty to criminal charges including one count for violating safety standards resulting in death and a $4.5M fine.  The Court noted that in Massey the company’s CEO “publicly stated that the idea that governmental safety regulators knew more about mine safety than he did was silly.”  The Court distinguished Massey on the grounds that the red flags alleged there were far more egregious and indisputable; and that in that case the company had challenged the law itself, whereas in this case Qualcomm had not contested the antitrust laws themselves but taken the position that its conduct did not violate them.

In Pyott, the Board and CEO of a drug company knowingly approved a business plan that violated a ban on marketing drugs for off-label use.  It did so despite general counsel’s advice that the company “likely had engaged in such illegal conduct”.  Pyott criticized the Board’s view of the distinction between off-label selling and marketing “as a source of legal risk to be managed, rather than a boundary to be avoided.”  The Court emphasized that Pyott was based on the board’s alleged decision to cause the company to engage in illegal conduct, whereas here the allegation was that Qualcomm’s board did not put a halt to it.  Moreover, again, Qualcomm’s board had taken the position that its conduct did not violate the relevant rules.

Caremark claims are difficult in part because they strain against the boundaries of a basic principle of Delaware law, the business judgment rule.  As the Court observed in a quotation taken from another case, “In any business decision that turns out poorly there will likely be signs that one could point to and argue are evidence that the decision was wrong. . . . This temptation, however, is one of the reasons for the presumption against an objective review of business decisions by judges, a presumption that is no less applicable when the losses to the Company are large.”

Melbourne reinforces the view that Caremark claims are difficult to prevail on and that even decisions on whether one is colorable may well be fact-specific.  Other lessons of Melbourne are as follows:

  • Board or management statements of their well-informed belief that the activities in question are legal are helpful in defending such a claim.
  • On the other hand, statements that express or imply knowledge that such activities are illegal or show disrespect for regulatory authorities are unhelpful.
  • Legal rules protecting employee or customer well-being or safety, or those that involve or result in criminal prosecution, may be more dangerous to transgress than economic rules such as antitrust.
  • Creating a policy is more vulnerable than failing to discontinue an already-created one.
  • Board documents reaffirming the legality of a particular policy, and addressing and creating a strategy for continuing to support it, may support a later defense of failure to eliminate the policy. That being said, plaintiffs may also point to such documents as proof of red flags.
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Filed under: Caremark, Court of Chancery

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Disclaimer

Delaware Corporate Law Update solely reflect the views of Evan Williford of The Williford Firm, LLP. Its purpose is to provide general information concerning Delaware law; no representation is made about the accuracy of any information contained herein, and it may or may not be updated to reflect subsequent relevant events. This website is not intended to provide legal advice. It does not form any attorney-client relationship and it is not a substitute for one.