Caremark Revisited

POMERANTZ MONITOR | JANUARY FEBRUARY 2023

By The Editors

Given the large percentage of companies that are incorporated in Delaware, and the Chancery Court’s outsized role in interpreting corporate duties, the impact of the Delaware Chancery Court’s 1996 ruling in Caremark was felt far beyond that state’s borders. The ruling holds directors individually liable if they fail to supervise and monitor their company’s information and reporting systems.

The Caremark derivative suit, filed in 1994, claimed that the members of Caremark’s board of directors breached their fiduciary duty of care to Caremark in connection with alleged violations by Caremark employees of federal and state laws and regulations applicable to health care providers.

As a result of the alleged violations, Caremark was investigated for a period of four years by the United States Department of Health and Human Services and the Department of Justice (“DOJ”) and, in 1994, the company was charged with multiple felonies. Caremark subsequently entered into agreements with the DOJ and had to spend approximately $250 million to settle its federal lawsuits and repay third parties.

On the heels of the DOJ indictment, five stockholder derivative actions were filed in the Delaware Chancery Court that sought, on behalf of the company, to recoup these losses from the individual defendants who constituted Caremark’s board of directors. The separate suits were later consolidated. Defendants and plaintiffs agreed to settle the claims and the proposed settlement was submitted to the

• Delaware Court of Chancery for approval, which it received. It was in his ruling on the matter that then-Chancellor William T. Allen handed down two precepts that have largely defined the duty of care of corporate directors to this day: that “the core element of any corporate law duty of care inquiry [is] whether there was good faith effort to be informed and exercise judgment.”

• that “a director’s obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists, and that failure to do so under some circumstances may, in theory at least, render a director liable for losses caused by non-compliance with applicable legal standards.”

As Gustavo F. Bruckner, Pomerantz Partner and head of the Firm’s Corporate Governance practice, wrote in his Monitor article, “Director Oversight: Seeking the Holy Grail.”:

“A Caremark claim is possibly the most difficult type to pursue in corporate law, as most do not even survive the pleading stage. To survive a motion to dismiss, the complaint must plead specific facts demonstrating that the board totally abdicated its oversight responsibilities. Even the court in Caremark, a case which involved indictments for Medicaid and Medicare fraud, could not conclude that such a breach had occurred in that case.”