“Delaware law requires diligence not heroism”, is the most memorable quote from the Chancery Court case that I summarize here, in connection with claims against the board, in a decision entitled David B. Shaev Profit Sharing Account v. Armstrong, download file. The court dismissed claims based, in essence, on Caremark, or lack of sufficient oversight by the board. The facts at issue in this case were first sued upon two years ago in the case captioned In Re:Citigroup, Inc. Shareholders Litigation, 2003 Del. Ch. LEXIS 61 (Del. Ch., June 5, 2003); aff’d sub nom. Rabinowitz v. Supero, 839 A.2d 666 (Del. 2003) (TABLE). In that case, the plaintiffs claimed, among other things, that certain directors of Citigroup either knew or should have known about allegedly fraudulent relationships between Citigroup and its clients, Enron and WorldCom, and therefore, breached their fiduciary duties in either approving or recklessly failing to discover those links. The court dismissed those claims as presenting “wholly conclusory” allegations devoid of particularized facts needed to show that the company’s Board of Directors was disqualified from considering a demand under Chancery Court Rule 23.1. The court dismissed the action and observed that the plaintiffs failed to use the “tools at hand” including a Section 220 books and records demand, before filing suit.
In dismissing this “second” case, the also court found that this complaint did little more than the prior complaint and there was “literally nothing” to suggest that the defendants willfully or recklessly ignored information that would have led to the discovery of the misconduct at issue. The court found that the directors had erected a full panoply of audit systems designed to detect misconduct but that for some reason the system failed to work. The court reasoned that when “a board rationally makes a decision, its actions are protected by the business judgment rule.”
When a board fails to act, under Delaware law, the claims will survive a Motion to Dismiss based on Rule 23.1 only if the plaintiff presents well pleaded facts to suggest a reasonable inference that a majority of the directors consciously disregarded their duties over an extended period of time.
The court also noted that where, as here, a dereliction of duty or Caremark claim is made, the court uses a variation of the Aronson v. Lewis test based on the Rales case to determine demand futility under Rule 23.1. In Rales, the two prong Aronson test is folded into one broader examination. It allows a court to determine both whether a corporate board on which demand might be made is disinterested and independent, and whether a majority of directors faces substantial likelihood of personal liability, because doubt has been created as to whether their actions were products of a legitimate business judgment.
The court provided some instruction to plaintiffs’ lawyers on this point as follows: One option for a plaintiff in such a situation is to plead that the directors on which demand would be made are not disinterested or independent. Alternatively, a plaintiff can allege that a board violated its fiduciary duty by utterly failing to exercise oversight of the corporation, such as failing to assure the existence of reasonable information and reporting systems. The latter allegation might take the form of facts that show that the company entirely lacked an audit committee or other important supervisory structures. See Guttman v. Huang, 823 A.2d 492, 507 (Del. Ch. 2003). Without a formally constituted audit committee or one that failed to meet, a plaintiff might also plead that the directors “ignored red flags” indicating misconduct in defiance of their duties.
However a Caremark claim will fail if it is a mere “bald allegation that directors bear liability or a concededly well constituted oversight mechanism, having received no specific indications of misconduct, failed to discovery fraud.”
The court concluded by reasoning that “Delaware law requires only diligence, not heroism.” Boards are expected to erect mechanisms designed to bring misconduct to their attention, and to investigate in good faith when warnings appear. Because the complaint alleges no failing on the part of Citigroup or the Citigroup Board as to these obligations, the defendants’ motions to dismiss must necessarily be granted for failure to make proper demand.