This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.
The business judgment rule cannot shield Clovis Oncology Inc.’s directors from shareholder charges that they breached their oversight duty by ignoring reports that their flagship cancer-fighting drug was unlikely to pass regulatory tests, the Delaware Chancery Court has ruled in the matter styled: In re Clovis Oncology Inc. Derivative Litigation, No. 2017-0222-JRS, memorandum opinion (Del. Ch. October 1, 2019).
Vice Chancellor Joseph R. Slights’ Oct. 1 opinion allows the biopharmaceutical startup’s investors to proceed with derivative claims that Clovis lost $1 billion in value after the market learned that its directors failed to comply with regulatory protocol for Rociletinib.
He said duty-of-oversight charges have been among the hardest to prove, but the Clovis plaintiffs well-pled that their directors did not respond to red flags at a time when the company’s fate. depended largely on the outcome of a single lung cancer therapy trial.
A duty-of-care duo
The Clovis opinion, and the Delaware Supreme Court’s June decision in Marchland v. Barnhill, 212 A.3d 805 (Del. 2019), are being closely examined by corporate law specialists because together they provide a new avenue to sue for violating the duty of oversight.
In June, the Delaware Justices reversed a Chancery Court dismissal of a consolidated shareholder suit that charged the Blue Bell Creameries directors’ failure to oversee ice cream safety resulted in a deadly and costly listeria outbreak in 2015. The opinion, written by Chief Justice Leo E. Strine Jr., found the Blue Bell board “made no effort to put in place a board-level compliance system.”
That, he said, was a violation of the first part of the oversight duty spelled out in the seminal 1996 Caremark decision which said directors must set up and monitor systems to ensure that they get adequate information on whether the company is being operated properly. In re Caremark Int’l. Inc. Deriv. Litig. 698 A. 2d 959 (Del Ch. 1996).
Caremark duty, part two
Vice Chancellor Slights’ Clovis opinion was based on Marchand decision and focused on the second part of the Caremark duty: to properly monitor the systems the directors set up,
The plaintiffs claimed the Clovis directors in fact paid very little attention to the plan and protocol they set up for the clinical trial of Roci, an initially promising lung cancer treatment. In later stages though, there were ample indications that Roci would not get the U.S. Food & Drug Administration’s approval for market, Vice Chancellor Slights said.
The consolidated suit charged Clovis executives entered ineligible information in the clinical trial’s records that “allowed the company to mislead the market regarding the drug’s efficacy.”
The plaintiffs said when Clovis was later forced to enter the correct information, it was clear that Roci would not be approved, but some directors and a senior executive sold stock before the market learned the bad news.
In response to the defendants’ motion to dismiss, the vice chancellor said the duty to implement a proper oversight system and then monitor it is important, “especially so when a monoline company operates in a highly regulated industry.”
He noted that at the beginning of the clinical trial Clovis had no other drugs on the market, received no sales revenue and was entirely dependent on investor capital.
Business risk vs. oversight risk
Directors must have great latitude in making decisions on business risk, but “it is appropriate to distinguish the board’s oversight of the company’s management of business risk” from the board’s oversight of compliance with regulatory mandates, the judge said.
In refusing to dismiss the breach-of-duty charge he said he was satisfied that plaintiffs have properly pled that the directors “consciously ignored red flags that revealed a mission critical failure to comply” with the protocol and FDA regulations.
However, Vice Chancellor Slights dismissed an insider selling charge for lack of proof of scienter, finding that it is not enough that the sale took place near the time that the insider acquired non-public information.
This is especially true where the size of the trade is not abnormally large and does not represent a dramatic change in trading pattern, he said.
Based on the same findings, the Court also dismissed a charge that some defendants improperly enriched themselves from the insider selling.
Vice Chancellor Slights’ detailed recitation of what he found to be the Clovis directors’ failures to monitor and disclose Roci’s true test history could serve as a cautionary tale for a new, stricter Caremark era.
Or, turned around, it could provide proactive directors and their counsel with a to-do list for revising board-level control and disclosure.