Delaware Court Of Chancery Dismisses Caremark Claims Against Directors After Company Publicly Disclosed Misconduct
On October 31, 2019, Vice Chancellor Kathaleen S. McCormick of the Delaware Court of Chancery dismissed a stockholder derivative suit against the directors of LendingClub Corporation for failure to plead demand futility. In re LendingClub Derivative Litigation, C.A. No. 12984-VCM (Del. Ch. Oct. 31, 2019). Plaintiffs asserted breach of fiduciary duty claims against the directors after the company disclosed that it had self-reported certain alleged misconduct by the CEO and others to the SEC, as well as the problems that prompted the company’s internal investigation, the results of that investigation, and the company’s remediation efforts. Plaintiffs alleged that the board did not adequately implement a system of controls or monitor company operations and “thus disabled itself from being informed of problems requiring its attention.” Determining that the complaint did not allege facts demonstrating bad faith—as is necessary to prevail on a Caremark claim for violation of oversight duties—and, therefore, that a majority of the directors did not face a substantial risk of liability, the Court concluded that pre-suit demand was not excused.
Specifically, plaintiffs alleged that the directors “failed to take steps to maintain adequate internal controls necessary to prevent against the issuance of false and misleading statements” about adherence to certain policies, which were violated by management. But the Court explained that the complaint itself indicated that the board’s Audit Committee “both (1) existed, and (2) met monthly” and highlighted that the complaint “offers no facts concerning [the company’s] internal controls—or lack thereof” that could lead to an inference that the board had “utterly fail[ed] to implement them.” Likewise, the Court explained that the complaint did not plead facts demonstrating that the directors “consciously ignored red flags.” Therefore, the Court concluded that the claims did not support a finding that the directors faced a substantial likelihood of liability.
Separately, the Court also found that a parallel putative securities class action in which shareholders were asserting claims against the directors for alleged violations of Section 11 of the Securities Act of 1933 did not render demand excused. Plaintiffs argued that the directors faced a substantial likelihood of liability “for violations of federal securities laws arising from the same factual nexus as [plaintiffs’] derivative claims.” Indeed, by the time the motion to dismiss was considered in the derivative action, a motion to dismiss had already been denied in the securities case. But the Court explained that the claims against the directors in the derivative case were “exceptionally weak” because plaintiffs were required to plead and prove bad faith, whereas no showing of scienter was necessary to establish liability in connection with the claims asserted against them in the securities class action.
Finally, the Court concluded that allegations that certain directors lacked independence from the CEO and one another were similarly insufficient to excuse demand. For example, the Court observed that allegations of a “thirteen-year working relationship” based on employment at the same company were unavailing where the complaint provided “no facts indicating whether [the two] worked in the same office, held positions that required them to work together, or otherwise knew each other.”