On November 6, 2006, the Supreme Court of Delaware expressly adopted a director liability standard in corporate oversight matters to be applied under Delaware law.1 The decision benefits corporate directors, and imposes a heavy burden on potential plaintiffs seeking to impose personal liability on directors for failing to exercise proper oversight.
The Stone matter was a derivative complaint that was originally brought against fifteen present and former directors of AmSouth Bancorporation. The complaint arose out of payments by AmSouth and certain affiliates of $50 million in fines to resolve government investigations pertaining to the failure of its employees to file “suspicious activities reports” as required by federal law. The Plaintiffs acknowledged that there were no “red flags” before the directors, but nonetheless alleged that the named directors breached their fiduciary duty to the company by “failing to implement any sort of statutorily required monitoring, reporting or information controls that would have enabled them to learn of problems requiring their attention.” AmSouth had, in fact, established an information and reporting system that permitted its directors to periodically monitor AmSouth’s legal compliance.
The Court ultimately dismissed the derivative complaint, applying the Delaware standard that had been previously adopted by the Court of Chancery in In re Caremark International Derivative Litigation.2 In reaching its decision, the Court affirmed the Caremark standard:
Generally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation, . . . only a sustained or systematic failure of the board to exercise oversight – such as an utter failure to attempt to assure a reasonable information and reporting system exists – will establish the lack of good faith that is a necessary condition to liability.
Based on this standard, the Court held that the directors were not guilty of a “sustained and systematic failure to exercise oversight.” Rather, based on a report incorporated into the complaint, the Court held that the AmSouth board had exercised sufficient oversight by “receiving and approving relevant policies and procedures, delegating responsibility to certain employees and departments, and exercising oversight by relying on periodic reports from them.” The Court further noted that despite reasonable efforts, it is inevitable that good faith oversight will not always prevent employees from violating criminal laws, or from causing the corporation to incur significant financial liability. Even in such situations, however, only conduct that drops below the Delaware standard will actually impose personal liability.
For directors, the Stone case provides a measure of comfort that under Delaware law, it is not the director’s responsibility to prevent or “ferret out wrongdoing by corporate employees.” Rather, as long as directors ensure that a company has implemented a system for reporting critical issues to the board, the directors will not be liable if corporate employees fail to bring issues to the board’s attention.
1 Stone v. Ritter
2006), 911 A.2d 362. 2 In re Caremark International Derivative Litigation
(Del. Ch. 1996), 698 A.2d 959.