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Introduction to the Law of Corporations: Cases and Materials

Oversight Claims

Of the categories of good faith claims identified by the Delaware Supreme Court in Disney, oversight claims have received the most attention in recent years, especially in the wake of the global financial crisis of 2008. In Caremark, plaintiff stockholders argued that the board violated its duty of good faith by failing in its obligation to provide reasonable oversight of the corporation's activities, leading to avoidable losses. In approving a settlement of the litigation, the Chancery Court in Caremark formulated the following standard for assessing the liability of directors where the directors are unaware of employee misconduct that results in the corporation being held liable (i.e. oversight claims):

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.       
- In re Caremark Inter'l S'holder Litigation, 698 A.2d 959 (1996).

Caremark articulates two categories of potentially successful oversight claims: first, where the directors utterly failed to implement any reporting or information system or controls thus blinding themselves to knowledge about the corporation's activities; or second, having implemented a system or controls, where the board consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.

Although Caremark  oversight claims are extremely difficult to prevail, a recent line of cases suggests courts are open to entertaining arguments at least for purposes of demand futility under Zuckerberg (Rales) where the board of a corporation in a highly regulated industry fails to actively engage with business critical regulatory authorities.