January 09, 2007
More on Caremark
Posted by Gordon Smith

Last week I wrote a post entitled "Good Faith, Care, and Loyalty in Delaware" in anticipation of the Disney panel at AALS. In that post, I tried to explain how the Delaware Supreme Court came to embrace Caremark as the standard by which the duty of good faith would be measured. Just prior to the panel, I discovered a new Caremark decision by Vice-Chancellor Strine. Decided on December 21, 2006,  ATR-Kim Eng Financial Corp. v. Araneta may be an important marker of future developments.

The case involved a claim by minority shareholders (ATR) that a majority shareholder (Carlos Araneta) had " caused the corporation to transfer its key assets -- its ownership of several businesses worth over $35 million ... -- to members of his family in violation of his fiduciary duties." That's a straightforward duty of loyalty claim. The more interesting part of the case was the claim against the other two directors (Bonilla and Berenguer) for failing to stop Araneta. Vice-Chancellor Strine refers to those two directors as Araneta's "stooges," a conclusion that is supported by the following facts:

[B]oth Berenguer and Bonilla testified that they entirely deferred to Araneta in matters relating to the [corporation]. Berenguer is, as mentioned, Araneta's niece and served as the CFO for the [subsidiary companies] worldwide. She testified that she would not insert herself into a disagreement between ATR and Araneta about how the [corporation] should proceed on an issue because such a disagreement would be between those parties and would not affect her as a director of the [corporation]. Similarly, she stated that she would take Araneta's word as authoritative if he claimed that he had agreed with ATR to take certain actions.

Bonilla, the head of Araneta's U.S. operations, was more explicit--explaining that to him Araneta and the [corporation] were basically one and the same and that he took the word of Araneta as being the word of the company. Moreover, when pressed regarding whether he would undertake an independent inquiry if told to act by Araneta, Bonilla responded, "Why should I ask him all these questions? He's telling me they have already agreed .... It's not like I'm going to go out there and check on him, doesn't make sense."

This looks like model Caremark claim (failure of oversight). Vice-Chancellor Strine, citing his own opinion in Guttman (which I discuss in my prior post), describes a director's duty of oversight as follows:

Under Delaware law, it is fundamental that a director cannot act loyally towards the corporation unless she tries--i.e., makes a genuine, good faith effort--to do her job as a director. One cannot accept the important role of director in a Delaware corporation and thereafter consciously avoid any attempt to carry out one's duties.

Notice that a director must "consciously avoid any attempt to carry out one's duties." Such a director is so hard to find, at least after a trial, that (if I am not mistaken) this is the first successful Caremark claim ever in Delaware. (Even the plaintiffs in Caremark were not successful on their Caremark claim.)

At the Disney panel, I described this as an intentionality requirement that was designed to distance the duty of good faith from the duty of care. Hilary Sale observed that the standard could include "recklessness," though I am not sure what that adds to the Court's other descriptions of bad faith. Recklessness is simply a way of shading the intentionality requirement, and my main point is that the Delaware courts are eager to confine fiduciary liability to extreme cases.

Notice the language used by Vice-Chancellor Strine later in ATE: "Their behavior was not the product of a lapse in attention or judgment; it was the product of a willingness to serve the needs of their employer, Araneta, even when that meant intentionally abandoning [their] important obligations...." (emphasis added) This case was a first, and I think we will not have many more like it.

By the way, Vice-Chancellor Strine found all three directors jointly and severally liable for damages, but he clearly felt that Araneta's breach of loyalty was more reprehensible than the loyalty breaches of the other directors ("to the extent it is later important, if Bonilla and Berenguer pay any or all of the judgment, Araneta should be required to make them whole, to the extent that is consistent with applicable law"). This tends to reinforce my understanding that the "good faithy version of loyalty" created by the Delaware Supreme Court in Stone v. Ritter is really just a second-class version of loyalty. Indeed, the only reason to call it "loyalty" is to send a message to plaintiffs and legal academics that the duty of good faith is not an extension of the duty of care.

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