In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), is a Delaware Court of Chancery

Delaware Court of Chancery

The Delaware Court of Chancery is a court of equity in the American state of Delaware. It is one of Delaware's three constitutional courts, along with the Supreme Court and Superior Court.-Jurisdiction:...

 decision setting out an expanded discussion of a director's duty of care

Duty of care (business associations)

In United States corporation and business association law , a duty of care is part of the fiduciary duty owed to a corporation by its directors...

 in the oversight context. The opinion was written by Chancellor Allen.

Facts

The shareholders of Caremark International, Inc.

Caremark Rx

Caremark Pharmacy Services is the prescription benefit management subsidiary of CVS Caremark Corporation, headquartered in Woonsocket, Rhode Island and Nashville, Tennessee.-Company history:...

 brought a derivative action, alleging that directors breached their duty of care by failing to put in place adequate internal control systems. This in turn was said to enable the company’s employees to commit criminal offences, resulting in substantial fines and civil penalties.

Judgment

Chancellor Allen noted that most company decisions do not need director supervision. ‘Legally, the board itself will be required only to authorize the most significant corporate acts or transactions: mergers, changes in capital structure, fundamental changes in business, appointment and compensation of the CEO, etc.’

He pointed to Graham v. Allis-Chalmers Mfg. Co. 188 A.2d 125 (Del 1963), where the company violated antitrust law, without the directors knowing what the employees had done. But the court rejected that the directors ought to have known, because ‘absent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists.’ There were no grounds for suspicion here. He said this means that boards do no wrong ‘simply for assuming the integrity of employees and the honesty of their dealings.’

But, since Smith v. Van Gorkom

Smith v. Van Gorkom

Smith v. Van Gorkom 488 A.2d 858 is an important Delaware Supreme Court decision, primarily because of its discussion of a director's duty of care. It is often called the "Trans Union case".-Facts:...

, it was clear that ‘relevant and timely information is an essential predicate for satisfaction of the board’s supervisory and monitoring role under s 141 of the DGCL.’ Directors must be ‘assuring themselves that information and reporting systems exist in the organization that are reasonably designed to provide senior management and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to reach informed judgments concerning both the corporation’s compliance with law and its business performance.’ The level of detail for any such system is a business judgment matter. But failure to have some reasonable system may ‘render a director liable for losses caused by non-compliance with applicable legal standards.’
"A director's obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists, and that failure to do so under some circumstances may, in theory at least, render a director liable for losses."

Significance

The court went on to define a multi-factor test designed to determine when this duty of care is breached. To show that directors breached their duty of care:

• The directors knew or should have known that violations of the law were occurring, and
• The directors took no steps in a good faith effort to prevent or remedy the situation, and
• Such failure proximately resulted in the losses complained of (though this last element may be thought to constitute an affirmative defense).

Caremark is most widely known and cited for this expanded vision of the duty of oversight.