Updates to the Caremark Standard

Rachel Kemel
Senior Editor
Loyola University Chicago School of Law, JD 2020

In re Caremark International Inc. Derivative Litigation was a landmark Delaware case that changed the way what is expected out of a board of directors, and how they are in turn able to run a corporation. In 2019, Delaware courts brought Caremark to meet modern day duty of care standards in the cases of In re Clovis Oncology, Inc. Derivative Litigation and Marchand v. Barnhill.

What happened in Caremark?

Caremark International Inc.’s (“Caremark”) shareholders brought suit against the corporation’s board of directors. The shareholders argued that the directors had breached their duty of care in their failure to institute adequate internal controls after it had been revealed that many high ranking employees had engaged in criminal offenses.

In 1996, the Delaware Court of Chancery held that the board of directors of a corporation have a duty to make good-faith efforts to ensure that adequate internal corporate information and reporting system exist. This was in determining when this duty of care is breached through the establishment of a multi-factor test. Caremark does not require a board of directors to go above and beyond, but to make a good faith effort to ensure that they are able to gather information on the company.

Since Caremark, corporate directors have tried to be careful to institute proper safeguards to ensure they receive accurate and timely information about the inner workings of the company.

What happened in Marchand?

The shareholders of Blue Bell Creameries USA Inc. (“Blue Bell”) filed suit against Blue Bell’s board of directors after a there was an outbreak of listeria from Blue Bell’s ice cream. The product caused customers to become sick and led to a total product recall.

In June 2019, the Delaware Supreme Court held that the Blue Bell board of directors failed to implement any oversight for monitoring the company’s food safety performance or compliance. The court held that because Blue Bell was in a specialized field, it had discretion to institute appropriate oversight measures. But despite lower-level management knowledge, the issue never made its way to the board of directors. The court held that the board had breached their duty of care, and their failure to make that effort also constituted a breach of their duty of loyalty.

What happened in Clovis?

Clovis Oncology, Inc. (“Clovis”) is a biopharmaceutical firm which specializes in cancer treatments and had been developing a promising treatment for lung cancer. Despite hopeful initial trials, later trials found that the treatment had adverse effects and Clovis ended up withdrawing its FDA application due to these findings. But this withdrawal led to a dramatic drop in Clovis’ stock prices. The shareholders argued that the board of directors had a “duty to monitor” or a duty of oversight – which in this case they had failed to do based on their failure to meet FDA clinical trial standards.

In October 2019, the Delaware Court of Chancery refused to dismiss a suit against the Clovis board of directors. The Clovis court applied Marchand and held that there was such a duty, and that the shareholders had provided adequate facts that the Clovis board had breached this duty to monitor.

How have the cases changed Caremark?

Clovis and Marchand together seem to indicate that corporations may face more shareholder suits due to a new belief that they are no longer reaching appropriate duty of care standards. In Marchand, the Delaware court found that specialized industries have a higher standard to reach in order to comply with the Caremark standard.

Prior to these two cases, Caremark claims were unlikely to prevail if plaintiff argued that there was a failure due to a breach of duty of oversight. Courts had previously found this duty to be insufficient to go to trial unless there was a systematic failure by the board, but now board of directors have to be diligent in ensuring their corporation are adhering to statutes and industry standards.

What does this mean for corporations going forward?

Originally, Caremark required a corporation’s board of directors to make a good faith effort to institute appropriate safeguards, so they understand the inner workings of the company. Now, corporations have to ensure that their protections are not only properly set up, but that they must meet industry-similar standards. Directors now have to fulfill a duty of oversight, which is a more difficult duty to meet than simply a duty of care. Overall, it appears the Delaware courts are becoming more likely to find Caremark breaches and institute penalties on corporate directors.