Don’t look now, but the Delaware Chancery Court just upheld another Caremark claim in the face of a motion to dismiss. In his 50-page opinion in In re Clovis Oncology Derivative Litigation, (Del. Ch.; 10/19), Vice Chancellor Slights held that the plaintiffs had adequately pled that the board breached its fiduciary duties by failing to oversee a clinical trial for the company’s experimental lung cancer drug and then allowing the company to mislead the market regarding the drug’s efficacy.

In declining to dismiss the case, the Vice Chancellor observed that Delaware courts are more likely to find liability under Caremark for oversight failures involving compliance obligations under regulatory mandates than for those involving oversight of ordinary business risks:

Caremark rests on the presumption that corporate fiduciaries are afforded “great discretion to design context- and industry-specific approaches tailored to their companies’ businesses and resources.” Indeed, “[b]usiness decision-makers must operate in the real world, with imperfect information, limited resources, and uncertain future. To impose liability on directors for making a ‘wrong’ business decision would cripple their ability to earn returns for investors by taking business risks.”

But, as fiduciaries, corporate managers must be informed of, and oversee compliance with, the regulatory environments in which their businesses operate. In this regard, as relates to Caremark liability, it is appropriate to distinguish the board’s oversight of the company’s management of business risk that is inherent in its business plan from the board’s oversight of the company’s compliance with positive law—including regulatory mandates.

As this Court recently noted, “[t]he legal academy has observed that Delaware courts are more inclined to find Caremark oversight liability at the board level when the company operates in the midst of obligations imposed upon it by positive law yet fails to implement compliance systems, or fails to monitor existing compliance systems, such that a violation of law, and resulting liability, occurs.”

VC Slights cited the Delaware Supreme Court’s recent decision in Marchand v. Barnhill, and noted that that case “underscores the importance of the board’s oversight function when the company is operating in the midst of ‘mission critical’ regulatory compliance risk.”

Caremark requires a plaintiff to establish that the board either “completely fail[ed] to implement any reporting or information system or controls” or failed to adequately monitor that system by ignoring “red flags” of non-compliance.  While the board’s governance committee was responsible for overseeing compliance with regulatory requirements applicable to the clinical trial, the Vice Chancellor held that the plaintiff adequately pled that it knowingly ignored red flags indicating that the company was not complying with those requirements.  Accordingly, he declined to dismiss the case.

Ann Lipton has some interesting perspectives on VC Slights’ distinction between business & legal compliance risks over on her Twitter feed. Check it out.

Caremark still may be, as former Chancellor Allen put it, “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” But after decades of routinely dismissing Caremark claims at the pleading stage, this marks the second time this year that the Delaware courts have declined to do so – and it’s the third case in the last two years in which they’ve characterized a Caremark claim as “viable.”

Is Caremark becoming a more viable theory of liability, or is board’s conduct in these cases just more egregious than in prior cases? It’s hard to say based on the limited evidence we have. For now, maybe the ’60s band Buffalo Springfield put it best  – “There’s something happening here. What it is ain’t exactly clear. . .”

– John Jenkins

Financial buyers used to insist on financing conditions in their acquisition agreements.  They learned long ago that a financing condition usually ramped up their offer’s uncertainty beyond what public company boards were willing to stomach.  In order to remain competitive with strategic buyers, they abandoned the financing condition and opted to instead offer up a reverse termination fee that would come into play if they couldn’t finance the deal.  But the terms of those deals made it clear that, as far as the seller was concerned, that reverse termination fee was all they were going to get.

While that combination of reverse termination fee and exclusive remedy provisions has become almost universal for deals involving private equity buyers, that’s not the case when it comes to strategic  sellers.  As this Cooley blog points out, not only do they rarely get maximum liability caps, but their ability to assert that the termination fee is an exclusive remedy is usually contingent on their compliance with other deal terms.

In the wake of the Delaware Chancery Court’s recent decision in Genuine Parts v. Essendant, the blog suggests that strategic parties would be wise to push for the kind of “clean break” that private equity buyers have been able to negotiate.  Here’s an excerpt:

The Genuine Parts decision highlights why strategic parties would be wise to take a page out of the financial buyer’s exclusive remedies playbook. For a board of directors of the target company, the certainty of a clean break from a prior transaction is crucial and can raise questions that could factor into a board’s decision-making when evaluating competing bids.

Should the board discount the financial terms of a competing bid for the risk attendant to possible litigation above and beyond the payment of the termination fee? Will potential competing bidders be more reluctant to make competing offers if the potential cost is greater than the termination fee? Worst of all from the intervening buyer’s (and target company’s) perspective, when the payment and acceptance of the termination fee does not act as a bar to further claims, the intervening buyer essentially funds the aggrieved first buyer’s litigation case (which was never the intent of the termination fee).

The blog doesn’t suggest that a target’s failure to comply with a non-solicitation covenant should just be shrugged off – but it says that the better approach would be to require the jilted buyer to elect its remedies & either accept the termination fee or take its chances in court.

In situations where the buyer may not know whether the seller breached its obligations at the time it needs to make this decision, the blog says the appropriate alternative may be to sue the buyer for tortious interference. As I blogged over on “John Tales” a while back, there’s some very interesting case law on tortious interference with an acquisition agreement.

– John Jenkins