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Chancery Addresses Pleading Standards for Caremark Claims

Posted In Caremark, Chancery

In re LendingClub Corp., Consol. C.A. No. 12984-VCM (Del. Ch. Oct. 31, 2019).

Delaware law sets a high bar to sufficiently plead a Caremark claim for failure of board oversight, especially when the plaintiff must satisfy the heightened pleading requirements for establishing demand futility under Court of Chancery Rule 23.1.  To overcome those hurdles, a plaintiff must plead with particularity that the board of directors either (i) utterly failed to implement any reporting or information systems or controls to address the risk that ultimately manifested, or (ii) having implemented such safeguards, consciously failed to oversee their operation and thereby disabled themselves from being informed of the risk that ultimately manifested.  For either Caremark prong, the plaintiff must sufficiently plead bad faith, essentially that the directors knew they were not discharging their fiduciary duties.

The Delaware Supreme Court’s recent decision in Marchand v. Barnhill, 212 A.3d 805 (Del. 2019), illustrates the type of allegations required for a Caremark theory to survive dismissal, there involving particularized allegations of a complete absence of any board-level oversight system for monitoring certain mission critical issues.  This decision by the Court of Chancery illustrates the type of allegations that will not pass muster, contrasting them with the allegations of Marchand

In re LendingClub arose out of a situation where the board of a peer-to-peer lending company (LendingClub) discovered, investigated, self-reported, and remediated several types of wrongdoing within the company.  The plaintiffs’ theories of liability for the different instances of wrongdoing alternated between Caremark’s two prongs (lack of safeguards and failure to oversee).  But in each instance the Court found that the complaint lacked particularized allegations to support an inference of bad faith, such as the board consciously ignoring red flags suggesting misconduct.  Important to the Court’s decision were the conceded systems of monitoring and oversight within the company, including various committees, such as Risk, Audit, and Investment Policy Committees.  In light of the foregoing, the Court concluded that the plaintiffs failed to allege sufficient particularized facts in support of their Caremark claims to establish a substantial likelihood of director liability and thus demand futility.  The decision also addresses the relevance of separate securities laws claims to the assessment of demand futility, distinguishing between claims requiring scienter and those involving strict liability.

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