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Chancery Upholds Caremark Claim Based on Alleged Failure to Adequately Monitor Biopharmaceutical Company’s Clinical Trials

In Re Clovis Oncology, Inc. Derivative Litigation, C.A. No. 2017-0222-JRS (Del. Ch. Oct. 1, 2019).

The Delaware courts have observed that a Caremark claim for failure of oversight against a board is among the most difficult to sustain.  Nonetheless, a set of particularized allegations showing serious oversight shortcomings regarding a mission-critical topic will succeed, as illustrated by the Delaware Supreme Court’s recent decision in Marchand v. Barnhill, 212 A. 3d 805 (Del. 2019).  Clovis is the latest example.

Clovis involved a biopharmaceutical company with one particularly promising drug among its products that it was trying to bring to market.  Conflicting reports of the drug’s efficacy during clinical trials led to FDA inquiry, to disclosure of a reduced efficacy, and to withdrawal of the new drug application, causing the company’s stock price to plummet.  A stockholder sued the company’s board of directors alleging, among other claims, a Caremark claim for failure of oversight.  According to the plaintiff’s allegations, while the clinical trials were subject to strict protocols and FDA regulations, the board ignored red flags that the company was not adhering to those protocols and regulations and was permitting the company to deceive regulators and the market regarding a drug’s efficacy.  The defendants moved to dismiss for failure to state a claim and for failure to make pre-suit demand.

The Court of Chancery denied defendants’ motion to dismiss with respect to the Caremark claim.  Important to the Court’s ruling was the mission-critical nature of the relevant drug and regulatory environment in which the company operated.  According to the Court, “[a]s Marchand makes clear, when a company operates in an environment where externally imposed regulations govern its ‘mission critical’ operations, the board’s oversight function must be more rigorously exercised.”  While Caremark “does not demand omniscience” in this regard, “it does demand a ‘good faith effort to implement an oversight system and then monitor it,’” which “entails a sensitivity to ‘compliance issue[s] intrinsically critical to the company[].’” 

Here, accepting plaintiff’s allegations as true, the directors failed in the obligation to monitor the company’s oversight system.  The board ignored multiple warning signs that management was inaccurately reporting the drug’s efficacy in a manner that offended both internal clinical trial protocols and associated FDA regulations.  Those allegations supported a pleading-stage inference of a bad faith breach of the board’s oversight obligations, excusing demand on the basis of potential liability and otherwise stating a claim for relief. 

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