June 30, 2020

Coffee & Conversation - A Guide for Directors to Avoid Fiduciary Liability

In this episode of Coffee and Conversation, attorneys Mackenzie Wallace and Catherine Rowsey sit down with Cathy Dearlove, a director at Richards, Layton & Finger in Delaware, to discuss director liability under Delaware law. They cover some of the basics on director oversight, such as the business judgment rule and Caremark duties, and analyze key cases on director liability. They also offer best practices for responding to records requests and maintaining good recordkeeping standards as well as explain other tools and considerations to reduce liability risks.


Podcast Transcript

Mackenzie Wallace: Thank you so much for joining us for today's Coffee and Conversation. We are going to discuss today how directors can avoid liability. I know that Cathy and Catherine and myself enjoy to be nerds. Thank you for listening. Our goal is to simply break down these complex topics and to provide a guide for directors to avoid liability. So let me begin by introducing our special guest and Delaware expert Cathy Dearlove. Cathy is a director at Richards, Layton & Finger in Delaware, and she has extensive experience advising clients on corporate governance and fiduciary duty issues. She's appeared as lead counsel in many of the notable cases that we know of out of the Delaware Chancery and Supreme Courts. And Cathy has more accolades than I can truly discuss during our session for coffee this morning. But just to name a few, she has been listed as a fellow of the American College of Governance, she's been recognized by Chambers, by Benchmark, by The Best Lawyers in America and by Super Lawyers. Cathy is a mom of two kids. She is currently joining us from Avalon, New Jersey, at her beach home, and we might get a little sneak peek of Ollie, her dog, in the back during our session. So good morning, Cathy. To introduce myself briefly, I'm a partner at TK with a focus on securities, governance and enforcement as well as healthcare. Also joining us is Catherine Rowsey, and her practice focuses on corporate partnership disputes, fraud and breach of fiduciary duty issues as well as white collar defense. So we are so excited you were joining us. With no further ado, I'm going to jump right into our first topic and question. There seem to be a lot more Delaware cases where claims for breach of fiduciary duty are surviving what we as lawyers describe as the dismissal phase, meaning that the plaintiff files a petition of a complaint and the defendant responds with a motion to dismiss it on the basis of legal issues. And in the past week, we've seen more of those cases get dismissed at that phase. And now for the non-lawyers listening, we're seeing that less of those are being dismissed. Cathy, has there been a change in law? What is your view on what's happening?

Introducing Delaware Corporate Law: Business Judgment Rule, Marchand and More

Cathy Dearlove: Thank you. So first and foremost, let me say that I don't think Delaware law has changed in a fundamental way. The business judgment rule, the deference that the Delaware courts give to decisions of boards of directors, it's alive and well in Delaware and elsewhere. As for the frequency with which cases are surviving a motion to dismiss, I've not done a quantitative study of that. I think as a defense lawyer, I tend to have a little bit of a cognitive bias that I pay more attention to the things that survive the motions to dismiss than those where the dismissals are granted in Delaware courts as compared to courts in a lot of jurisdictions do take motions to dismiss seriously. I know from colleagues, there are some jurisdictions where motions to dismiss are so rarely granted that it's news if one is granted, as opposed to news if one is not. But anecdotally, there have been a few more high-profile cases involving motions to dismiss that were not granted that we're going to talk about today. And I think those come up in probably two areas for two different reasons. The first is going back about five or six years to about 2014, there has been a change in the law with respect to transactional disputes. When a merger happens and there's a claim that there's a breach of fiduciary duty in connection with that merger, going back to about 2014 with the M&F case, M&F Worldwide, the courts have moved to draw a clear path to get to business judgment protection in cases where there wasn't previously a way to have the case subject to the business judgment rule and those, of course, are the cases where motions to dismiss are most frequently granted.

Mackenzie Wallace: And Cathy, not to interrupt you, but just to break it down. For those directors that do not recall specifically what the business judgment rule is, can we just back up one step and say what that standard is and how that impacts them?

Cathy Dearlove: Yeah, I would say the business judgment rule at the end of the day is a presumption, and it is a presumption that the courts give to decisions made by boards of directors as long as they are made on a fully informed basis and without conflicts of interest. And so directors in Delaware corporations start with that presumption, and the plaintiff has to rebut that presumption in the complaint in order for the claim, the case, to proceed. So really, while there's more technicality around it, at the end of the day, it comes down to whether the complaint pleads facts, not just conclusions, but facts from which the court can infer that it's reasonably conceivable that if all those facts were true — and giving the benefit of inferences to plaintiffs because all of that happens on a motion to dismiss — that there was a breach of duty. And so the plaintiff has to get over that pleading bar in order to get to discovery and other sentence. And the two ways that we've seen some shift is first in cases involving a merger, which is a large majority of the cases that people pay attention to coming out of Delaware, there are now more motions to dismiss being brought because cases where, as lawyers, under the prior law, we didn't have a path to bring a motion to dismiss. We knew the case was going to go at least to discovery. Cases like MFW and Corwin, which I know we're not going to talk about in detail, but they each provide a path to a motion to dismiss. So since we can now bring more motions to dismiss, more motions to dismiss, they're not all granted. So more are granted, and more are denied. And in the case of MFW and Corwin, those are new doctrines adopted by the court within the last several years. And in what we see in the first few years of a new doctrine is defense lawyers tend to push the boundaries of that doctrine and plaintiffs as well, to try and define where you can expect a dismissal and where you can't. And so in that area, I think there probably are more motions, and we see more that are granted and also more that are not granted. But maybe some of us on the defense side pay more attention to the ones that aren't granted. And then the second area and this, I know, is one that you and Katherine have written about or are soon to publish some writings that you've done about, the second area is in the area of the duty of oversight, which I'll just say it's not a separate duty, but the Caremark or oversight duty. There have been a couple of cases that we're going to get into talking about where the court has in this case, we saw the Delaware Supreme Court reversing a dismissal from the Chancery Court. And that's I think what people are noticing is a little bit of evolution in the law there. But Catherine, do you want to take the case that we're hinting about?

Catherine Rowsey: Thanks. So we're talking about the Marchand case. And just for those of you who are a little bit newer to the Delaware law scene, so Marchand is dealing with a shareholder derivative suit against the directors of Blue Bell — Blue Bell Ice Cream, as many of you know, especially in Texas, it's near and dear to our heart. It all arose out of a listeria outbreak that, I think it killed three consumers, and there was a recall. I mean, it was a huge crisis for this company. And in the wake of that crisis, a shareholder brought a lawsuit against the directors alleging one of these so-called Caremark claims for this breach of fiduciary duty, for failing to monitor oversight, to implement any kind of reporting structure to the board about these health and safety issues that were going on in the manufacturing, Blue Bell's manufacturing plants where the listeria outbreak happened. And so I know that Marchand has been kind of a lightning rod. What's been the real effect of it in Delaware, in Delaware practice, and does it signal a change in the law, a change in, what's been the kind of practical effect of Marchand in your practice, Cathy?

Caremark Duty of Oversight: Two Prongs to Meet for Liability

Cathy Dearlove: Sure. So let me just go back, so Mackenzie doesn't ask me to in a moment, to just go back and give a little bit of the basic on the duty of oversight. Delaware Law, the Delaware General Corporation Law, provides that the business and affairs of every corporation are managed by or under the direction of a board of directors in modern corporations. It's not by the board of directors, of course, it's under the direction of the board of directors. And as a result of that, the directors' core fiduciary duties of care and loyalty include the duty to oversee the management of the business, and that arises out of their both care and loyalty duties. And Caremark, which is how everybody refers to oversight cases, refers to a 1996 Court of Chancery case that laid out this doctrine. It was then adopted by the Delaware Supreme Court in the Stone vs. Ritter case in 2006. And essentially since 2006, and still today, there are two prongs to a potential oversight liability, two ways a plaintiff can plead a breach of the duty of oversight, and they're both pretty extreme. The first is by pleading facts in your complaint and that demonstrate — to ultimately get to liability, you have to prove the facts, but let's just say at the pleading stage — you have to plead facts from which the court could infer that it's reasonably conceivable, again, the motion to dismiss standard, that the board utterly failed to implement any reporting system or controls. That's the first prong. And the second prong would be or, that the board, having implemented a system of controls, consciously failed to monitor or oversee it, thereby disabling themselves from being informed of risks or problems requiring attention. And those both are quoted from the Stone vs. Ritter case, which continues the quote to say, "In either case, imposition of liability requires a showing the directors knew they weren't discharging their fiduciary obligations." So what that shows is you have to have — again the legal term I'm citing here — it has to be a "knowing" breach. This isn't, it isn't, although the name is Caremark, it isn't a duty of care issue. This is a duty of loyalty issue. The directors are simply refusing to, to even try to fulfill their fiduciary duties. And so perhaps the reason why Marchand has gotten so much attention is that the Supreme Court in Stone vs. Ritter, the Chancery Court in the Caremark case itself and in innumerable cases since then — and I will say on behalf of defense lawyers, every defense lawyer in every brief on every motion to dismiss has always said, has always quoted Stone vs. Ritter and Caremark and say at that quote that Caremark cases are possibly the most difficult theory in corporate law on which a plaintiff might hope to prevail. Now that's a pretty extreme statement. So it is newsworthy that there is a case now in which Caremark -

Mackenzie Wallace: Cathy, before we jump into Marchand and why it's newsworthy and why it's potentially a shift or why we're discussing whether it's a shift, why was it so hard or why is it so hard to meet those two prongs of the Caremark under the duty of loyalty, but the oversight piece in the monitoring piece? Why is that so challenging?

Cathy Dearlove: Well, it's challenging for two reasons, and the first is, as a litigator who's defended boards of directors and governance professional who sat in a boardroom with reports of directors, most boards of directors are trying to properly oversee the business and affairs of the corporation. You know, I fundamentally believe that 99, not 100, percent of directors when they're sitting in the boardroom are acting in good faith. And effectively what Caremark requires is facts be pled that lead a court to believe that it's conceivable that this board of directors was simply blinding itself to its obligations. And that's just not it. It's not my experience, it's not human nature. So I think that's part of why it's hard. And if you think about it another way, again, sort of human nature, if you have a board of directors of well qualified individuals, because nobody gets in the boardroom without being well qualified, and they are well informed, they're well advised and they don't have conflicts of interest. This is not a situation where people are motivated by personal financial gain.

It's just somewhat difficult to reach the burden of reasonably conceivable that a group of people with their reputations on the line, serving as directors and understanding the importance of that, just blinded themselves.

And again, this is the standard for liability. It's not the standard for getting past the motion to dismiss, but because it's so hard to plead and prove, it's hard to survive a motion to dismiss it historically. Most cases are brought by public companies. Public companies have SEC reporting obligations. They have audit committees. And as the Supreme Court pointed out in the Marchand case, most of them fail, well, certainly fail to get over the first prong, because plaintiffs have to admit that the company has an audit committee. And so to that extent, perhaps the Marchand case is a little bit of an outlier. But we can talk a little bit about how we've gotten to the point that plaintiffs have the facts in Marchand or elsewhere to plead beyond a motion to dismiss and that plaintiffs are now going to be using Section 220 of the DTCL to go beyond the company's public disclosures.

Section 220 Corporate Records Requests and Best Practice for Corporate Minutes

Catherine Rowsey: Right. And that's, just for those following along at home, just Section 220, that's just the statutory reference to the books and records demand that a shareholder can demand to review, to inspect and review certain books and records. And so, Cathy, I understand that that's exactly what the plaintiff in Marchand was able to do was use a Section 220 request to be able to obtain the facts that allowed them to plead sufficiently to get over this motion to dismiss stage. How have, I mean, what are the kind of documents that we're now seeing being requested in these 220 requests? Are they different, are they broader, has your advice to clients changed in responding to them in light of recent practice?

Cathy Dearlove: Yeah. And that's where I think we've seen a change in how most, in how all cases are regulated in the M&A context, as well as the Caremark context. Again, going back a little bit for context and going back into the 1990s, the Delaware Supreme Court, in granting or affirming a motion to dismiss, started to hint to plaintiffs that, to the extent they were having trouble getting over the burden of pleading, that there was a tool provided by Delaware law in Section 220. And so the phrase that is always used is that the plaintiffs should "use the tools at hand," and the tool that the court was referring to is Section 220, which allows a stockholder for a proper purpose, meaning a purpose related to their status as a stockholder, to ask to see corporate books and records. And one of the purposes the Delaware law has recognized as a proper purpose is in order to investigate potential mismanagement or wrongdoing. And so it took a little bit of time for this to play itself out. But plaintiffs started using Section 220 much more frequently to investigate potential claims of wrongdoing to the point now where it happens in almost every case. You have a significant corporate crisis. You can be assured that the company is going to get a books and records demand, maybe several books and records demands. And so one thing is we've gotten more Section 220 demands. Plaintiffs are going through those motions effectively a form of mini discovery before even filing the cases. And the law has also evolved over time in terms of what Section 220 involves. When I was first practicing oh, too many years ago, I have to say, Section 220 investigation, Section 220 production, was largely limited to the binders in the office of the corporate secretary.

Catherine Rowsey: Right, the true corporate records.

Cathy Dearlove: I mean, first of all, people still kept them in binders in a an office, but they were corporate minutes. Maybe the background materials that were distributed to the board in connection with a transaction. But it was really very high-level, corporate secretary-type documents. And over time as people's practices have changed, they're no longer binders in the office. People communicate by email, and people are less formal. You don't draft memos for every issue anymore. It's happened in our legal practice. It's happened in corporations. The conception of what our books and records have extended beyond the formal corporate records to the records of the corporation, and that has, in a number of cases over time, starting in the Court of Chancery and as a patchwork of very factually specific decisions, there were decisions allowing emails, allowing officers' presentations, even if they weren't, they were the notes from which an officer spoke. They extended to personal devices in certain instances, and in one very notable instance in the Wal-Mart case, even to privileged documents. And then that, as I said, it was sort of a patchwork of cases, and particularly with respect to published documents, directors and corporations got very nervous about everything. And eventually we got some guidance from the Delaware Supreme Court in a case called KT4 vs. Palantir, over the last year, little more than a year ago now, as to what Section 220 does and does not entail and how you get there. And effectively what KT4 vs. Palantir teaches is that Section 220 has to evolve with people's recordkeeping processes and practices. 220 does involve potentially email, but that it is still not the equivalent of discovery, and where the formal corporate records are sufficient for the investigation, Chancery Court should not be ordering broad email inspection as a matter of course. And so that really goes to making sure that the formal corporate records do, in fact, reflect what the board was thinking about and what deliberations the board undertook.

Catherine Rowsey: And Cathy, I mean with this, with obviously the evolving way that we communicate the proliferation of, we've seen it in all of our practices across litigation in general. Text messages, emails, it's almost like a stream of conscious thing. How is that, now knowing that those could be available potentially, that we do have a little bit of a hedging to say that it is, should be, we still are the formal corporate record documents, what is your advice to clients with respect to email communication, text messages, that sort of thing? How are you advising clients, especially with regard, now that we're in a COVID era where I know many, many boards are facing these new and wild times? What's your advice on emails and texts?

Mackenzie Wallace: Well, and one thing, Cathy, before you jump in on that, I think it might be helpful to talk about the negative inference in Marchand. And I think that requires a little bit more explanation, which is that this wasn't a situation where the plaintiffs pored through the 220 request response and found an instance of something that was said or done and quoted to that. They used the lack of the board's discussion about these listeria outbreaks, the negative inference, the lack of that information existing in what they found, to support their claim. And so when our clients talk to us and ask us, how are our duties shifting under Delaware law, it's not really a shift in law, it's more of a paradigm shift, I think is how you coined it. And how does that negative inference kind of play into Catherine's previous question?

Cathy Dearlove: Yeah. So look, I'll reframe the question I guess a little bit. Let me first go back and explain what you're talking about in terms of the negative inference. I don't really think it's fair to call it a negative inference, or it might be misinterpreted to call it a negative inference, but it is true that the court can infer that from the absence of information that a particular topic wasn't discussed. And in the Marchand case in particular, the defendants tried to argue, they argued to the court, that the fact that the minutes reflected a discussion of operational concerns should lead the court to conclude that the board had considered issues relating to food safety, which the court in Marchand described as the critical regulatory issue, mission critical regulatory issue, for this corporation. And I will tell you it is, where in the case, but I don't know, I don't know the underlying facts. I would suspect they probably did talk about food safety. But on a motion to dismiss where all inferences have to be drawn in favor of the plaintiff, what the Supreme Court said is if we were just to infer from a general reflection of a discussion of operational concerns that the board had discussed this particular issue where it's not otherwise specifically referenced in the minutes that would make Caremark case not just the most difficult, but almost impossible, to ever prove. And on a motion to dismiss that makes sense. But what it teaches is that boards, through their recordkeeping, and us, as lawyers when we're thinking strategically about how to respond to the Section 220 demand, can improve the chances that the boards will get credit, even at the motion to dismiss stage, for all the good work that I assume they are doing on these issues. And so what that teaches is first of all, keep good minutes that in fact reflect the discussions that you have, and I'll circle back to that. But the other thing is, to get back to the questions, to think strategically when you're answering a Section 220 request. People do communicate in different ways. Boards that have adopted board portals, that's a nice way to manage things, if you encourage your directors to communicate through the board portals. Regularly having discussions with your board about the need to take care in your communications, that emails and texts — as I have this discussion with my children, people have this discussion within our law firm — emails and texts are not the equivalent of a face-to-face conversation. They can be misconstrued. And so thinking a little bit more formally about communications that are in writing, even if it's only electronic writing, is good advice. And, as I said, to think about what you produce in a Section 220 production because the court can infer from the absence of materials, at least at the motion to dismiss stage, that those things weren't discussed. So if you have materials that show that they were discussed but you are not producing them because you are drawing a line, a hard line, and saying, "I am not producing any piece of paper that did not go to the board, so I am not going to produce to you this nice report that my compliance chief went through in discussing with the board," and all you're going to have in the minutes is there was a report from the compliance team, well, if you think strategically about how that 220 production may be used on a motion to dismiss, you might choose to offer to produce officer-level documents that reflect presentations made by the officers. And that's sort of how one can manage the process through the 220 to put yourself in a better position at a motion to dismiss. It's become common, for example, to have an agreement with the plaintiff that if you produce a set of documents under Section 220 production, that those documents can be deemed incorporated by reference on any motion to dismiss. We call it the anti-cherry picking rule. The plaintiffs can't cherry pick the bad documents that say this red flag was waved in front of a board without showing the minutes from the next meeting. And those are ways you can help through your Section 220 production to position yourself.

Mackenzie Wallace: So what I hear you saying, Cathy, is that there's a balance between weighing the cost of gathering all of these documents, which we know discovery and gathering these types of documents can be very expensive, but there's a value in basically giving the plaintiffs or showing the plaintiffs the documents that will prove to them that pursuing these claims will be an unworthy or a failing pursuit. At the same time, that seems like it's the right time to engage counsel to determine that approach on what to include, what not to include, what are the strategies with cost and to prevent litigation.

Cathy Dearlove: Absolutely. And let me be perfectly clear, I am not talking about defense lawyers cherry picking the helpful documents from the unhelpful documents. That is not OK. I know some plaintiffs' lawyers suspects that that's what's happening, but that's not what we're talking about here. What we're talking about is ensuring that you meet the requirements of Section 220. Section 220 enables a plaintiff to obtain those documents that are essential and sufficient to their purpose. All the documents that go to the crux of the issue that they are seeking to investigate. It doesn't mean all of the documents. It means those documents that go to the crux of the issue, and it is not every document. So if I say officer-level documents, what I'm suggesting is that you investigate where the substance of the meat of the decision was, and if it's not in your minutes — we'll get to that in a minute, it should be in your minutes — but if it's not in your minutes, it's in attachments to the minutes that for whatever reason, or things referenced from the minutes, then include those in the production. Because if you don't, then the plaintiff will have a very good case following KT4 vs. Palantir to sue under Section 220 for a broader production, which is going to be more costly. So this isn't about hiding the story. This is about getting the information that exists out in a most cost-effective way and fairly.

Catherine Rowsey: And so, Cathy, that kind of segues really nicely to the thrilling and just super exciting topic of corporate minutes. And I wanted to know, I wanted to hear what your advice is because I know that there has been and there continues to be debates over a long form versus short form. And, you know, the pros and cons of explaining everything that was discussed by the board versus being more succinct so that you can't be a Monday morning quarterback. What's your insight into that? Which is the best practice from your perspective?

Cathy Dearlove: Here too, I think the advice has evolved, let's start with that. Nobody really likes talking about minutes. Nobody likes drafting minutes. It's one of those chores that everybody wants to put off. But I'm going to say, I think people who consider minutes to be the chore that you want to put off are missing an opportunity. And that is because, again, I fundamentally believe that boards are doing the right thing in the boardroom, and they're certainly trying to do the right thing, even if they don't always hit a 100 percent, and they're not getting credit for that when people use short form minutes. And I know my firm has in the past probably recommended short form minutes, but our thinking has evolved a bit over time as we've seen, first in the context of, again, M&A litigation, special committees considering transactions, special committee investigations, people started to keep longer form minutes. And those longer form minutes, especially when they are prepared contemporaneously, you do it right after the meeting, you approve them, if not at the very next meeting, but as you're going along, they're really a tool to make sure, first of all, the support is getting credit for everything that they're doing, that the information is all in one place, that down the road when I have to defend a deposition of one of the directors, I can use those minutes to refresh their recollection of what was discussed. And the other thing that I think people miss is that in doing that, particularly if you're taking a board through a complicated issue, a complicated transaction, if you're preparing the minutes as you go, you as a counselor may notice that hey, we should have talked about this a little bit more. And I think as litigators, we bring a lot of value to that. Some of my partners who are more transactional lawyers get me involved in the transaction, and I like to review the minutes as we're going with a little bit of a devil's advocate perspective of, hey, what's not here? Did the board talk about this? And I think that all makes for a better presentation, a better search for the truth, ultimately, when a transaction is challenged. So I do think longer form minutes make sense. They make sense because it's a nice formal record. There are some pitfalls in that. If your minutes read like a lawyer drafting a brief, then the court may not give them the same credit. So you obviously got to always be faithful to the truth. It is best if they are reviewed and approved contemporaneously. The court has a very jaundiced eye when you go through this — again, more M&A transactions than fair market — but if you go through an entire process and then you see 12 sets of minutes all neatly packaged at the end and approved all in one company, the court may not look at that as favorably, won't give it as much weight persuasively.

But I think good recordkeeping practices and some strategic thought in the Section 220 area can certainly best position people, defense lawyers and defendants in Caremark litigation.

That said, and to circle back to where we started, look, I do think the Supreme Court in Marchand was sending a signal to the Court of Chancery that a motion to dismiss is not a time to draw inferences in favor of the corporation. I think there is, it certainly was sending a message that having, having regulatory compliance at the management level, regulatory compliance staff at the management level, that is not enough to demonstrate the board-level oversight. And so I think there's a little bit of a shift in focus under Marchand reminding people that what you're looking for in those minutes is that the board was exercising oversight, not just that someone down in management had an eye on regulatory issues. And I think there was a little bit of a reminder to the Court of Chancery that while it is the most difficult theory in corporate law or whatever it is, it's impossible and there needs to be some "there, there," for plaintiffs as well.

Are Certain Industries More Vulnerable Than Others?

Mackenzie Wallace: Let's shift away from minutes now and 220 requests and talk a little bit more about potentially the distinctive facts that are present in Marchand and some of its progeny, some of the other cases that have followed it, and what may be different about those cases and distinct from certain boards, or like certain boards or members, directors that are listening, listening in today. I know one of the things that you touched on was this food safety piece, the operational piece that wasn't present in their discussion, at least not in in the minutes that were produced in that case. So I know that there was also this legal compliance issue that was woven in both with this case and some of the other cases that we will briefly touch on today. Are there any certain types of, I guess, issues that are less likely to survive or certain types of industries or companies that are more, I guess, vulnerable post-Marchand?

Cathy Dearlove: Yeah. And your time is short, so I won't I won't spend much time on the specifics of the cases, and I'll just try and cut to the chase. I think it's always been true, when you talk about oversight of risks, there are there are two kinds of risks that every corporation undertakes. Business risks. That's what boards are in place to do, to decide what is the appropriate level of business risk. Should we invest in this product? Should we introduce a new product line here? There's inherent risk in all of those business ventures, and historically, and I think still today, you aren't going to get a lot of traction in a hindsight challenge to the level of investment risk, those sorts of risks. Where Caremark really, I think, is most active is in areas — and in all of those, there's probably a regulatory element, right? Someone's going to say you didn't disclose things of risk appropriately. But it's in areas like environmental risks, drugs, food safety, those core areas where the government regulates not just what you say about what you're doing, but actually regulates the safety of what you're doing to the public. Those regulatory claims, particularly when they are again, as Marchand said, mission critical to the business, are where I think the court's going to look a little deeper in how the board managed that risk and that they did not blind themselves to those types of risks. And so it's always been the case that a highly regulated industry is potentially more vulnerable to an oversight, the board would be more vulnerable to an oversight claim than a finance, you know, just a general financial services type company. And I think that's still true. And I think we can, you know, we can take some lessons from that. Again, I don't think it's things that boards aren't doing, but sometimes the purpose of these, I wouldn't say the purpose, the silver lining in some of these cases and the learning experience from them is reminding boards of what Delaware law expects of them in connection with their fiduciary duties.

Are Industry Experts Held to a Higher Standard?

Mackenzie Wallace: That's great, and I think that leads to just a brief discussion of this case, which followed Marchand in October of last year. And in that case, similar to Marchand, we've got a safety, a health issue. It's a pharmaceutical company who's doing a clinical trial for a lung cancer therapy, a treatment. And basically, the stockholder sued the Clovis board, and they said you breached your fiduciary duties. They said you failed to oversee this clinical trial, and you allowed the company began to mislead the market on the drug's efficacy, essentially. And the court, just like in Marchand, allowed this to go past this dismissal phase, thereby exponentiating the value of the case, arguably. And the court found that the board had ignored red flags and that Clovis wasn't adhering to the clinical trial protocols and that particularly Clovis' board was composed of industry experts, pharmacy industry experts. And I think that kind of leads to the next point or question, which is what advice do you have for boards today, directors who are also experts in the industry of the board on which they serve? Does that kind of change the analysis, if you will?

Cathy Dearlove: Yeah. You know, this question comes up from time to time in, it came up last time with financial experts on audit committees. Are they being held to a higher standard? I would say ultimately, I don't think experts, whatever kind of experts, are going to be held to a higher standard under Delaware law. I think again, that the explanation is in the motion to dismiss standard, at the motion to dismiss phase, where the court has to give all reasonable inferences to the plaintiff. The issue in Clovis was whether the board gets a second prong of Caremark versus the first. Were the red flags being waved, and did they ignore them? And the expertise was pointed to as a way of saying, "You should have understood the nature of the distinction between success rates that were confirmed and success rates that were unconfirmed." Certain directors should have because they were industry experts. And I think at the motion to dismiss stage, that's a fair assessment. I also think it is a fair assessment that ultimately at a liability phase, the standard that is applied is the same: Were you acting in good faith? And ultimately, every director will, their good faith will be assessed individually, it's not a boardwide issue.

I think that directors who have a particular expertise should be given the same advice that all directors are, which is you're sitting on the board because of your qualifications and you're not a passive rubberstamp for management. You should be actively questioning the information that's put in front of you. That does not mean that you are a guarantor and that any time something slips past you, you are going to be held liable for that. I think it means we expect directors, Delaware expects directors, to act in good faith to try.

And again, the standard isn't that you had a red flag and you consciously ignored it. Obviously in any particular case, I don't know what the ultimate facts will prove, and a court on a motion to dismiss doesn't know what the ultimate facts will prove, but they have to give the inferences at that stage to the plaintiff.

Conclusion: Key Takeaways for Boards and Directors

Mackenzie Wallace: That's great. We have talked about some really heavy legal concepts today, and so I'd like to finish up our coffee and conversation with just a few practical takeaways. I think one, first, is reassess. Reassess where responsibility should reside. Should it be at the board level, should it be at committee levels? What are some other takeaways for directors post-Marchand, post-Clovis as this paradigm shift has occurred. Catherine, we'll start one with you, and then we'll toss it over to Cathy.

Catherine Rowsey: I think that as all of these cases, I mean, it's difficult to talk about the practical application of these cases because the facts are going to be different for every board. It's just going to be about customizing your oversight process with your specific company in mind. And I think that's a real takeaway and of course, not only customizing the oversight process but also customizing possibly your 220 response. Cathy, I'll throw it to you.

Cathy Dearlove: Sure. And then I'll just wrap up picking up on that context. Delaware is a is not a one-size-fits-all requirement, but ultimately one of the core functions of a board of directors is to manage risk. And I think what Marchand teaches us, what Clovis teaches us, is that a board should first and foremost identify those mission critical risks, those risks that are so important to your business that a failure there is more likely to have a significant adverse effect and ensure that the board is focused — at least periodically, and the frequency will vary — on reassessing, to pick up Mackenzie's point, whether the processes you have in place are sufficient to ensure that the board gets notice when there are potential problems. And if they do that, then I think the fact that a couple of other cases have survived a motion to dismiss will ultimately not be a problem for them.

Mackenzie Wallace: Wonderful. Thank you so much. Thank you all for listening, and thank you very much to Cathy. I can speak for Catherine as well as myself that we thought we were experts on this topic writing on it. But Cathy is just a wealth of information and such a powerhouse female for us to look up to all of us at different stages of our careers, but chatting together about something that we find really fascinating and fun, even though some of you may find it pretty dry. We won't preview that Catherine and I have written a three-part article, and it's set to come out in the next month, month and a half. We can provide you more information on that should you want to read those materials, again on this topic, on just director duties and loyalty and duty of care, and then also on insolvency in light of COVID-19. And so we very much appreciate you listening and thank you again, Cathy, and have a wonderful day.

Cathy Dearlove: Thank you very much.

Catherine Rowsey: Bye, Cathy, thanks.

Cathy Dearlove: Bye-bye.

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