Court of Chancery Rejects 'Caremark' Liability for Imperfect Compliance With Legal Obligations

By K. Tyler O'Connell

Originally published on Delaware Business Court Insider | October 9, 2024

Delaware corporations are not permitted to pursue profits by violating the law. Under Caremark and its progeny, directors’ fiduciary duties include the good faith obligation to oversee and monitor the corporation’s compliance with laws and regulations that are material to its business. See In re Caremark International Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996). Recently, the Delaware Court of Chancery dismissed a derivative claim premised upon the notion that independent directors breached their fiduciary duties by failing to ensure compliance with a consent decree. See In re TransUnion Derivative Shareholder Litigation, 2024 WL 4355571 (Del. Ch. Oct. 1, 2024). In dismissing for failure to plead demand futility, Vice Chancellor Lori W. Will explained that that allegations of independent directors’ knowledge of “imperfect compliance” did not provide a reasonable inference of bad faith “intentional lawbreaking.”

Following a Consumer Financial Protection Bureau (CFPB) investigation into misleading advertising and marketing practices, TransUnion entered into a consent decree requiring remediation efforts. As reflected in board meeting minutes, presentations and other documents from TransUnion’s pre-suit books and records production, the board of directors, the audit committee and a separate committee formed to ensure compliance with the consent decree all oversaw changes to the specific advertising and marketing practices. They did so with the benefit of advice from senior officers, in-house counsel and outside counsel who formerly served as a CFPB enforcement attorney. TransUnion began to make some changes but refrained from making others due to legal advice that they were not required until the CFPB approved of its compliance plan. The CFPB then expressed that TransUnion had not complied in certain respects. The board and management continued to receive regular updates, and the company communicated with the CFPB to attempt to avoid sanctions. Ultimately, the CFPB brought suit, and its complaint survived a motion to dismiss. TransUnion continued to contest any wrongdoing, and the litigation remained pending.

Considering the director-defendants’ motion to dismiss for failure to plead that a demand upon the board would be futile, the Court of Chancery rejected the stockholder-plaintiffs’ argument that the alleged continued non-compliance supported that independent directors acted in “bad faith.” According to the court, because the plaintiffs were unable to fault the directors’ deliberative process, they pivoted to what they called a “Massey claim”—or, in the court’s words, “because the board learned that the regulator’s views diverged from TransUnion’s, … the board purposefully violated the law for greater profit.” In In re Massey Energy, 2011 WL 2176479 (Del. Ch. May 31, 2011), the Court of Chancery declined to dismiss claims that directors of a mining company knowingly broke safety laws in order to prioritize coal production and profits, which resulted in a mine explosion that killed 29 workers. Here, the court explained that the Massey decision “did not create a separate claim untethered from those explored in Caremark” and its progeny. The?court reasoned that Massey and similar cases involved knowing approval of “illegal but profitable business practices that led to criminal sanctions and employee or consumer deaths. These are meaningful—not trifling or technical—violations of laws integral to the company’s operations.” Rather than amounting to a separate claim, such decisions fundamentally involved directors’ duties under Caremark and its progeny to “take corporate compliance seriously.” The court reasoned that, regardless of the label applied, “for liability to attach, the risks identified and ignored cannot be business matters on which deference to the directors’ decision-making is owed.” The alleged facts also must involve “legal violations so obvious and material that disregarding them amounts to bad faith.”

Here, the court held that: the relatively narrow and technical nature of the dispute with CFPB, the board’s conduct in repeatedly deliberating upon such issues with the benefit of legal advice, the steps taken to comply, and the fact TransUnion had arguments against liability in the pending enforcement action, all undermined any reasonable inference of “bad faith.” As the court explained, directors’ alleged “inadequate, delayed, or misguided response to red flags cannot support a claim for breach of the duty of loyalty—no matter how it is categorized.” The court stated that the plaintiffs’ arguments amounted to “second-guessing of the speed and thoroughness of TransUnion’s response,” which “amounts to the sort of backward-looking critiques” foreclosed by precedent confirming that Caremark liability requires scienter. The court reasoned that “there is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard for those duties. There is an even wider gulph between imperfect compliance and purposeful lawbreaking.” Accordingly, the court granted the director-defendants’ motion to dismiss under Court of Chancery Rule 23.1.