Opinion ID: 2996267
Heading Depth: 4
Heading Rank: 1

Heading: where a business decision was made by the board

Text: of a company, but a majority of the directors making 14 No. 01-1952 the decision have been replaced; (2) where the subject of the derivative suit is not a business decision of the board; and (3) where [ ] the decision being challenged was made by the board of a different corporation. Id. at 934. Given the facts in the present case that a majority of the directors during the six years in question remained at the time the demand was made and that the board of a different corporation was not involved, the district court determined that plaintiffs were alleging an omission rather that a conscious decision of the board. In re Abbott, 141 F.Supp.2d 946, 948 (N.D. Ill. 2001) (citing Rales, 634 A.2d at 934). However, in arriving at this conclusion, we find the district court failed to fully scrutinize Delaware case law and the necessary circumstances for application of the Rales test. The plaintiffs in In re Caremark Int’l Inc. Derivative Litigation, 698 A.2d 959, 967 (Del. Ch. 1996), charged the board of directors with a breach of their duty of attention or care in connection with the on-going operation of corporate business. Where there is no conflict of interest or no facts suggesting suspect motivation, it is difficult to charge directors with responsibility for corporate losses for an alleged breach of care. Id. In determining the directors’ alleged breach of the duty of care, the court noted that liability may arise from two possible situations— liability for decisions made by the directors or liability for the directors’ failure to monitor the actions of the corporation. Director liability for a breach of the duty to exercise appropriate attention may, in theory, arise in two distinct contexts. First, such liability may be said to follow from a board decision that results in a loss because that decision was ill advised or “negligent.” Second, liability to the corporation for a loss may be said to arise from an unconsidered failure of the No. 01-1952 15 board to act in circumstances in which due attention would, arguably, have prevented the loss. Id. at 967 (citation omitted) (emphasis in original). The first setting for liability is subject to review under the business judgment rule, assuming the decision “was the product of a process that was either deliberately considered in good faith or was otherwise rational.” Id. (citing Aronson, 473 A.2d at 812). The Caremark court labels the second approach as “unconsidered” failure to act, id. at 968, the same characterization the district court gave in describing the board’s inaction in Abbott. 141 F.Supp.2d at 948, 951 (“plaintiffs allege an omission, rather than a conscious board decision”) (discussing defendants’ inaction). In analyzing a case of unconsidered failure to take action by the directors, the court in Caremark followed the reasoning in Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125 (Del. 1963), which addressed the issue of director liability for corporate losses suffered as a result of anti-trust violations. In re Caremark, 698 A.2d at 969. “There was no claim in [Graham] that the directors knew about the behavior of . . . employees of the corporation that had resulted in the liability.” Id. In re Caremark is a case where the corporation was comprised of 7,000 employees with ninety branch operations, having had a decentralized management structure, and, as a result of government investigations, had begun making attempts to centralize management oversight of the company’s business practices. Id. at 962. The court compared the defendants in In re Caremark to the defendants in Graham, stating that the claim asserted in both cases was only that the directors “ought to have known” of the violations, and that the directors had no duty “to ferret out wrongdoing which [the directors] have no reason to suspect exists,” particularly where “there were no grounds for suspicion . . . and the directors 16 No. 01-1952 were blamelessly unaware of the conduct leading to the corporate liability.” In re Caremark, 698 A.2d at 969 (quoting Graham, 188 A.2d at 130) (emphasis added). The court noted that the true intent of a review where there is no “considered” board action is based more upon corporate governance—whether there is a corporate information gathering and reporting system in existence. See id. at 969-70. As the court in Caremark explained, review of directors liability was “predicated upon ignorance of liability creating activities,” 698 A.2d at 971, where there were no facts to indicate the directors “conscientiously permitted a known violation of law by the corporation to occur.” Id. at 972. Plaintiffs in Abbott allege facts that the directors were aware of known violations, providing evidence that there was direct knowledge through the Warning Letters and as members of the Audit Committee. Under proper corporate governance procedures—the existence of which is not contested by either party in Abbott—information of the violations would have been shared at the board meetings. In addition, plaintiffs have alleged that, as fiduciaries, the directors all signed the annual SEC forms which specifically addressed government regulations of Abbott’s products. The Abbott case is clearly distinguished from the “unconsidered” inaction in In re Caremark. Plaintiffs allege that the directors “knowingly” in an “intentional breach and/or reckless disregard” of their fiduciary duties “chose” not to address the FDA problems in a timely manner. Although Brehm v. Eisner, 746 A.2d 244 (Del. 2000), dealt with a shareholder derivative action which was limited to breach of the duty of care, we agree with the court’s analysis as to the proper application of the Rales test. This is a case about whether there should be personal liability of the directors of a [ ] corporation to the No. 01-1952 17 corporation for lack of due care in the decisionmaking process and for waste of corporate assets. This case is not about the failure of the directors to establish and carry out ideal corporate governance practices. 746 A.2d at 255-56. The facts in Abbott do not support the conclusion that the directors were “blamelessly unaware of the conduct leading to the corporate liability.” In re Caremark, 698 A.2d at 969 (quoting Graham, 188 A.2d at 130). The district court noted, correctly, that the plaintiffs did not allege that Abbott’s reporting system was inadequate. In Abbott, the first two Warning Letters were copied to Burnham, chairman of the board. After the Voluntary Compliance Plan was initiated in 1995, the FDA sent a letter in 1998 closing down the plan due to continued violations. The final Warning Letter was sent to White, at the time a member of the board. The directors who were members of the Audit Committee were aware of the violations. The SEC disclosure forms acknowledging noncompliance with the QSR imputes knowledge to the directors. And as early as 1995, the FDA’s problems with Abbott were public knowledge. All of these alleged facts imply knowledge of long-term violations which had not been corrected. In Abbott, reasonable inferences determined from all of the facts taken together are exactly the opposite of Caremark; members of the board in Abbott were aware of the problems. Where there is a corporate governance structure in place, we must then assume the corporate governance procedures were followed and that the board knew of the problems and decided no action was required. Therefore, we cannot agree that the Rales test is applicable in this particular factual situation. 18 No. 01-1952