Recent cases in the Delaware Court of Chancery have permitted personal liability claims against directors who fail to monitor warning signs within businesses. To protect against liability, boards should implement clear, thoughtful procedures that alert them to issues within their organizations.
A Director’s Duty to Monitor
Directors typically owe fiduciary duties to the businesses they serve, including the duty of care and the duty of loyalty. One aspect of a board member’s responsibilities is the duty to monitor.
The duty to monitor requires directors to implement a system to monitor the business’s compliance with applicable laws, standards, and internal protocols. Additionally, board members cannot consciously ignore red flags suggesting the company may not be in compliance, whether these red flags arise from the monitoring system or otherwise. Essentially, the duty to monitor requires that directors engage in basic risk management.
Traditionally, the bar for liability is quite high. In Reiter v. Fairbank, the Delaware Court of Chancery explained that that plaintiffs must prove each of the following:
The directors knew or should have known that violations of the law were occurring;
The directors took no steps in a good faith effort to prevent or remedy the situation; and
The directors’ failure proximately caused harm to the plaintiffs.
Recent Delaware Cases Highlight the Risks of Failing to Monitor
In the past two years, several cases in the Delaware Court of Chancery have showcased the importance of fulfilling the duty to monitor. Despite the high bar to rule against directors, courts have refused to dismiss several claims against board members regarding essential compliance matters.
Consumer safety considerations in a food company (Marchand v. Barnhill, 2019 WL 2509617 (Del. Supreme June 19, 2019));
FDA compliance for clinical trials in a drug development business (In re Clovis Oncology, 2019 WL 4850188 (Del. Ch. Oct. 1, 2019)); and
Pipeline safety in an energy company (Inter-Marketing Group USA, Inc. v. Armstrong, C.A. No. 2017-0030-TMR (Del. Ch. Jan. 31, 2020)).
In each of these cases, the regulatory matters in questions were central to the business’s critical functions. As a result, failing to adequately monitor compliance functions may be a breach of the board’s fiduciary duties.
Best Practices for Directors
To protect themselves from liability — and encourage responsible business operations — boards should implement well-organized compliance procedures that help them monitor the state of the company. Directors should actively review the conduct of the company and avoid sweeping red flags under the rug.
If you have any questions about the duty to monitor and how it affects directors’ potential liability, please feel free to reach out.