USA: Delaware: the business judgment rule and director liability for risk oversight

Posts on the Delaware Corporate and Commercial Litigation Blog and the Harvard Law School's Corporate Governance Forum have alerted me to the Delaware Court of Chancery decision Re Citigroup Inc. Shareholder Derivative Litigation, No. 3338-CC (Feb. 24, 2009). The decision indicates the difficulties shareholders will face in arguing breach of duty by directors in respect of risk oversight and provides a very strong endorsement of the business judgment rule. The opening paragraph of Chancellor Chandler's opinion sets the scene well:

This is a shareholder derivative action brought on behalf of Citigroup Inc. (“Citigroup” or the “Company”), seeking to recover for the Company its losses arising from exposure to the subprime lending market. Plaintiffs, shareholders of Citigroup, brought this action against current and former directors and officers of Citigroup, alleging, in essence, that the defendants breached their fiduciary duties by failing to properly monitor and manage the risks the Company faced from problems in the subprime lending market and for failing to properly disclose Citigroup’s exposure to subprime assets. Plaintiffs allege that there were extensive “red flags” that should have given defendants notice of the problems that were brewing in the real estate and credit markets and that defendants ignored these warnings in the pursuit of short term profits and at the expense of the Company’s long term viability".

With regard to the business judgment rule's operation in respect of directors' oversight and risk management, Chancellor Chandler stated:

The Delaware Supreme Court made clear in Stone that directors of Delaware corporations have certain responsibilities to implement and monitor a system of oversight; however, this obligation does not eviscerate the core protections of the business judgment rule—protections designed to allow corporate managers and directors to pursue risky transactions without the specter of being held personally liable if those decisions turn out poorly. Accordingly, the burden required for a plaintiff to rebut the presumption of the business judgment rule by showing gross negligence is a difficult one, and the burden to show bad faith is even higher..."

"Business decision-makers must operate in the real world, with imperfect information, limited resources, and an uncertain future. To impose liability on directors for making a “wrong” business decision would cripple their ability to earn returns for investors by taking business risks. Indeed, this kind of judicial second guessing is what the business judgment rule was designed to prevent, and even if a complaint is framed under a Caremark theory, this Court will not abandon such bedrock principles of Delaware fiduciary duty law."

The claims relating to oversight were dismissed but one claim, arguing corporate waste in respect of CEO pay, was not. For further discussion, see here and here.