In re Citigroup Inc., S'holder Deriv. Lit., C.A. No. 3338-CC (February 24, 2009) (Chandler, C.)
In an opinion discussing the adequacy of demand futility allegations in the context of claimed breaches of fiduciary duty relating to oversight and disclosure, the Court of Chancery clarified directors’ duties under Caremark finding that, while there remains an obligation to monitor corporate activity to prevent employee misconduct or illegal activity, in the absence of bad faith Caremark does not provide for personal liability of directors for failing to monitor ordinary business risks to prevent losses.
In this derivative action against directors and officers of Citigroup, the Court of Chancery denied defendants’ motion to stay or dismiss in favor of an action in the United States District Court for the Southern District of New York (the “New York Action”) and denied defendants’ motion to dismiss a claim of waste for approving compensation and benefits upon the retirement of former CEO, Chuck Prince. The Court dismissed stockholder plaintiffs’ claims alleging breach of fiduciary duty for failing to adequately oversee and disclose Citigroup’s subprime exposure and also dismissed claims of waste relating to Citigroup’s investment in structured investment vehicles (“SIVs”), the purchase of subprime loans from Accredited Home Lenders and Ameriquest Home Mortgage in 2007, and the approval of the buyback of Citigroup’s shares at allegedly artificially inflated prices because all of the aforementioned claims failed to adequately allege demand futility.
The Court first addressed the motion to dismiss or stay in favor of the New York Action, finding that the two actions were filed contemporaneously and therefore applying a traditional forum non conveniens analysis. After reviewing the factors of this analysis, the Court concluded that defendants had not met their burden, in part due to the important issues of Delaware corporate law raised by the case in the context of ongoing market conditions.
Turning to the fiduciary claims, the Court stated that a plaintiff who fails to make a pre-suit demand must allege particularized facts to support claims that demand is futile. Demand will be excused based on the possibility of personal director liability only in extreme cases where director behavior obviously fails to meet the business judgment test. To establish such personal liability for directors from oversight claims, the Court explained that Delaware law requires a plaintiff to show either that the directors knew they were failing to meet their fiduciary obligations or that the directors consciously disregarded their duties by failing to act in the face of a known duty. Chancellor Chandler distinguished between a typical Caremark case, where the failure to monitor relates to misconduct or violations of law, with the allegations at hand that focus on a failure to properly oversee Citigroup’s ordinary business risks. The Court found that the essence of the plaintiffs’ complaint was that the directors should be personally liable for making business decisions that resulted in poor performance and that such claims are usually analyzed under the fiduciary duty of care and the business judgment rule. The Court stated that if a corporation has adopted an exculpatory provision under Section 102(b)(7) of the Delaware General Corporation Law, regardless of whether the analysis is couched in terms of the duty of care or oversight liability, the only way for a plaintiff to establish personal liability on the part of the directors based on a failure to properly oversee corporate action is to show bad faith. The Court noted the substantial risk to undermining the settled policy of Delaware corporate law embodied in the business judgment rule if a court allowed liability for failed oversight in the absence of bad faith based on a hindsight review of whether business risks were properly monitored.
Here, the plaintiffs alleged that Citigroup suffered extreme losses and that numerous warning signals or “red flags” existed that should have alerted the directors to the risks related to subprime exposure. Plaintiffs acknowledged that an oversight system existed but alleged that the system was inadequate or the directors did not make a good faith effort to comply with the existing procedures. The Court stated that the plaintiffs’ conclusory allegations regarding the warning signs presented no evidence of bad faith and the complaint failed to allege how the oversight system was inadequate or how the directors breached their duty of oversight, and therefore, the Court dismissed the oversight claims based on the absence of particularized allegations of bad faith conduct of the directors. The Court distinguished between failing to oversee employee misconduct and failing to recognize the extent of a company’s business risk, holding that Caremark-type duties are “fundamentally different” from monitoring business risks for the purposes of establishing personal liability of corporate directors.
The Court also dismissed the disclosure claims because plaintiffs relied on conclusory allegations that failed to specifically identify any insufficient or misleading disclosure and failed to assert that the directors had any knowledge of any false or misleading disclosure that may have occurred and therefore did not comply with the pleading standard under Rule 23.1. The Court similarly dismissed claims of waste relating to the purchase of subprime loans and investment in SIVs because plaintiffs failed to allege that the directors took any action and therefore cannot establish demand futility. The Court dismissed the waste claim regarding the stock repurchase program because plaintiffs could not show that the transaction was so one sided that no business person would accept it because the stock repurchase was done at the then current market price and plaintiffs provided no further particularized facts to support a claim of waste. Finally, the Court refused to dismiss a waste claim related to the compensation package of Chuck Prince because the Court accepted the well pleaded allegations as true finding them sufficient to overcome a motion to dismiss under either Rule 23.1 or Rule 12(b)(6).