Good faith, not a good result, is what is required of the board

According to the Delaware Court of Chancery in its decicion of 18 October 2016 regarding Capital One (click here), the standard under Delaware law for imposing oversight liability on a director (sometimes referred to as Caremark liability) is an exacting one that requires evidence of bad faith, meaning that “the directors knew that they were not discharging their fiduciary obligations.”

In this derivative action, a stockholder of Capital One Financial Corporation asserts that its directors breached their fiduciary duty of loyalty and unjustly enriched themselves by consciously disregarding their responsibility to oversee Capital One’s compliance with the Bank Secrecy Act and other anti-money laundering laws. Plaintiff’s central allegation is that the directors ignored red flags (i.e. numerous reports) that the bank’s compliance program failed to satisfy statutory requirements relating to services the bank provided to clients engaged in check cashing, a business that poses an inherent risk for money laundering.

Directors are entitled to a presumption that they were faithful to their fiduciary duties, and it is therefore the plaintiff’s burden to overcome that presumption. According to the court, the allegations (of the complaint and the documents incorporated therein) would allow reasonable minds to argue either side of a debate over whether the directors’ oversight of the bank’s compliance program was sufficiently robust or flawed. The plaintiff has failed to allege facts from which it reasonably may be inferred that the defendants consciously allowed the bank to violate anti-money laundering laws so as to demonstrate that they acted in bad faith.

To demonstrate that the directors had breached a fiduciary duty by failing to adequately control the company’s employees, plaintiffs would have to show either (i) that the directors knew or (ii) should have known that violations of law were occurring and, in either event, (iii) that the directors took no steps in a good faith effort to prevent or remedy that situation, and (iv) that such failure proximately resulted in the losses complained of. In other words, the plaintiff would have to show that the case is not just about simple inattention or failure to be informed of all facts material to the directors’ decision. He must show that the directors knew that they were not discharging their fiduciary obligations.

It should be noted that there is a difference between failing to fulfill one’s oversight obligations with respect to fraudulent or criminal conduct as opposed to monitoring the business risk of an enterprise.

Good faith, not a good result, is what is required of the board. Directors can be found liable for an oversight claim only if they have consciously disregarded their fiduciary duties.

Karel Frielink
(Attorney/Lawyer, Partner)

(1 November 2016)


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