Board Oversight in 2020: “Mission Critical” Risks Become Mission Critical for Directors

In brief: Two decisions of the Delaware courts issued in 2019 allowed Caremark claims to proceed beyond the motion-to-dismiss stage. As boards go forward, they can learn from these decisions of the Delaware courts. This brief, written by Weil, Gotshal, & Manges, and originally appearing in the 2020 Governance Outlook: Projections of Emerging Board Matters, focuses on how important it is for boards to take a fresh look at identifying, understanding, and overseeing their company’s “mission critical” risks.

This resource can help your board to

• understand the key implications of the Caremark claims,

• consider where the board is overseeing mission-critical risk at the committee level, and

• ensure that oversight is built into the board agenda.

Most relevant audiences: Lead director, risk committee chairs, risk committee members, audit committee chairs, and audit committee members

The Caremark case set a very high bar for holding directors personally liable for failing to properly oversee their company’s affairs. Cases alleging that boards have breached their oversight duty in the wake of a wide range of “corporate traumas”—and even tragedies—generally have not survived motions to dismiss. As boards refresh their oversight agendas for 2020, there are useful lessons to be drawn from two decisions of the Delaware courts issued earlier this year that allowed Caremark claims to proceed beyond the motion-to-dismiss stage. Against the backdrop of growing investor demand for board oversight of environmental, social, and governance (ESG) related risks and a widening vision of “corporate purpose,” these decisions highlight once again how important it is for boards to

• take a fresh look at identifying their company’s “mission critical” risks;

• ensure the company’s reporting system elevates information about these risks not only to management but also to the board itself in a timely, actionable way;

• document how the board pays attention to these risks; and

• respond appropriately as a board when the reporting system raises red flags.

Key Projections

1. Boards Will Face Heightened Expectations to Zero in on “Mission Critical” Risks

While directors are not expected to be omniscient about each and every risk a company may face, the well-known Caremark case made clear that directors are expected to put in place and monitor reporting systems reasonably designed to provide the board with timely, accurate information sufficient to enable it to stay on top of, and make informed judgments about, key risks to legal compliance and business performance. At the same time, claims that boards have not lived up to their Caremark duty are described as “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” In order to prevail, a plaintiff must show that directors acted in bad faith—that they “utterly failed” to implement a board-level reporting system or, having done so, that they “consciously failed” to monitor it. 

In Marchand v. Barnhill, the Delaware Supreme Court took the unusual step of allowing a Caremark claim to proceed. A stockholder of Blue Bell Creameries alleged that the board had breached its oversight duty where, as a result of listeria contamination, three people died from eating Blue Bell ice cream, and Blue Bell was forced to recall all of its products, shut down its plants, and accept a dilutive private-equity investment to address a liquidity crisis. The Delaware Court of Chancery dismissed the plaintiff’s claim that the board had “utterly failed” to implement a reporting system—the first prong of the Caremark duty—citing evidence of Blue Bell’s compliance with FDA regulations, third-party testing, and reporting by senior management to the board on “operational issues.” In a unanimous reversal, the Delaware Supreme Court stated that, as a monoline company, food safety was “intrinsically critical” to the operation of Blue Bell’s business. The Court found that the plaintiff had met his pleading burden based on the following indicia that there was no system at the board level for monitoring this critical risk:

The focus on the board’s compensation committee has never been sharper. The components of compensation plans and the link between compensation and company performance are under intense scrutiny from shareholders, employees, policymakers, the media, and other stakeholders. The Report of the NACD Blue Ribbon Commission on the Compensation Committee revisits NACD’s 2003 Report of the NACD Blue Ribbon Commission on Executive Compensation to highlight the new environment in which compensation committees—and, more broadly, boards—are now operating. It recommends that the compensation committee and board work together to establish an executive compensation philosophy that supports the company in creating long-term, sustainable value.

The report includes ten specific recommendations for compensation committees to consider when evaluating their compensation philosophies. It also provides practical tools, such as sample compensation committee charters, a compensation committee assessment, and guidance on executive employment contracts.