A rare case of finding a board vulnerable to a liability claim:
The Delaware Court of Chancery has sustained another Caremark claim, pointing to the absence of documents produced in response to a stockholder’s inspection demand as evidence that the directors “face a substantial likelihood of liability” for “failing to act in good faith to maintain a board-level system for monitoring the Company’s financial reporting.” Hughes v. Hu, C.A. No. 2019-0112-JTL (Del. Ch. Apr. 27, 2020).
The case involved Kandi Technologies, a Delaware corporation headquartered in China that sells automobile parts. Kandi had a long history of inadequate internal controls, including improper insider transactions and a 2017 restatement of earnings. The stockholder plaintiff complained that the board failed to implement responsible auditing protocols notwithstanding these clear red flags.
The Court reaffirmed that Delaware directors are at risk of Caremark liability only if they “utterly fai[l] to implement any reporting or information system or controls” or, “having implemented such a system or controls, consciously fai[l] to monitor or oversee its operations.” But that high bar was met in this case, the Court ruled, because the complaint alleged that the audit committee met only infrequently and briefly, and routinely overlooked important issues—“chronic deficiencies [that] support a reasonable inference that the [board], acting through its Audit Committee, failed to provide meaningful oversight.” [emphasis added]