The Management Friendly Nature of Delaware Courts: Of Boards, Ostriches, and the Absence of a Duty to Create a “Better” Reporting System (Part 4)

We are discussing In re General Motors Co. Derivative Litigation, a recent case in the Chancery Court holding that directors had no obligation to ensure that a reporting system was sufficiently robust to ensure that certain vehicle safety issues were reported to the board prior to 2014.  

In assessing the applicability of the Caremark claim brought by plaintiffs, the court noted that there were no allegations of a “total lack of any reporting system”.  Instead, plaintiffs challenged the inadequacy of the system.  “[T]he Plaintiffs allege the reporting system should have transmitted certain pieces of information, namely, specific safety issues and reports from outside counsel regarding potential punitive damages. In other words, GM had a system for reporting risk to the Board, but in the Plaintiffs' view it should have been a better system.”

For the court, however, it was enough to have a reporting system that allowed for "some" oversight.  Id. ("Stated more generally, in criticizing the Board's risk oversight and its delegation thereof, throughout the Complaint, the Plaintiffs concede that the Board was exercising some oversight, albeit not to the Plaintiffs' hindsight-driven satisfaction.").  

Allegations that the reporting system could have done "better" would not be enough. Id.  (“It shows, perhaps, an overly bureaucratic system of 'information silos,' but not a conscious disregard of fiduciary duties by the Board. In other words, the Plaintiffs complain that GM could have, should have, had a better reporting system, but not that it had no such system.”).  Said another way, "[c]ontentions that the Board did not receive specific types of information do not establish that the Board utterly failed 'to attempt to assure a reasonable information and reporting system exists'”.  

But of course the plaintiffs were not alleging merely that the system could have been better. The characterization came from the court.  The Complaint, in contrast, asserted something far more fundamental: "The Director Defendants herein, have a fiduciary duty to adopt internal information and reporting systems that are reasonably designed to provide to senior management and the board itself, with timely, accurate information sufficient to allow management and the Board, within the scope of their duties, to reach informed decisions concerning the corporation’s compliance with the law and its business performance."  The Board allegedly violated that duty by failing to "create a policy whereby serious defects detected by various Company sources were reported to the Board as well as litigation matters which would incur punitive damages." 

In other words, it wasn't enough to have a reporting system.  The system must also ensure that directors receive the information needed to exercise their fiduciary obligations to monitor the activities of the company. The court, however, made no attempt to assess the qualitative importance of the omitted information to General Motors, to shareholders, or to the board's duties.  Instead, it was enough to have a reporting system. The actual content of the reported information was not particularly important to the analysis.    

The approach creates an incentive to have a reporting system.  It does not create an incentive to have a robust system that ensures the board receives information material to the well being of the company.  The analytical approach suggests that the incentive to improve the quality of a reporting system will need to be a matter of federal law.  Preemption, in other words.   

For primary materials in this case, go to the DU Corporate Governance web site.

J Robert Brown Jr.