A Caremark claim is a type of lawsuit brought by shareholders against a corporation’s board of directors, alleging a failure to uphold their oversight responsibilities. It is a concept rooted in corporate governance that seeks to hold directors personally accountable for allowing a company to suffer significant harm due to a lack of internal controls. This legal action is one mechanism used to enforce the fiduciary duties directors owe to the company and its investors. Such a claim focuses on a board’s systemic failure to implement or monitor compliance systems designed to prevent corporate misconduct, regulatory violations, or other business-threatening issues. The existence of this claim establishes a baseline expectation that directors must make a good faith effort to be informed about the company’s compliance with law and the risks inherent in its operations.
Defining the Caremark Claim
A Caremark claim alleges a breach of the fiduciary duty of loyalty, specifically by demonstrating that directors acted in bad faith regarding their oversight function. The name originates from the 1996 Delaware Chancery Court decision, In re Caremark International Inc. Derivative Litigation. This decision established that a director’s fiduciary duty includes an obligation to attempt in good faith to ensure that an adequate corporate information and reporting system exists.
This claim is distinct from a mere bad business decision, which is typically protected by the business judgment rule. A successful Caremark claim requires demonstrating an intentional dereliction of duty or a conscious disregard for known responsibilities, constituting a breach of the duty of loyalty. Directors are exculpated from liability for negligent oversight. The core issue is whether the board made a good faith effort to implement and monitor a reasonable oversight system, not whether that system worked perfectly.
The Three Standards for Liability
A shareholder attempting to prove a breach of oversight duty under the Caremark standard must demonstrate one of two distinct paths. The first path, the “Information Systems Claim,” involves the board’s utter failure to implement any reporting or information systems. This means the board failed to establish a mechanism for gathering information on legal compliance and business risks.
The second path, the “Red-Flags Claim,” applies when a system is in place, but the directors consciously fail to monitor or oversee its operations. This failure effectively disables the board from being informed of risks or problems that demand their attention. For instance, if a compliance system generates warnings, but the board deliberately ignores them, this satisfies the second standard.
In both paths, the plaintiff must prove the directors acted in “bad faith,” demonstrating a knowing or intentional failure to act. This requires showing the directors knew they were not fulfilling their oversight obligations or demonstrated a systematic, continuous failure to oversee and monitor over time. The focus is on intentional failure, not simply a negligent failure to prevent a loss.
Bringing a Derivative Action
A Caremark claim is nearly always brought as a derivative action, meaning the shareholder sues on behalf of the corporation itself, not for personal damages. Any financial recovery from the directors goes back to the company, addressing the harm suffered by the corporation due to the alleged breach of duty.
Before filing a derivative suit, the shareholder must satisfy the “demand requirement.” This mandates that the shareholder formally demand the board of directors take action itself to remedy the alleged harm. The board can then choose to pursue the claim or refuse it.
If the shareholder does not make a demand, they must plead with particularity why such a demand would be futile. To plead “demand futility,” the shareholder must present facts showing that a majority of the board members face a substantial likelihood of personal liability for the oversight failure. This demand requirement is a significant barrier, as courts are often reluctant to infer that directors acted in bad faith.
The Judicial Standard for Success
Caremark claims are widely recognized as the most difficult corporate claims for a plaintiff to successfully pursue. Courts apply an extremely high pleading standard, often referred to as the “outer limit of director liability,” because they grant significant deference to the board’s decisions under the business judgment rule.
To succeed, the shareholder must demonstrate a “sustained or systematic failure” of the board to exercise oversight, amounting to an “utter failure” to act. A bad outcome, even a catastrophic one, does not automatically equate to a Caremark violation; the plaintiff must prove the directors acted with the requisite bad faith or intentional disregard. The claim is reserved for the extraordinary case where fiduciaries’ conscious disregard of the law gives rise to corporate trauma.
This rigorous standard prevents directors from being held personally liable for general business mismanagement or for failing to anticipate every possible risk. The focus remains on whether the board made a good faith effort to establish and monitor compliance systems, as recent cases affirm that the bar for proving this intentional failure remains exceptionally high.