In re Caremark Intern. Inc. Derivative Litigation

Brief Fact Summary.

A managed healthcare provider, Caremark International, Inc., entered into contractual arrangements with hospitals and physicians, often for “research†or “consultation,†before clarifying the unsettled law surrounding prohibitions against referral fee payments.

Synopsis of Rule of Law.

A board of directors has an affirmative duty to attempt in good faith to make sure that a corporate information and reporting system is in place and is adequate.

Facts.

Caremark International Inc. (Caremark) participated in providing patient health care and managed healthcare services.  Much of their revenue came from third-party payments, insurers, and Medicare and Medicaid reimbursement programs.  The Anti-Referral Payments Law (APRL) applied to Caremark and prohibited payments to induce the referral of Medicare or Medicaid patients.  Caremark was involved with entering into service contracts, including consultation and research, with physicians who sometimes prescribed Caremark products or services to Medicare recipients.  Although the APRL did not prohibit these contracts, this practice did raise the issue of unlawful kickbacks.  Caremark’s board of directors (Defendant) tried to monitor these contracts internally by seeking legal advice and devising employee guidelines.  However, the government began an investigation of Caremark.  In response to the investigation, Caremark began making structural changes to centralize management.  Nevertheless, Caremark and two officers were indicted.  This was followed by the filing of derivative actions by several shareholders who charged Defendant with failure to adequately monitor as part of its duty of care.  Negotiations for settlement began.  In the settlement, Caremark agreed to stop all payments to third parties that referred patients to Caremark and to establish an ethics committee, which it had effectually already done.  Caremark also agreed to make reimbursement payments to private and public parties that totaled $250 million.  All other claims in the proposed settlement were waived.  The proposed settlement was submitted to the court for approval.

Issue.

Does a board of directors have an affirmative duty to attempt in good faith to make sure that a corporate information and reporting system is in place and is adequate?

Held.

(Allen, Chan.)  Yes.  A board of directors has an affirmative duty to attempt in good faith to make sure that a corporate information and reporting system is in place and is adequate.  Generally, directors do not monitor day-to-day operations in a company.  The Supreme Court has said where there is no basis for suspicion, directors cannot be liable.  It would, however, be extending this holding too far to say that directors have no obligation whatsoever to determine whether or not they are receiving accurate information.  The duty of care implies that a board will make a good faith effort to ensure that a corporation’s information and reporting system is adequate.  Here, acts that resulted in indictments do not, by themselves, establish that the Defendant was not adequately monitoring corporate behavior.  On the contrary, Defendant appears to have been making structural changes all along in order to gain greater centralized control of the company.  Also, well before a settlement was reached, an ethics monitoring group was in place.  The settlement is fair, given that the evidence on record suggests that success in the derivative suit was unlikely, but that Caremark gave up little in the way of concessions not already in place.

Discussion.

A board is not required, by a duty to monitor, to be aware of all the details of a corporation’s activity.  In fact, in a large company, such oversight would be physically impossible.  However, the duty does require the board to be aware of major activities and related issues that could potentially threaten the company.  The choice of what structure to use in information gathering is still subject to the safe harbor of the business judgment rule.  A claim that the duty to monitor has been breached, therefore, is extremely difficult to successfully prove.