Risk Management

Ignorance Is a Defense

Clarifying its views on director liability, the Delaware Supreme Court will hold shareholder litigants to a very high standard of proof.
Kate O'SullivanFebruary 12, 2007

Directors around the country sighed with relief late last year when the Delaware Supreme Court ruled for the defense in Stone v. Ritter, a lawsuit involving director liability at AmSouth Bancorporation. The court clarified its views on director liability, reaffirming the landmark 1996 Caremark decision that requires a very high standard of proof. Complainants, in short, must show that directors “knew that they were not discharging their fiduciary obligations,” says the court.

Shareholders filed the suit against AmSouth in 2004, after the bank paid $50 million in fines and civil penalties to resolve investigations into its failure to disclose the activities of bank customers who were engaged in a Ponzi scheme. (AmSouth has since merged with Regions Financial Corp.) Plaintiffs argued that AmSouth’s 15 directors had breached their fiduciary duty by failing to detect the scheme. But the court ruled that the directors could be held liable only if they had completely failed to implement any reporting or control structure, or if they had consciously failed to monitor such a system. AmSouth did have control systems in place, and the court found the directors not personally liable.

To win cases against directors going forward, plaintiffs will need to show that directors willfully did something wrong. “Proving simple negligence is not going to be enough,” says William Schuman, a partner at McDermott Will & Emery in Chicago. “What [the Delaware court] is looking for is something very close to intent. It’s a really tough standard to meet.”

The Stone decision may play an important role in what seems likely to be an onslaught of upcoming cases involving stock-option backdating. Rather than suing directors on the simple basis that they allowed backdating to occur, plaintiffs will have to allege that the directors backdated options on purpose. Of course, if a director himself benefited from board-approved backdated options, such an allegation could be easier to prove.