Health Care Corporate Governance: Recent Developments from Delaware Case Law

Rob Gerberry, Senior Vice President and Chief Legal Officer, Summa Health, speaks with Michael Peregrine about recent Delaware case law on issues related to director conduct, illustrating the nexus between recognized case law and corporate governance standards. They discuss a few recent decisions from the Delaware courts and their implications for corporate governance.

Watch this conversation: https://www.youtube.com/watch?v=CpjSe66ARaY

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Transcript

SPEAKER_00 0:04

This episode of AHLA Speaking of Health Law is brought to you by AHLA members and donors like you. For more information, visit American Health Law.org.

SPEAKER_01 0:16

Hello, everyone. This is Rob Gerberry. I'm the Chief Legal Officer of SUMA Health and the president-like designate of the American Health Law Association. I'd like to welcome you to the latest in our continuing series of podcasts on corporate governance issues affecting healthcare organizations. Today's episode involves a topic we've touched on several times during the run of this podcast, and that relates to the nexus between recognized case law and corporate governance standards. In particular, we're talking about Delaware case law today and issues that relate to director conduct. As many of our listeners are aware, Delaware has what we refer to as a unified corporate law statute. In other words, not for profit corporations incorporated under Delaware law are subject to the same statute the Delaware general corporation law that applies to for-profit corporations. There may be many reasons for a non-for-profit corporation to incorporate under the DGCL. And we'll talk about those reasons in a future podcast. But for today, we want to discuss the relevant governance aspect of Delaware law, the steady volume of governance-related judicial decisions that have been issued by its courts. Even though these decisions are binding on healthcare companies organized under the DGCL or otherwise domestic Delaware, but they're often influential to courts and to regulators in other states who are called upon to address governance issues. This is primarily because the unique business law experience of the Delaware judiciary in the volume of cases they address some topics that touch on corporate governance standards. And because of that, corporate governance advisors frequently refer to these Delaware decisions when advising their own clients. So today we're going to touch on a trio of recent decisions from the Delaware courts that may have implications for corporate governance advisors as well as for companies supported by HLA members and help us discuss these issues. As always, we're joined by my HLA colleague, Michael Perrigan, who is an HLA fellow and a fellow of the American College of Governance Council. So, Michael, we've touched previously on podcasts related to Delaware decisions affecting such issues as books and records requests, director's duties of candor to his fellow directors and to the company. What do we have on our docket today?

SPEAKER_02 2:31

We've got a couple of pretty interesting cases considering CAREMARC claims, which are always good to review, especially as they relate to stuff like risk oversight and I think especially the quality of internal risk information reporting requirements. And we've also got one that involves a little bit of backhanded dealing amongst the members of leadership.

SPEAKER_01 2:53

So beyond you and I, this sounds juicy, right? And let's get right into it.

SPEAKER_02 2:57

That's right. And and Rob, as a preface, I want to underscore for our listeners uh something you said before. Obviously, Delaware uh law applies to organizations incorporated Delaware, but I I can't underscore enough the extent to which uh Delaware these Delaware cases have received deference by courts and regulators, for example, state jury officials in other states. Um it really, you know, if if your executive asks the question, why are you citing Delaware law? It's because there's a lot of it, and and uh by far and away, Delaware courts have a huge library of decisions affecting uh corporate governance issues, and that's where other state law courts and regulators are going to look to. So we really need to care about it. But as far as what you said, yeah, I call it the case of the sneaky meeting agenda. Um, the background was uh an attempt by three members of a five-person board to remove the other two directors from their officer positions, not their director positions, their officer positions, and they tried to do it at a special meeting of the board. Pursuant to Delaware law, the three board members pursued confirmation that indeed, you know, after the meeting had been held, the two directors had actually been validly been removed from their officer positions. In other words, a belt and suspenders approach. Now, the defendants opposed litigation in part on the basis that the agenda for the special meeting was misleading, that it, and this is, I think, really important, that it failed to reference the removal action, and in fact suggested that the officer duties of at least one of the directors was going to be broadened. And the Court of Chancery agreed, uh, holding that the meeting notice was duplicitous, voided the vote, and restored the directors to their prior officer roles.

SPEAKER_01 4:40

So, Michael, for a special meeting like that, I've rarely seen that type of agenda get that messed up.

SPEAKER_02 4:45

Well, I think that's one of the things that our podcast listeners want to listen to. It's you know how much time is spent on the board agenda and the importance that's attributed to the description. Here, according to the Chancery Court, uh you mess up an agenda when you pull your punches about what you intend to do at the meeting. In this situation, and the court decision went into a lot of detail about this, the stated purpose of the meeting was to discuss how to effect a better governance and transparency to the company. Rob, I gotta tell you, that's kind of something that I think I would draft if I was told by the client. Don't let anybody really understand what the purpose of the meeting is. Um, there was no reference made to officer removal in the agenda items. Rather, they they focused on stuff that was, you know, on your face, appeared to be run of the mill. Review of requests for financial statements and records, discussion of alleged unauthorized transactions, proposal for new signatory protocols, uh, role expansion for one of the uh director officers, and additional matter, you know, catch all additional matters raised by board members or shareholders in good faith. Real generic stuff. Nothing that would have signaled to a director that something more detailed and and and severe was on tap. Now there was some agenda in the the the court said there's there was some evidence that agenda-related communications amongst the members of the board occurred before the meeting, but but none of it again related to the removal of the officer positions. In fact, the the court pointed that that while the possibility of potential areas of concern was raised by one of the directors, the evidence uh uh indicated that the described meeting notice was really it contained no action or no accusation of wrongdoing against any individual, but was just simply an informal invitation to clarify and remedy governance shortfalls, kind of like putting governance effectiveness on the board agenda. You know, it's just super broad. Um the court also noted that the direct targeted directors were invited to submit any contrary evidence and agenda it additional agenda items ahead of the meeting. I guess the suggestion was, hey, we're gonna give you your chance. Um, you know, but uh apparently the relations between the board members cooled right before the meeting, and the two directors decided declined to show up uh due to tight schedule. So it was a real, you know, a lot of bad blood there.

SPEAKER_01 7:12

So so much for a good inner board culture that promotes strong governance.

SPEAKER_02 7:17

Well, I you you wonder whether the meeting results ultimately came as a surprise to the two directors. But that whatever the case, the the point to our podcast listeners was the Chancery Court was really pissed. Uh it noted that there were no meeting minutes to substantiate what occurred. Uh while the court ruled that the meeting notice itself satisfied the company's bylaws, it held the actual vote to be invalid. It called it, Rob, a bait and switch that concealed plaintiff's real intention to remove the directors as officers. Um, it then held that the defendants remained officers of the company, underscoring its view that equity will not abide such duplicity towards fellow directors. Fair notice fosters a genuine deliberative process. A purpose was subverted here. That's a lot of tough language. Uh bait and switch, uh, equitable, duplicitous, subverted. I I'm not sure you want to have that uh in an opinion against you.

SPEAKER_01 8:18

So, other than an angry judiciary, Michael, what's the key takeaways that you'd share with our listeners? Um you don't play games with meeting notices, or is it broader?

SPEAKER_02 8:27

Well, yeah, actually, that's one of it. You know, we talk about a lot of really fascinating things in these podcasts, meeting minutes and duties of candor and things like that, which are just super stimulating to so many people. But there are a couple things here which I think really, you know, it's one of those situations, Rob, where I think that the the uh uh the the simple nature of the case hides a lot of important messages that go to what some people might think as routine duties. The little stuff when it comes to corporate governance really matters. Number one, were minutes taken, whether the bylaw provisions dealing with notices were filed. Rob, when was the last time you looked at your bylaws and how they handled special and re and regular meetings and the issuance of notice? I bet you read that, that's under your pillow every night, isn't it? Um whether the, you know, another thing, what whether the meeting is accurately described as regular or special. I caught that caught my attention too. Do we do that enough? And then the board, you know, the court also got into the question of board frequency. Does the board meet frequently or not? Um, but in the context of this decision, obviously meeting notices matter. They need to be truthful and accurate. They need to be consistent with the bylaws, so you better check that section. They shouldn't play hide the ball. Uh they sh and you know, I got to admit, Rob, I have been in situations working with the with the chair and the CEO and the chief legal officer on the agenda where the you know the the uh there's a request from somebody to to try and make bylaw agenda uh excuse me, agenda items as nebulous as possible. Uh that's that's a no-go after this case. You just don't do that. Uh you'll get caught and your reputation at the very least will suffer. You know, the other thing is what constitutes equitable and non-equitable behavior in the context of corporate governance is brought up here. It covers a wide area, and I think it says the message that if you're trying to jerk somebody around, judges aren't going to be fooled. And so I think that the case, you know, it carkens back to the podcast we had last fall about the duty of candor. It just talks, it really it it this case invokes a much broader set of concerns than just trying to remove officer titles. It's the kind of thing that I'd want to flag uh uh with the corporate secretary and whatever group uh works on um meeting agendas and things of that nature.

SPEAKER_01 10:41

So, Michael, as we look at the CAREMAR case, the one my law students love to cite on all those exams.

SPEAKER_02 10:46

Yeah.

SPEAKER_01 10:46

Does that apply in this situation?

SPEAKER_02 10:48

Well, Rob, do you catch them when they use AI to do their law school exams? Or uh well, maybe maybe we'll do that. That's actually in our next podcast. We'll get to that. Um before we dig into the care mark cases, uh I think we need to remind everybody that there are essentially uh two prongs or two ways to prove a Claremark care mark claim. You know, these cases always come up in the context of a motion to dismiss a derivative action, usually. Uh, and also want to emphasize that care mark claims are still amongst the most difficult claims to prove under Delaware law, uh, getting in decreasingly so. But the the two prongs are first, that the directors or officers utterly failed to implement any reporting or information system or controls to facilitate board oversight. They call that the information systems claim. Uh, the the other uh prong is that having implemented such a system or controls, uh the board consciously failed, consciously failed to monitor or oversee its operations, thus disabling themselves from being informed of risks or problems requiring their attention. That's the so-called red flags claim. I also think it's important for our podcast listeners to remember that a couple of years ago, the Delaware course expanded the application of CAREMARC to uh include not only directors uh but executives who are officers of the company. You know, that's uh if nothing else from these cases, Rob, I think that's a good reminder for the CLO to executive officers that they too are held to these standards. So uh again, that's the that's the background of of these KARAMARC allegations.

SPEAKER_01 12:27

That McDonald's case did get our executive officers' attention as well. I appreciate you saying that, Michael. So when we look at these two prongs, which one applies in this situation?

SPEAKER_02 12:37

Well, we're actually both. And in the one of the cases involved claims against the former officers and directors of a pharma company that they didn't monitor regulatory risks facing the company, and you know, the failure to do that was a contributing factor to its subsequent bankruptcy. This wasn't the usual derivative-based claim, but it was one that was instituted by a court-approved uh plant administrator, um, which uh goes to some of the uh issues in the case. Both prongs were pled in this action. The court ruled for the plaintiff on the first prong, the information systems prong, holding that there, you know, that the sufficient facts were pled to indicate, and that's the standard. Did you plead for uh facts that were sufficient to overcome any uh presumption to the contrary? Um the the just the argument was despite the intense regulatory environment in which the company operated, and we as health lawyers can all sympathize, um uh the the board had essentially hit what I would call a reverse triple play of noncompliance. In other words, number one, the facts showed no board committee was overseeing the central compliance risk or regulatory risks of the organization. There were no processes or procedures requiring management to keep the board posted on such risks, and there were no uh sets of regulatory or compliance risk training for employees. I don't know, Rob, if you ever used the emoji with the palms of the forehead. That's immediately what I thought, like, what are these guys doing? But you know, apart from that, what was interesting in this particular case was the was the court concluded that in the absence of any evidence that the board actually got from management information that might constitute a red flag, they couldn't infer that the board had received such information and ignored it. So what happened was that the strength of the first claim, that there was no information systems reporting, knocked out the second claim, the red flag claim. But you know, you only need one uh uh allegation to succeed, but it was kind of funny how they get the intersection of the two uh prongs of the Keramark claim. There is one other point uh that to raise from this particular case. Um, red flag oversight claims against two corporate officers were sustained on the basis of internal emails that indicated that they had discussed how to minimize compliance risk information to the board and then ultimately to the FDA. Who who talks about this stuff? Who's you know, uh the the truth will set you free, I guess. But it's one to remember if you're talking to an executive at an officer level, is to say, you know, don't even think this stuff because you you you'll you'll make a mistake and you'll get caught. This was an expensive mistake.

SPEAKER_01 15:18

So those key uh takeaways from this case would be?

SPEAKER_02 15:22

Well, I think the usual care mark ones apply, you know, that it remains just critically important to assure the vitality of a corporate compliance system and that it works to provide the board with unfiltered information on central compliance risks. To that point, regular education on what may constitute a red flag is a big deal. And, you know, I wouldn't go light on that. And as we've preached often on this podcast, accurate minute taking can play a huge role in confirming the board and officer level of consideration. You've got minutes to say we talked about it, we talked about it in detail, you know, to X, Y, and Z. Here there wasn't anything.

SPEAKER_01 16:00

So, Michael, you've got a great pulse on our industry. As you look across our national landscape, are you really thinking there are companies out there that don't have these compliance and reporting systems in place?

SPEAKER_02 16:09

Oh, absolutely, 100%. Uh I worry that in some companies, compliance is perceived as a frictional cost, um, that too many officers and directors don't see it as providing value to the company and essentially ignore the lessons of the past. You know, uh it's been 20 years since uh the Enron, World Commons, Sarbanes, and a lot of those people have left the boardroom. A lot of those people who knew what those cases were about have left the executive suite. And I also believe, you know, it's human nature, Rob, that there remain this, you know, what they called in Enron, the smartest guys in the room, the the folks who are bold enough to play hide the ball in what they report upstream to the board, like the executives here. But then again, I'm something of a scold on this stuff. But to answer your question, sure. Every time you think that this concept of compliance is universal within the health system, you read a case like this where there were just nothing, zero, nada, and you've got executors talking and typing on the email about how to play hide the ball with the board.

SPEAKER_01 17:05

So, Mike, let's move on to the other decision that you referenced. What do you see there?

SPEAKER_02 17:09

Well, it's a super interesting one to me, and you can fill in what whatever you want to say about what my personal interests and psychodilios are. But I thought it a fascinating case because it goes to the heart of the what might constitute a red flag in a particular circumstance. And this is again what I think would be relevant to our listeners. In this situation, the essence of the claim was that the board of a financial institution had failed to adequately evaluate and respond to three different notices that the plaintiff's claim should have warned the board to the potential that the bank's overdraft uh policies violated federal law. Um, and the bank ultimately paid a penalty of over$190 million for this. I love bank policies. I was a collector uh of indirect and direct car loans when I was uh at TCU, and so I get all excited about stuff like overdraft rules and things of that nature, what banks can and can't do. But that's beside the point. The notices here included a letter from U.S. senators. I mean, okay, a couple of senators write them a letter on this stuff, okay, a consent order with a regulatory agency, and a draft whistleblower complaint that was prepared by the bank's former general counsel. I suspect a number of our podcast listeners are now getting excited. Um, the court distinguished the first two notices on the basis that they were, you know, vague, they were exploratory in nature or or talked about violations of a separate federal law. But the draft whistleblower complaint was the real deal. Allegations from the former general counsel who had been fired, that the banks continued was to have problems uh uh with the uh implementing the policy on overdraft and that they were dragging it out for financial reasons. What's really interesting here, Rob, is that the court found a red flag claim, even though the draft complaint was considered by the board's audit committee. I want to repeat that. The board had asked the complaint to be sent to the audit committee, which looked at it and which it engaged outside counsel to invest the allegations. Ultimately, the issue was the board took no action. I think that's really important, and that's why I think this case might be a very useful subject for discussion by the board's audit committee.

SPEAKER_01 19:25

Yeah, Michael, I might have thought that the work of the audit committee might have gotten the directors off the hook with them delegating that important responsibility to that board committee.

SPEAKER_02 19:33

Well, I think that's one of the special takeaways in this case, Rob, beyond the basic red flag evaluation. The board or here, its audit committee, should always help assure the adequacy of investigative council review and then have a really, really, really good reason if it subsequently chooses not to take action. I'm not saying that it can't say we've got it, you know, peregrine, nice report, we don't agree, we're not going to take action. I'm saying you go the next step peregrine, we like your report, we're not gonna take action because X, Y, Z, W1, Two, Three, Supercalifragilic SBLDOCus. There's no question that the court gave a greater level of credence to the fact here that the whistleblower was a former in-house counsel. And I think that should be understated, uh, excuse me, uh underscored. Uh, and even if they the guy had an axe to grind, which uh because he had been terminated, which was referenced in you know in some of the evidence that there was a clear feeling by the board and the committee that you know they discounted it because this guy had a beef with the company. The other thing was important here was that the court also found bad faith, which is a prerequisite here, in the length of time between the when they got the investigative report uh and the decision on the to act on a whistleblower complaint. So I, you know, um I I think the key th takeaway here is as you said, is just because you punt the the uh this facts to the audit committee uh isn't an automatic uh free pass. It's what you do, and it really relates to the process, what the audit committee or other special committee considers. And again, if the board decides to take no action, there's great clarity on its decision why not to do so.

SPEAKER_01 21:16

So, Michael, at least our members forget the value of these podcasts, you humming a couple of bars of Mary Poppins, that's got to be value in itself.

SPEAKER_02 21:23

I had a crush on Julie Andrews, Rob. That's just that's just that's another podcast episode.

SPEAKER_01 21:28

So before we break today, I recall there was one other Delaware care mark decision that you wanted our listeners to be aware of.

SPEAKER_02 21:35

Yeah, Rob, you you're right. Uh and I I want to say first of all, it's a it's a significant case. And these are all cases over the last couple of months. This one's a tough one because it involves really um really difficult uh allegations of sexual harassment uh and uh disgusting count uh uh action by uh corporate officers. Uh and you know we it A truly egreso, egregious and disgusting fact pattern, which you know sometimes when that happens, you say, Well, I'm this case is distinguishable because this was just super gross stuff. Um, but it's an important case uh because it does involve circumstances in which care mark might apply to allegations of sexual harassment and and potentially other employment misconduct claims. There, there's there's there's this policy push uh or conflict. You know, if we we want to acknowledge the importance of monitoring uh sexual harassment claims and to support policies that prohibit that. But at the same time, we don't want to have a standard of so law regarding KARIMARC applying to employment misconduct that, you know, it just opens the floodgates to it to every minor complaint. This is a case that's going to undoubtedly go to the Delore Supreme Court, so it's it's worth monitoring. But again, it's still worth uh talking about for a couple reasons. It was a KAREMARC claim, among other claims, there was a fiduciary duty of loyalty claim, too, that the board of directors of a company involved in the modeling business, and of course, that should raise the hackles in the uh uh and back around neck, um, that, and it included graphic allegations of sexual assault and misconduct by senior executives that were reported to the board, especially by a director who in himself was a whistleblower. Uh both prongs of KARAMARC were pled, and the Chancery Court sustained the red flags claim. Didn't even get to the information claim systems claim because it felt it unnecessary. Um the allegations on which the court made its decision uh to the court credibly pled facts, and again, that's the standard, that showed uh it it made it reasonable to infer that the board effectively did nothing in response to company-wide allegations of drugging, rape, and sexual assault that were at the heart of the red flags. Again, really disgusting stuff, but the the bottom line is that the the facts uh suggested that there just was nothing done by the board uh with respect to the allegations. And that's and that's again shocking under the circumstances, but these things do happen.

SPEAKER_01 24:21

So, Michael, what's so unique in the legal doctrine or takeaways from this case when we think about it? Is it just another example of a board asleep at the switch?

SPEAKER_02 24:29

Yeah, well, first of all, it's a reminder that that does happen, but I think it's special for a couple of reasons. First, it's different from the McDonald's case a couple of years ago, which we may have talked about in one of our podcasts back then. Some might remember because that case focused primarily on the adequacy of the board's response to the red flags of sexual harassment by corporate officers. Remember, that was the one where uh much of the complaints were leveled not only at the CEO, but also the VPHR, which is you know unbelievable. Um, and the court in that case uh uh confirmed the adequacy of the McDonald's board response. In this case, facts were pled that inferred that the board responded to the allegations with inaction. And this is what the court said called it deliberate heel dragging campaigns of concealment, deliberate heel dragging and a campaign of concealment. It's also important because the underlying action was sufficient to sustain a separate duty of loyalty claim against the senior executive officer and uh of the organization. But third, this is what I think we really want to mention to our listeners, it underscores the Delaware court's willingness to extend CAREMARC to some kinds of claims that the board ignored, warning signs of employee workforce misconduct. Now, how the Supreme Court deals with this question, the Delaware Supreme Court will really be important. Again, because of the concern that's out there that routine employee misconduct cases not give unwarranted rise to director liability. So, again, you know, uh I think the reason we wanted to raise it is uh not because of the egregious facts and not because of the uh campaign of concealment, but because it goes to the issue of to what extent uh do do warning signs of employee workforce misconduct uh fall within a red flag. That's something I think uh the chief legal officer meeting with its employment counsel uh should should be addressing for the board. I I can't underscore that enough. There are technical areas here I think that fall into labor and employment law where a competent uh labor attorney should be uh uh on the speed dial of the CLO in this situation.

SPEAKER_01 26:46

Well, Michael, thank you as always for sharing these great learnings with our audience. I want you to feel comfort knowing that I've been taking effective minutes of this conversation. There we go, documented, but in all seriousness, you've highlighted today a variety of ways in which the board actions can place officers and directors at risk and why the chief legal officer does play such a key role in making sure that we advise on a wide range of activities, ranging from agenda preparation, minute taking, to spotting these red flags as we see things that are organizational risk. Next month we'll be back with our next governance podcast discussion. We plan to focus next month on AI-related developments, including the possibility of enterprise risk arising from some of these latest technological developments. So for now, thanks to everybody for joining us and listening today. And Michael, thank you again.

SPEAKER_02 27:32

Thank you, Rand.

SPEAKER_00 27:38

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