Following this summer’s much publicized decision by the Delaware Supreme Court in the Marchand v. Barnhill (Blue Bell Creameries) case1 (see our prior post), the Delaware Court of Chancery’s holding in In re Clovis Oncology, Inc. Derivative Litigation2 earlier this month serves as a second recent reminder to directors of their duty of oversight obligations. This time, the case involved the second prong of Caremark, and the court found another well-pleaded Caremark claim where plaintiffs alleged that the board of directors of Clovis Oncology, a publicly traded biopharmaceutical firm focused on acquiring, developing and commercializing cancer treatments, “ignored multiple warning signs” that management was inaccurately reporting the efficacy of a trial drug in violation of internal trial protocols and related Food and Drug Administration (“FDA”) regulations with respect to a product that was “intrinsically critical to the [C]ompany’s business operation.”3
As a brief reminder and as set out more fully in our prior post, Delaware’s seminal Caremark decision establishes the conditions for director oversight liability: “(a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.”4 In the Marchand case, which involved a company that was not publicly traded, plaintiffs successfully pleaded under the first Caremark prong, with the Delaware Supreme Court holding that the stockholder’s complaint pleaded “particularized facts that support a reasonable inference that the Blue Bell board failed to implement any system to monitor Blue Bell’s food safety performance or compliance.”5
Like Blue Bell Creameries, Clovis had a monoline business model. As ice cream was to Blue Bell Creameries, Clovis’ Rociletinib (“Roci”) drug candidate to treat lung cancer was Clovis’ mission critical product. Roci was under development in a trial dubbed “Tiger-X,” which incorporated the well-known clinical trial protocol “RECIST,” a “preferred and accepted system for use in new drug applications to regulatory agencies” and one that would, according to plaintiffs, “give investors confidence in the Company’s reported results” by facilitating “comparisons between [Roci] and competing therapies.”6 Moreover, RECIST established the criteria defining success for the clinical trial, called objective response rate (“ORR”), which is important to investors, the FDA and future prescribers of the drug, and was the primary metric of focus in the case.
Unlike in Marchand, the Clovis plaintiffs acknowledged that Clovis’ Nominating and Corporate Governance Committee was specifically charged to provide “‘general compliance oversight . . . with respect to . . . Federal health care program requirements and FDA requirements’” and that the Board received and reviewed detailed information about the drug trial at each meeting.7 Accordingly, the Clovis plaintiffs pleaded under Caremark’s second prong, which requires alleging that the board failed to monitor an oversight system that it put into place. Specifically, a plaintiff “must well-plead that a ‘red flag’ of non-compliance waived[sic] before the Board Defendants but they chose to ignore it.”8 The “court must remain mindful that ‘red flags are only useful when they are either waived[sic] in one’s face or displayed so that they are visible to the careful observer’ [and], as Marchand makes clear, the careful observer is one whose gaze is fixed on the company’s mission critical regulatory issues.”9 The Clovis plaintiffs alleged particularized facts to support their Caremark claim, which allowed “reasonable inferences” by the court that:
(i) the Board knew the TIGER-X protocol incorporated RECIST;
(ii) RECIST requires reporting only confirmed responses;
(iii) industry practice and FDA guidance require that the study managers report only confirmed responses;
(iv) management was publicly reporting unconfirmed responses to keep up with [a competing drug’s] response rate; and
(v) the Board knew management was incorrectly reporting responses but did nothing to address this fundamental departure from the RECIST protocol.
Though the defendants argued that the FDA “blessed Clovis’ plan to report unconfirmed responses for ‘interim’ results because Roci was on an accelerated approval track,” and that the plaintiffs oversimplified the FDA guidance, at the motion to dismiss stage, all reasonable inferences are drawn in favor of the plaintiffs, and the Delaware Court of Chancery was satisfied that the plaintiffs met their pleading burden.
As the opinion notes, and similar to Marchand, it remains to be seen whether the allegations in these cases will actually hold up in later phases of litigation – discovery, summary judgment or at trial. Neither Marchand nor Clovis alters the duty of oversight in Delaware, though both serve as a stark wake-up call to show that plaintiffs actually can and have satisfied the pleading burden associated with “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.”10 While it will be interesting to monitor how these cases ultimately resolve, the practical takeaway for directors remains that “to satisfy their duty of loyalty, directors must make a good faith effort to implement an oversight system and then [actually] monitor it.”11
3 Id. at 2.
4 Stone ex rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362, 370 (Del. 2006) (citing In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch.1996)).
5 Marchand, 212 A.3d at 809.
6 In re Clovis Oncology, Inc. Derivative Litigation, C.A. No. 2017-0222-JRS at 12 (internal citations omitted).
7 Id. at 37.
8 Id. at 37 (citing South v. Baker, 62 A.3d 1, 16-17 (Del. Ch. 2012)).
9 Id. at 38 (internal citations omitted).
10 Stone ex rel. AmSouth Bancorporation, 911 A.2d at 372 (quoting In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959, 967 (Del.Ch.1996)).