“Bad Things Can Happen to Corporations” – But Officers Cannot Be Liable Absent Bad Faith

In Segway, Inc. v. Cai, the Delaware Court of Chancery dismissed one of the increasingly common breach of fiduciary duty cases brought against corporate officers after last year’s seminal McDonald’s decision, which clarified that officers owe a duty of oversight just as directors do. No doubt reassuringly for those officers, Vice Chancellor Will corrected the “misimpression that an oversight claim pursued against an officer is easier to plead than one against a director.” The opinion definitively confirms that “bad faith remains a necessary predicate to any Caremark claim.”

Segway, Inc. was acquired in April 2015 by Ninebot (Beijing)Tech Co., Ltd., but continued to operate as an independent business and brand. Hong Cai joined Segway in 2015 as a Vice President of Finance, and was responsible for overseeing the Company’s finance department, which included administrative, business planning, tax, accounting, and budgeting functions. Cai became Interim President in December 2015 and was named President in February 2017.  In those roles, she continued to have responsibility for overseeing the same business functions she did as Vice President of Finance.

Not long after the Ninebot acquisition, Segway “experienced declining sales and a shrinking customer base,” which led the Company to pivot away from its existing business lines and downsize operations. In 2020, Segway closed its doors, laid off the majority of its remaining employees, and tasked the remaining employees, including Cai, with “transitioning Segway’s operations” to Ninebot and “ensuring the orderly closing” of U.S. operations. Upon the closure of the Company’s U.S. headquarters in November 2020, Cai was terminated. Ninebot continued to integrate Segway’s financial information, and discovered certain “egregious discrepancies” between information Cai had provided Ninebot during her employment and “the actual numbers in Segway’s financial records.” These errors included, for example, an “excess of $5 million in accounts receivable that were ‘not properly recorded and/or booked,’” which Ninebot was “unable to reconcile” and Cai declined to assist with untangling.

In December 2022, Segway brought a breach of fiduciary duty action against Cai predicated on a breach of Cai’s “duty of loyalty – specifically, her oversight obligation.”  Segway alleged that Cai (1) “knew or should have known that there were potential issues with some of Segway’s customers,” which should have alerted her to the issues with the booking of the Company’s accounts receivable; (2) “continuously ignore[ed]” similar issues “and the resulting impact on Segway’s profitability”; and (3) failed to take any action to address these issues or advise the Company’s board as to their existence.

Vice Chancellor Will questioned whether these allegations were best read as a “claim that Cai breached her duty of care.” But, Segway was “adamant that it only intended to advance a claim for breach of Cai’s duty of loyalty” pursuant to Caremark. The Company argued that McDonald’s allowed Caremark claims to be brought against officers and without a showing of bad faith.

The Court rejected this argument, holding that “[o]fficers will be liable for violations of the duty of oversight if a plaintiff can prove that they acted in bad faith.” The Vice Chancellor then reiterated the familiar Caremark standard and confirmed it applies to claims against a corporate officer:

To plead a viable claim for breach of the duty of oversight, a plaintiff must allege sufficient facts to support a reasonable inference that the fiduciary acted in bad faith. Under Caremark, bad faith can be established when fiduciaries (1) utterly fail to implement any reporting or information system or controls; or (2) having implemented such a system or controls, continuously fail to monitor or oversee its operations, which disables them from being informed of risks or problems requiring their attention.

Vice Chancellor Will further noted that, as explained in McDonald’s, “an officer’s duty of oversight [will generally] only extend to matters within the officer’s remit.”

After rejecting Segway’s reading of McDonald’s, Vice Chancellor Will explained that Segway’s allegations “are an ill fit for a Caremark claim” because (1) no potential wrongdoing within Cai’s purview was alleged; and, even if such wrongdoing within her purview was alleged, (2) Segway “lacks facts suggesting Cai acted in bad faith.” With respect to the alleged wrongdoing, Vice Chancellor Will explained “Segway does not, for example, state that Cai overlooked accounting improprieties, fraudulent business practices, or other material legal violations,” rather “it merely asserts that Cai learned (at some point) about ‘issues’ with unspecified customers, revenue decreases for a product line, and increases in receivables.” “Such generic financial matters are far from the sort of red flags that could give rise to Caremark liability if deliberately ignored.”

Similarly, with respect to bad faith, the Court concluded that “Segway – with 20/20 hindsight – wants Cai to answer for a decrease in sales and an increase in receivables.” However, “[o]versight duties under Delaware law are not . . . designed to subject fiduciaries to personal liability for failure to predict the future and to properly evaluate business risk,” and they are “not a tool to hold fiduciaries liable for everyday business problems.”  Instead, “the Caremark doctrine . . . . is intended to address the extraordinary case where the fiduciaries’ ‘utter failure’ to implement an effective compliance system or conscious disregard of the law gives rise to a corporate trauma,” and “these tenets of the law persist regardless of whether a Caremark action is brought against a director or an officer.”

The Segway decision thus strongly rebuffs recent attempts to expand Caremark liability for corporate officers. It is also a reminder that Delaware courts recognize that “[b]ad things can happen to corporations despite fiduciaries exercising the utmost good faith.”

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.