Fracking in a World With Fiduciary Duties: a Suggestion for the Future
| Publication year | 2020 |
Fracking in a World with Fiduciary Duties: A Suggestion for the Future
Kathryn White
Big businesses are regulated by a variety of sources. Depending on the industry, influencers and regulators range from local municipalities to agencies of the federal government. This Comment seeks to analyze the In re Clovis Oncology, Inc. decision, and the clear message the majority opinion sends to directors and agents of corporations: one's fiduciary duties are indispensable obligations, irrespective of the occupational field at issue. By applying the Clovis principles to fracking companies, this Comment will encourage proactive, dynamic, and bold directors to change their reporting requirements before a shift in societal interests and concerns could expose them to liability.
Beginning with a brief introduction into Clovis itself, this Comment will proceed by providing background information regarding fiduciary duties and the momentous Delaware Caremark case, in which the court produced tests for breaches of those obligations. The focus of the piece will then shift to the topic of hydraulic fracturing by analyzing the federal and state provisions that are in place to regulate the fracking industry, and the potential reverberations that the industry may feel from the Clovis opinion. The main argument of this piece rests on the idea that the regulations imposed on these large corporations, and therefore the directors and agents of those companies, are negligible and leave room for exploitation or abuse despite extreme environmental and health concerns related to industry practices. The Comment concludes by suggesting that states should impose more stringent and transparent reporting regulations on fracking operations, and that directors of these large oil organizations should make certain changes to their own documentation habits in order to proactively, as opposed to reactively, minimize the potential for future litigation and damages.
Clovis Oncology is a relatively small "biotechnology company focused on acquiring, developing and commercializing cancer treatments in the united States, Europe and other international markets."1 The company was founded in 2009, and within five years was conducting itself in a way that exemplified
[Page 108]
flawed business practices.2 The "Relevant Period", as defined by the complaint, spans from "February 26, 2014, through the initiation of . . . litigation."3 The behavior of the directors, and the courts treatment thereof, is particularly pertinent to this Comment.
"During the Relevant Period,. Clovis had no drugs on the market but did have three drugs in development. Of these, Roci was the most promising."4 Cash flow into the company was marginal, if any occurred at all, and as such "Clovis 'reli[ed] solely on investor capital for all operations.'"5 The company anticipated that Roci would be profitable, but members of Clovis' Board knew the only way to secure a sizable return would be to obtain FDA approval of the drug, Roci.6 "[T]he Board was hyper-focused on the drug's development and clinical trial . . . [and members of the] Board . . . were 'regularly apprised' of the drugs progress."7 For approval by the FDA, "new drugs like Roci . . . must prove their efficacy and safety in clinical trials."8 Such trials were designed to track "the percentage of patients who experience meaningful tumor shrinkage when treated with the drug."9 These numbers are known within the field as "ORR", or "the objective response rate."10 Members of the Board knew that in order to generate public excitement, encourage investor participation, and guarantee FDA approval, Clovis' ORR numbers would have to be promising.
[T]hroughout the Relevant Period, Clovis' press releases, investor calls, Securities and Exchange Commission ("SEC") filings and statements to medical journals reinforced the belief that Clovis was reporting a confirmed ORR of about 60%. . . ."11 Meanwhile, "the Board received reports indicating Clovis was improperly calculating Roci's ORR."12 For months Clovis continued to produce and publish inflated efficacy numbers, and reported the same values to the FDA. "The conflicting reports regarding Roci's ORR eventually prompted the FDA to ask questions and to call for a meeting with Clovis executives. . . ."13 Shortly thereafter [t]he public was finally informed of Roci's true ORR
[Page 109]
when . . . Clovis issued a press release stating the correct confirmed ORR was as low as 28-34%."14 Following these revelations the company's stock value plummeted "70%, wiping out more than $1 billion in market capitalization."15 A few months later "the FDA voted to delay action on Clovis' . . ." new drug application, prompting the stock price to fall an additional 17%.16 Yet, Clovis' problems did not end there.
"In addition to the Company's refusal to properly report ORR, the Board was advised that Roci had serious, undisclosed side effects and that the . . . trial had been compromised by other clinical trial protocol violations during the Relevant Period."17 The Board of directors was aware "that one of the drug's side effects, QT prolongation, was more common than management publicly reported. Specifically, the Board received a report . . . that a grade 3 out of 4 (indicating a severe response) QT prolongation occurred in 6.2% of patients."18 Such was very misleading to prospective consumers and investors, because it appeared to promise a drug with "manageable side effect[s]", which was inaccurate.19 A series of class actions suits arose against Clovis directors, all of which alleged securities fraud.20 "One of these cases was settled for $142 million in cash and Clovis stock."21 A derivative suit, followed, in which shareholders alleged rampant breaches of fiduciary duties on behalf of the directors of the corporation.22 In particular, shareholders alleged that the reporting was inaccurate and insufficient in violation of the duty of care.23 Seeking recovery for losses, the plaintiffs successfully brought forth a Caremark claim based on those allegations, which is the foundation for this Comment's suggestions.
A. Introduction to Fiduciary Duties
The business judgement rule (BJR) is a presumption that in making business decisions, directors and officers act on an informed basis and in good faith, i.e.,
[Page 110]
in the honest belief that their actions are in the best interest of the company.24 The BJR protects directors and officers of corporations from liability when they make honest mistakes, but it cannot protect against all liability.
A fiduciary duty exists when one enters into an agency relationship, which is established by mutual agreement.25 In the context of businesses, this is often exemplified by a manifestation of consent by a principal to an agent that the agent shall act on the principal's behalf and shall be subject to the principal's control.26 Consent of the agent to this arrangement is also necessary, though it is important to acknowledge that an agency relationship can be established without a formal contract. 27 In large corporations, typically the officers and managers of the companies act as agents, while the board of directors hold the position of principal.
In managing a business, particularly one that is publicly traded, business decision makers owe a duty of care, a duty of loyalty, and a duty of good faith to those who are shareholders of the corporation and the public.28 A breach of the duty of care is exemplified by an officer or director who makes uninformed decisions or fails to conduct adequate oversight of business practices.29 A breach of the duty of loyalty is slightly different, an illustration of which would resemble a director or officer whom competes with their own corporation, usurps a corporate opportunity, or completes a conflict of interest transaction.30 In contrast, "[t]he duty of good faith stands for the principle that directors and officers of a corporation in making all decisions in their capacities as corporate fiduciaries, must act with a conscious regard for their responsibilities as fiduciaries."31 That being said, "[a] violation of the duty of good faith may include an intentional derelict in the usual duties of an director or officer, intentionally acting for a purpose other than the benefit of the corporation, or intentionally violating the law."32 While "there is no private shareholder right of action for a violation of the duty of good faith, its violation may also raise a
[Page 111]
claim under the duty of loyalty."33 Should any of these events occur, harm to the corporation and its shareholders is presumed, and the business entity itself may consequently sue the breaching director. Such is a process known as a derivative suit, in which the shareholders sue to vindicate the corporation.34 If there has been a breach of these fiduciary duties, the BJR will not protect directors or officers from liability. Given the intricate relationship between these obligations and corporate officials, it would seem logical to assume these duties apply in equal force across all corporations, whether a thriving multinational oil and gas corporation, or a pharmaceutical company. A derivative suit is the exact remedy sought by the shareholders of the Clovis nightmare, and the duties imposed on directors of large companies are central to this entire piece. For that reason, this brief introduction was necessary before further analysis of a Caremark claim could be completed.
B. Introduction to Caremark
In re Caremark provides a framework with which courts can analyze the conduct, or lack thereof, of officers in the course of their employment. To be clear, courts have held that in order "to satisfy the[ir] duty of loyalty, directors must make a good faith effort to implement an oversight system and then monitor it."35 Such a requirement...
To continue reading
Request your trial