Hughes v. Hu: Territorial Adjustments in Determining Caremark Liability for Foreign-based Delaware Incorporated Companies

Ian J. Murray

In Hughes v. Hu, the Delaware Court of Chancery addressed the Caremark liability of Kandi Technologies Group, Inc., a Delaware corporation that principally does business in China. The court noted that Kandi’s board of directors did not implement nor maintain sufficient board-level oversight controls for the company’s accounting practices or related-party transactions. Therefore, the court correctly held that Kandi’s board of directors faced a substantial threat of liability under Caremark and denied the board’s motion to dismiss the shareholder derivative suit. The court’s decision was consistent with precedent, but the holding is likely to exacerbate a recent trend. The trend is the avoidance of and exodus by corporations—particularly those principally operating abroad—from choosing Delaware as their source of corporate governance law. This heightened avoidance is because the holding in Hughes represents a potential operational incompatibility between Delaware corporate governance standards and typical non-American business practices. Directors of foreign corporations will likely see the Hughes holding as a signal for potential litigation risks should they continue their typical business practices and incorporate in Delaware.

After synthesizing Delaware’s Caremark jurisprudence, this Note calls for Delaware courts to factor in a business’s underlying market practices when determining the acceptable level of oversight for companies. This approach would not lessen the requirements for boards under the duty of oversight but rather allow for the Delaware courts to better assess a company’s “good faith” efforts in meeting the duty. Although the Delaware legislature could also attempt to address this issue, the Delaware courts have the greater institutional capacity to reach case-by-case determinations. By allowing for “territorial adjustments” when considering Caremark liability, Delaware can maintain its preeminent position as an international supplier of corporation law.