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Delaware Chancery Court Dismisses Caremark Claim Highlighting That Unsupported Inferences Do Not Demonstrate Demand Futility
01/30/2017On January 19, 2017, Vice Chancellor Joseph R. Slights of the Delaware Court of Chancery dismissed a shareholder derivative suit claiming a breach of fiduciary duty by the directors of United Parcel Service, Inc. (“UPS”) for an alleged failure of oversight in connection with UPS’s compliance with laws governing the transportation and delivery of cigarettes. Horman v. Abney, C.A. No. 12290-VCS (Del. Ch. Jan. 19, 2017). Specifically, the Court found that plaintiffs failed to plead adequately that making a demand on UPS’s board to pursue the claims would have been futile because the complaint did not contain factual allegations sufficient to support a reasonable inference that the director defendants faced a substantial likelihood of personal liability.
This case was brought derivatively by shareholders of UPS based on a separate ongoing suit by the City and State of New York against UPS for alleged violations of state and federal laws governing the transportation and delivery of cigarettes, in which damages and penalties sought from UPS amounted to at least $180 million. Plaintiffs in the derivative case alleged that the director defendants breached their fiduciary duty of loyalty by consciously failing to monitor and manage UPS’s compliance with those laws, resulting in the separate suit against UPS.
As the Court noted, the alleged breach of fiduciary duty arising from a “failure of oversight” is known as a Caremark claim. See In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996); see also Stone ex rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362 (Del. 2006). Directors can be held personally liable in connection with such a claim only upon a showing that “the directors knew that they were not discharging their fiduciary obligations.” Stone, 911 A.2d at 370. Further, to plead demand futility under Delaware Court of Chancery Rule 23.1, the complaint must allege particularized facts demonstrating that the board either (a) “utterly failed to implement any reporting or information system or controls;” or (b) “consciously disregarded” any relevant “red flags.” Id. Vice Chancellor Slights found that the complaint did not adequately plead either.
First, Vice Chancellor Slights found that the complaint itself “acknowledge[d] the existence of reporting and compliance systems at UPS,” including a legal department, an internal audit, compliance and ethics department and a board audit committee, and the complaint acknowledged that the board was provided updates about legal compliance. Second, the complaint did not allege with particularity that certain of the “red flags” were in fact reported to the directors. The court concluded that it is insufficient to allege that an officer with an obligation to report to the board had received the pertinent information; instead, the complaint must plead particularized facts that the officer actually reported the information to the directors. Third, Vice Chancellor Slights determined that the complaint and the documents incorporated by reference therein demonstrated that when the board was actually made aware of red flags, it was also informed of various efforts to improve and ensure compliance.
