Delaware Court Of Chancery Dismisses Caremark Claim, Finding Consumer Class Action Settlement Was Not A “Red Flag” For Consumer Protection Law Violations
On July 29, 2019, Chancellor Andre G. Bouchard of the Delaware Court of Chancery dismissed a stockholder derivative action asserting breaches of fiduciary duty claims against the directors of J.C. Penney Company, Inc. for failure to make a pre-suit demand on the board. Rojas v. Ellison, C.A. No. 2018-0755-AGB (Del. Ch. July 29, 2019). After the Los Angeles City Attorney initiated litigation against the company asserting violations of California’s consumer protection laws, plaintiff filed this derivative action alleging that the company’s directors consciously disregarded their responsibility to oversee the company’s compliance with laws governing price-comparison advertising. Repeating past statements of the Court about the difficulty of proving director liability for a failure to monitor corporate affairs—known as a Caremark claim—Chancellor Bouchard determined that the complaint failed to plead facts demonstrating that the directors would face a substantial likelihood of personal liability. In particular, the Court found that a settlement of a consumer class action suit without any admission of liability was not a “red flag” with respect to any ongoing violations of law. Therefore, the Court concluded that pre-suit demand on the board was not excused.
The Court explained that to plead a substantial likelihood of liability under Caremark, a stockholder must allege particularized facts showing that either (1) “the directors utterly failed to implement any reporting or information system or controls” or (2) “having implemented such a system or controls, [the directors] consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.” In this case, the Court rejected plaintiff’s “faint-hearted” attempt to satisfy the first prong because the complaint and documents incorporated therein made it clear that the company “had a board-level reporting system in place . . . to monitor the Company’s compliance with laws and regulations.” As to the second prong, the Court noted that the typical way to satisfy this standard is by demonstrating that the board was “alerted to evidence of illegality—the proverbial red flag.” But Court found none here.
More specifically, plaintiff’s attempted reliance on the consumer class action settlement as a red flag was unavailing. As the Court explained: A settlement of litigation or a warning from a regulatory authority could constitute a red flag, “[b]ut the obverse also is true—such actions do not necessarily demonstrate that a corporation’s directors knew or should have known that the corporation was violating the law.” Here, the Court concluded that the settlement did not give rise to an inference that the directors were on notice of ongoing violations of the law. The Court noted that when the class action litigation was discussed with the board, it was “in terms of a settlement . . . without any admission of liability, with an express acknowledgement that the Company was not then violating any federal or California laws, and with a commitment to implement a program to ensure continued compliance with California’s price-comparison laws going forward.” The Court also rejected the implication that the “sheer amount of the settlement payment ($50 million)” and the loss of motions in the consumer class were sufficient to render pre-suit demand excused. In this regard, the Court highlighted that the suit was a “purely civil matter of the type that commercial parties routinely settle after motion practice.”