Reversing A Dismissal, The Delaware Supreme Court Finds The Absence Of Board-Level Monitoring Of "Central Compliance Risks" Sufficient To State A Caremark Claim
On June 18, 2019, in a decision authored by Chief Justice Leo E. Strine Jr., the Delaware Supreme Court en banc reversed the dismissal of a stockholder derivative suit against the directors and officers of Blue Bell Creameries USA, Inc. (the “Company”). Marchand v. Barnhill, No. 533, 2018, (Del. June 18, 2019). After a listeria outbreak at the ice cream manufacturer, the Company purportedly faced a liquidity crisis and accepted a dilutive private equity investment. Plaintiff alleged that the CEO and vice president of operations breached their fiduciary duties of care and loyalty by disregarding contamination risks and that the directors breached their duty of loyalty under In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996). As to the claims against the executives, the Court held that the complaint adequately pleaded demand futility because it alleged facts regarding the personal relationship of an additional director to the CEO sufficient to raise a reasonable doubt as to whether the director could impartially consider a demand. Reversing the dismissal of the Caremark claim, the Court found that “the complaint supports an inference that no system of board-level compliance monitoring and reporting existed at [the company].”
In early 2015, the Company suffered a listeria outbreak, which was allegedly connected to the deaths of three consumers and caused the Company to recall all of its products, shut down production at all of its plants, and lay off over a third of its workforce. According to the complaint, the outbreak followed years of contamination issues at its various plants, including as identified by the FDA and state regulators. Relying on books and records obtained through a request under Delaware General Corporation Law Section 220, 8 Del. C. § 220, plaintiff alleged, among other things, that (i) there was no board committee charged with addressing food safety; (ii) “no regular process or protocols that required management to keep the board apprised of food safety compliance practices, risks, or reports existed”; (iii) the board minutes did not reflect that reports of “yellow and red flags” received by management were disclosed to the board; and (iv) the board had no regular schedule for the consideration of food safety risks and there was no indication in the minutes that there was any regular discussion of that issue.
The Delaware Court of Chancery dismissed the complaint. Specifically, that Court held that demand was not excused because directors holding eight of the fifteen board votes were sufficiently independent to consider a demand to sue the executives. The Court of Chancery also found that the complaint failed to allege that the board “utterly” failed to implement compliance systems because the company did have procedures in place to address compliance and management generally reported on operations to the board.
The Delaware Supreme Court reversed the dismissal on both counts. First, the Court found that allegations regarding one of the directors found independent by the Court of Chancery were sufficient to raise a reasonable doubt. That director was the former CFO of the company. The Supreme Court found that the complaint adequately alleged that he (i) had a successful career “in large measure due to the opportunities and mentoring” given to him by the CEO’s father under whom he worked for 28 years; (ii) rose to the level of CFO and was added to the board due to the support of the CEO’s family; and (iii) had a facility at the local college named in his honor as a result of fundraising efforts by the CEO’s family. The Delaware Supreme Court held: “On a cold complaint, these facts support a reasonable inference that there are very warm and thick personal ties of respect, loyalty, and affection between [the director] and the [CEO’s] family, which creates a reasonable doubt that [the director] could have impartially decided whether to sue [the CEO] and his subordinate [the other executive defendant].”
Regarding the Caremark claim, the Court distinguished between management operations and board-level reporting, and emphasized that a board “must make a good faith effort—i.e., try—to put in place a reasonable board-level system of monitoring and reporting.” With respect to the allegations in the complaint, the Court explained that “the fact that [the company] nominally complied with FDA regulations does not imply that the board implemented a system to monitor food safety at the board level.” To the contrary, “the complaint pled facts supporting a fair inference that no board-level system of monitoring or reporting on food safety existed” even though food safety was the company’s “central compliance risk.” Therefore, the Court held that the complaint sufficiently stated a claim that the directors breached their duty of loyalty.