Key Holding and Facts. In Marchand vs. Barnhill, Chief Justice Leo E. Strine, Jr. writing on behalf of the Delaware Supreme Court earlier this month reversed the Court of Chancery’s 2018 dismissal of a stockholder derivative suit alleging Caremark claims. Caremark claims are essentially claims asserting bad faith by board members such that the directors breached their duty of loyalty. The facts underlying the case are well documented and spanned over several years, but generally involved a listeria outbreak at the ice cream production facilities of Blue Bell Creameries, a privately held monoline ice cream manufacturer, which resulted in devastating losses, including the death of three consumers, plant shutdowns, financial impairment and various regulatory investigation and private party litigation, including by the Food and Drug Administration (FDA), Centers for Disease Control and Prevention (CDC) and the Department of Justice (DOJ).
Why Important? This case does not change the common understanding that Caremark claims are difficult to plead or prove. Indeed, the court states that director liability claims are possibly the most difficult to make in corporation law. However, what is remarkable is that the court concluded that plaintiff pled sufficient facts to overcome defendant’s motion to dismiss. At its bottom, the case tells us that (i) a director must make a good faith effort to oversee risk; and (ii) failing to make that effort breaches the duty of loyalty, where good faith means “to try” to put in place a “reasonable board-level system of monitoring and reporting” using the wide discretion that the business judgment rule affords directors to implement such a program.
What Directors and Corporations Can Make of this Decision? Plaintiff pled this case based on corporate books, records, board minutes and similar documents that it accessed through a Delaware Section 220 request. The court noted that plaintiff did as “our law encourages and sought out books and records . . . regarding what has to be one of the most central issues at the company.” The allegations the court cites as being relevant were that (i) no existing board committee addressed food safety; (ii) no process kept the board apprised that these safety risks existed; and (iii) board minutes were devoid of evidence that management was disclosing these key risks to the board.
While board meeting minutes cannot, and should not, painstaking detail each and every matter discussed, in light of this case, minutes supporting that a board is acting in good faith in discharging its oversight of material risks, such as information regarding the directors’ review of material risk policies and presentation of information of material breaches of these policies and procedures, as well as information on past breaches and how they were remediated, can be helpful. Minutes, however, need not be the only source of evidence. For instance, other Delaware cases where directors were successful in overcoming a Caremark claim rested on board presentations identifying regulatory issues and the actions taken to address them, as well as an outside auditor’s report reflecting that the board received and approved relevant policies and procedures, delegated to certain employees the responsibility to monitor compliance, but exercised oversight by relying on periodic reports from those employees.
What this case tells us is that whatever risks are material or fundamental, or as the case says, central, to a corporation’s enterprise risk management, the board must ensure a system of monitoring and oversight exists for them.
On Director Independence. While the case is most noteworthy for its Caremark holding, it also addresses director independence. In the context of a motion to dismiss, the court held that plaintiff’s pleadings were sufficient to support a finding that one director with long-standing, personal and close ties with the CEO and his family could impact his ability to impartially decide whether the plaintiff needed to bring a presuit demand to the board before making a claim against the company executives. In short, this is not the first Delaware law case that has recently called into question long-standing personal ties between a director and the CEO and his family when analyzing director independence for Delaware law purposes.
What’s Next? The court remanded the case for proceedings consistent with its opinion. It remains to be seen if plaintiff will be successful in proving a breach of the duty of loyalty, as opposed to simply pleading the same.
Associate Rachel Hoberman and law clerk Harrison Perry-Daiter contributed to this post.