United States: Not So Sweet: Delaware Supreme Court Revives Caremark Claim, Provides Guidance On Directors' Oversight Duties

Last week, the Delaware Supreme Court reversed the Delaware Court of Chancery's dismissal of a Caremark claim[1] that arose out of the Blue Bell ice cream listeria outbreak in the mid-2010s. See Marchand v. Barnhill, No. 533, 2018 (Del. June 18, 2019). The Delaware Supreme Court's opinion in this closely watched case provides useful guidance to directors on the proper role of the board in overseeing risk management.

The allegations in Marchand were stark. The listeria outbreak resulted in the death of three Blue Bell customers, the complete recall of its ice cream products, months-long closure of its manufacturing facilities and a highly dilutive rescue financing that was required to keep the company afloat. To make matters worse, leading up to the outbreak, it was alleged that numerous deficiencies in the company's food safety controls of increasing severity were uncovered, yet there was no record the problems were ever discussed by the board. Instead, board minutes indicated the board was briefed on positive food safety developments during this period and that the board did not turn its attention to the listeria situation until after a product recall had been issued.

Based on the facts alleged, the Delaware Supreme Court concluded that it was reasonably conceivable the Blue Bell board had breached its Caremark duties by failing to take any steps to establish a board-level system to monitor a key risk facing the company — the safety of its ice cream products. Although the directors pointed to management's efforts to comply with FDA and state food safety regulations and general updates to the board on the company's operations, the Court noted that the board could not simply rely on management's compliance efforts or discretionary reporting on operational matters. Rather, to discharge its Caremark duties the board had to undertake a good faith effort to establish a risk oversight system at the board level to address key risks facing the company and then monitor such system.[2]

We do not believe Marchand signals a radical change in how Delaware courts will evaluate Caremark claims — among other reasons, the complaint alleged unusual, troubling facts and the court was required to draw all reasonable inferences in favor of the plaintiffs in the context of the motion to dismiss the complaint. However, the case is a reminder that Caremark claims are not impossible to establish and in the event of particularly egregious facts can be used to hold directors accountable. Marchand also includes important reminders for boards in performing their risk oversight role, including:

  • Ensure board-level protocols are in place that require management to regularly report on key risks, steps taken to manage those risks and any significant compliance deficiencies.
  • The board should also regularly consider the company's risk management efforts and adequacy of the board-level protocols — the Court suggested quarterly or biannually — and not wait for the crisis to arrive for the discussion to begin.
  • Ensure the board-level protocols are documented and that the board discussion of risk management is contemporaneously and accurately documented in the board minutes.[3]
  • Caremark is not a strait jacket and the Court was careful to note that boards have flexibility to design a risk oversight system that is tailored to the company's business and resources (and, as long as the board makes a good faith effort to implement such a system and then monitor it, the courts will defer to the board's business judgment as to how it is designed).

[1] See In re Caremark Int'l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996) (Allen, C.). Directors' "Caremark duties" require them to make a "good faith effort to oversee the company's operations." Marchand, slip op. at 29 (citing Caremark, 698 A.2d at 970, and Stone v. Ritter, 911 A.2d 362, 372 (Del. 2006)). Such effort requires an "information and reporting system [that] is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner." Id. Directors will only face personal liability under Caremark, however, where there is a complete failure to implement such a system or a conscious failure to monitor it, evidencing bad faith.

[2] In the same decision, the Court also held that it was reasonably conceivable based on the pled facts that a majority of the directors were not independent of, and thus incapable of impartially deciding whether to sue, the CEO and VP of Operations of the company. Emphasizing that "Delaware law should not be based on a reductionist view of human nature" incapable of accounting for the real-life "social nature of humans," Marchand, slip op. at 25 n.87, the Court explained that there was reason to doubt that the director whose independence was disputed would be capable of impartially deciding whether to sue the Blue Bell CEO based on the director's "long-standing, close relationship" with the CEO and family previously controlling Blue Bell that included giving the director his start at Blue Bell as a low-level employee, mentoring the director as he climbed the Blue Bell corporate ladder all the way up to CFO and spearheading a charitable contribution to a local college in the director's honor.

[3] As is increasingly common in stockholder lawsuits, the plaintiff in this case first obtained minutes and other documents from the company pursuant to a Section 220 inspection demand, and then used those documents to craft a detailed complaint. Because this is an increasing trend, it is all the more important for board minutes and other formal board records to adequately document the board's deliberations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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