Directors Beware: Caremark Claims Are Coming

In June 2019 in Marchand v. Barnhill, 212 A.3d 805 (Del 2019), the Delaware Supreme Court allowed a derivative Caremark claim to proceed against the board of directors of Blue Bell Creameries USA, Inc. Caremark claims are breach of duty claims that can be brought against corporate directors for failure of oversight. Caremark claims have been historically difficult to prosecute due to the insulation afforded to corporate fiduciaries by the business judgment rule. The Delaware Court of Chancery’s decision in In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), as explained by the Marchand court, requires directors to make a “good faith effort to implement an oversight system and then monitor it.” Marchand, 212 A.3d at 821. As the Marchand court noted, in order to survive a motion to dismiss a Caremark claim, a plaintiff must allege particularized facts that the board acted in bad faith, established “when ‘the directors [completely] fail[] to implement any reporting or information system or controls[,] or . . . having implemented such a system or controls, consciously fail[] to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.” Id. (quoting Stone ex. Rel AmSouth Bancorporation v. Ritter, 911 A.2d 362, 370–72 (Del. 2006).

Caremark Applications

The Marchand lawsuit stemmed from a 2015 outbreak of the bacteria listeria in Blue Bell ice cream, which resulted in the death of three people, and caused Blue Bell to “recall all of its products, shut down production at all of its plants, and lay off over a third of its workforce” and ultimately to suffer “a liquidity crisis that forced it to accept a dilutive private equity investment.” Id. at 807. In the years before the outbreak, state and federal inspections noted health and safety violations, and Blue Bell had positive tests for listeria and received a presumptive positive test from a third-party laboratory. The complaint alleged that the board did not receive information about these issues. The case was originally dismissed by the Delaware Court of Chancery for failure to plead demand futility and failure to plead a valid theory under Caremark. Regarding plaintiff’s Caremark claim, the Court of Chancery held that plaintiffs challenged the effectiveness of Blue Bell’s reporting and monitoring system, rather than appropriately alleging the absence of such a program. The Delaware Supreme Court reversed as to both holdings. Id. at 808.

The Marchand court highlighted several areas of potential exposure for directors in finding that plaintiffs sufficiently alleged failure to establish oversight under Caremark, including:

• absence of a board committee overseeing food safety,
• absence of a full board-level process to address food safety issues,
• no record of regular food safety discussions in board meetings,
• failure to establish policies or procedures to receive consistent food safety updates from management, and
• failure to obtain information known to management regarding safety defects.

Id. at 809.

The Marchand court also emphasized several factors that contributed to heightened oversight obligations under Caremark:

• safety of products mass-distributed for consumer use, and
• issues that present central safety and legal liability to a company, making them “mission critical.”

Caremark Reflections

Since Marchand, Delaware courts have allowed several more Caremark cases past the dismissal stage. Although Marchand did not change the Caremark standard, it signaled that, while Caremark claims continue to be difficult to pursue, Delaware courts are clearly willing to permit well-pled claims, and directors should take their potential liability seriously. Blue Bell settled for $60 million after the Marchand ruling. Allen Pusey, Blue Bell settles investor lawsuit for $60M, Dallas Business Journal (Apr. 28, 2020), https://www.bizjournals.com/dallas/news/2020/04/28/blue-bell-settles-investor-lawsuit-for-60m.html.

Caremark Prevention

Practitioners advising companies and directors should heed the lessons of Marchand. Directors should formalize oversight responsibility at the board level and should not delegate full responsibility to, or passively rely on reporting from, management. A formal mechanism should be created for routine reporting directly to the board, particularly on mission-critical issues. Boards should actively engage with their oversight systems. Finally, boards should consistently and thoroughly document oversight actions and discussions.