Friday, June 28, 2019

Some musings about the Blue Bell case

Last week, the Delaware Supreme Court issued an opinion, Marchand v. Barnhill, which is notable for two reasons.  First, it furthers the Court’s project of reinvigorating director independence standards, and second, it is one of the very few decisions to find that the plaintiffs properly pled a claim for Caremark violations.

The facts are these.  Blue Bell Creameries suffered a listeria outbreak in 2015 that killed three people and nearly bankrupted the company, and shareholders brought a derivative lawsuit alleging that the directors failed to oversee corporate compliance with FDA and other requirements.  First, they alleged that the CEO Paul Kruse, and the VP of Operations Greg Bridges, actually received notification from various agencies of the company’s lack of compliance and took no remedial action.  In so doing, Kruse and Bridges violated their fiduciary duties to the company, and a litigation demand on the board would be futile because of their close ties to the board members.

Second, plaintiffs alleged that the Board violated its Caremark duties by failing to institute a system for monitoring the company’s compliance.

Chancery dismissed both claims, and the Delaware Supreme Court reversed.

Starting with the issue of director independence, as Delaware-watchers are well-aware, in the past few years, the law has undergone something of a revolution.  Once upon a time, only clear financial ties or the equivalent of blood relations would be sufficient to show that one director lacked independence from another, but more recently, Delaware has begun to recognize how less concrete social and business ties, traveling in similar circles, ongoing professional and personal contacts, and so forth, can collectively create feelings of obligation that prevent one director from making an objective decision about whether to sue another.

Thus, in Marchand, the Court held that a particular director was likely biased in favor of Kruse because the Kruse family – not Paul Kruse personally – had mentored him throughout his business career, going so far as to make a sizeable donation to a local college that somehow ended up with the director in question getting a facility named after him.  Significantly, the Court emphasized that “independence” may vary depending on the type of decision at issue – directors may be willing to vote against close friends on some matters, but that’s a far cry from being willing to sue the friend for breach of duty, and judges need to be sensitive to the difference.

This entire line of caselaw might be described as Strine’s revenge: it’s a direction he recommended with In re Oracle Corp. Derivative Litig., 824 A.2d 917 (Del. Ch. 2003) when he was on the Chancery court, and that the Delaware Supreme Court rejected in Beam v. Stewart, 845 A.2d 1040 (Del. 2004).  Now in the Chief Justice spot, Strine has apparently persuaded his colleagues as to the correctness of his views and is moving full steam ahead, going so far in Marchand as to cite his Oracle decision, thus retroactively making it authoritative. 

As to the Caremark issue, what’s striking here is not only the rarity with which Caremark claims make it past a motion to dismiss, but the fact that the Court accepted the plaintiffs’ claim that no monitoring system at all had been put into place.  The Court highlighted that despite various compliance problems that arose over the years, the Board had no committee in place to address these matters and Board minutes did not indicate any discussion of them.

By contrast, in the few cases where Caremark claims have had some success – think something like In re Massey Energy Co., 2011 WL 2176479 (Del. Ch. May 31, 2011), where the claim was properly pled but lost in a merger – plaintiffs demonstrated that the Board didn’t simply fail to monitor, but was actually complicit in the legal violations.  They knew of the red flags and either ignored them or directly encouraged the misbehavior.  They were, in Elizabeth Pollman’s framework, actually disobedient regarding their legal obligations. (And to give credit where credit is due, I’ll say that Elizabeth Pollman is the one who has observed that successful Caremark complaints tend to plead willful violations of the law, and the paper she eventually releases on the subject is something to stay tuned for).  But notwithstanding that general tendency, in Marchand, the Delaware Supreme Court did not hold that the Board was complicit, or that it had actual knowledge of potential legal violations; instead, it held that the Board simply had no monitoring system in place at all – a much harder claim since just about any monitoring system will do, and its design is within the directors’ business judgment.  The Marchand Court went so far as to point out that monitoring systems in place at the management level were insufficient to absolve the Board, because there was no indication that the Board was monitoring at all – even to make sure that management did its job.

The thing to note about this aspect of Marchand is that the Court did not have to go that way, because Paul Kruse and Greg Bridges – who actually knew about the various problems – were both directors themselves, and Kruse later became Chair of the Board.  That is, the Court could have said that the Board, via Kruse and Bridges, did have a monitoring system, and that, via Kruse and Bridges, the Board was aware of problems but refused to take action to remedy them.  Yet the Court chose not to go this route – it didn’t even mention that Kruse was a director throughout the period and Bridges was a director for most of it (you have to look at the Chancery decision for those tidbits), and only grudgingly indicated that Kruse eventually became Chair of the Board – a fact to which the Court attaches no significance (and indeed, he only became Chair just before the problem reached crisis point).  Instead, ignoring the fact that at least two members of the Board were part of management and directly received notice of compliance issues, the Court simply declared that no monitoring system was in place.

So the opinion seems, in a way, motivated.

That impression is reinforced by the types of compliance problems that the Court identifies to establish that that Blue Bell had longstanding sanitation issues.  The Court lists regulatory citations that Blue Bell factories received dating back to 2009, but – to my untutored eye – they all read like, well, flyspecking.  You know, periodically an agency inspects, and they always find a problem to write up, and it’s quickly resolved.  Now, just to be clear, I am not an expert in the regulation of food safety and I may very well be misreading this, but a handful of problems like “equipment left on the floor and a ceiling in disrepair in the container forming room” just don’t strike me as the kind of thing to suggest systemic noncompliance.  Matters only get serious when listeria is first detected in 2013, and after that, though listeria is identified several other times, nothing in the opinion indicates that the company was ignoring regulatory complaints or failing to attempt to remediate the problem before it issued a general recall in early 2015.

The point being, it almost seems as though the Court is going out of its way to justify a “failure to monitor” theory and seizes upon (again, to my untrained eye) fairly minor problems as evidence that the Board was not paying sufficient attention.

That said, I do have to highlight this aspect of the Court’s reasoning:

In answering the plaintiff’s argument, the Blue Bell directors also stress that management regularly reported to them on “operational issues.” This response is telling. In decisions dismissing Caremark claims, the plaintiffs usually lose because they must concede the existence of board-level systems of monitoring and oversight such as a relevant committee, a regular protocol requiring board-level reports about the relevant risks, or the board’s use of third-party monitors, auditors, or consultants…Here, the Blue Bell directors just argue that because Blue Bell management, in its discretion, discussed general operations with the board, a Caremark claim is not stated.

But if that were the case, then Caremark would be a chimera. At every board meeting of any company, it is likely that management will touch on some operational issue….

I admit, if defendants just argued that the Board discussed “operational issues,” that’s pretty damning.

Okay, so what do we make of all of this?

Well, I have to go back to an argument I’ve previously made in this space, namely, that with decisions like Corwin, Delaware has transformed itself into something like a mini-SEC.  Suddenly, instead of emphasizing a Board’s substantive obligations, courts are scouring disclosures to determine if a shareholder vote was fully informed.  Except, of course, we already have an SEC – we don’t need Delaware to do that job. (But see Reza Dibadj, Disclosure as Delaware’s New Frontier, 70 Hastings L.J. 689 (2019)).  A contextual, nuanced take on independence carves out a space for Delaware that the SEC can’t replicate – and perhaps the same might be said of a more muscular approach to Caremark.

Ann Lipton | Permalink


Very interesting take and certainly appears right, particularly on the weakening of Beam. Who would have thought sharing ownership of a plane would be sufficient to overcome the presumption of independence. That is the trend and i think the Chief is definitely leading a gradual evolvement in the law in this area. Certainly critical for boards to identify the critical risk areas of the business and make sure there are some systems in place to measure, monitor and mitigate.

Posted by: eric waxman | Jun 28, 2019 10:27:56 AM

Super thoughtful as usual, thanks!

Posted by: VSJB | Jun 29, 2019 5:59:54 AM

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