Friday, April 28, 2023
In Amalgamated Bank v. Yahoo!, 132 A.3d 752 (Del. Ch. 2016), VC Laster allowed a corporation to condition production of documents sought under Section 220 on the stipulation that if the plaintiff filed a lawsuit that relied on any of the documents, the entire production set would be deemed incorporated by reference into the complaint. VC Laster considered this to be a reasonable stipulation to protect the defendant against the plaintiffs’ strategic cherry picking of documents in order to create a misleading impression of the facts.
Since then, such stipulations have become common, and the practice has evolved for defendants to certify that they have produced all responsive documents to the plaintiffs in order to get the benefit of incorporation-by-reference. See, e.g., In re Vaxart S’holder Litig., 2022 WL 1837452 (Del. Ch. June 3, 2022). The predictable result is that motions to dismiss are accompanied by ever-more-lengthy lists of exhibits. Delaware Chancery has repeatedly warned that these “incorporation by reference” stipulations do not change the standard of review, and that it has the option either to disregard excess submissions or use them as a basis for transforming the dismissal motion into a motion for summary judgment. See, e.g., In re Match Group Deriv. Litig., 2022 WL 3970159 (Del. Ch. Sept. 1, 2022).
In Oklahoma Firefighters Pension & Ret. Sys. v. Amazon.com, Inc., 2022 WL 1760618 (Del. Ch. June 1, 2022), VC Will permitted a defendant to redact documents produced in response to Section 220 demands to remove material that was nonresponsive to the plaintiffs’ request. As VC Will put it, “In my view, redactions to material unrelated to the subject matter of a demand are proper because Section 220 only entitles a stockholder to information essential to accomplishing its stated purposes for inspection. The redactions appropriately cabin Section 220 inspections to their intended scope.”
From VC Laster’s opinion this week in Ontario Provincial Council of Carpenters’ Pension Trust Fund et al. v. Walton, 2023 WL 3093500 (Del. Ch. Apr. 26, 2023), one gets the distinct impression that he believes these two developments – singly and in combination – have been abused by defendants, and he’s fighting back.
In Walton, the plaintiffs sued the Walmart board for violations of its Caremark duties with respect to opioid prescriptions, and relied on the heavily-redacted documents that Walmart produced in a prior 220 action. Walmart, of course, submitted its own documents in support of its motion to dismiss. Given the procedural posture (reasonable inferences drawn in the plaintiffs’ favor), VC Laster held that the certification of completeness, coupled with an incorporation-by-reference provision, allowed for the inference that “if the record lacks documentation relating to a particular event, and if it is reasonable to expect that documentation would exist if the event took place, … [then] the event did not occur.” Id. at *2. With respect to redactions, which he often found “dubious” because “a partial-sentence redaction … depends on the premise that the author incoherently injected an unrelated topic into an otherwise responsive sentence,” id. at 3 – he either gave them a plaintiff-friendly inference or also treated them as evidence of the absence of discussion. The net effect was a near weaponization of the lack of record evidence on various topics in order to conclude that the Walmart board failed to conduct proper oversight of the company.
Prior cases have drawn inferences from the lack of 220 documents on a subject, e.g., In re Boeing Co. Deriv. Litig., 2021 WL 4059934 (Del. Ch. Sept. 7, 2021); Teamsters Local 443 Health Servs. & Ins. Plan v. Chou, 2020 WL 5028065 (Del. Ch. Aug. 24, 2020), but I’ve never seen anything quite like this. To wit:
Walmart did not produce a final budget for the Health and Wellness Division as part of its Section 220 document production, entitling the plaintiffs to an inference that a budget sufficient to fund the projects necessary to comply with the DEA Settlement did not exist.
The memo identified two significant challenges. The first challenge, identified in a single sentence, was redacted. The redaction was marked “NR/ACP/AWP,” for non-responsive, attorney-client privilege, attorney work product. Because the single sentence redaction appears in an otherwise responsive paragraph, the redaction is dubious, and with three possibilities provided, the basis for it is unclear. At the pleading stage, the plaintiffs are entitled to an inference that the redacted text referenced a compliance failure that Walmart was not addressing.
An appendix to the slide deck identified a list of items that Walmart had completed during fiscal years 2011 and 2012. …Significant portions of the appendix are redacted. … The list of completed activities conspicuously omits significant items identified in the DEA Settlement, such as testing for doctor shopping, flagging requests for early refills, or checking for altered or forged prescriptions.
Read together, the 2012 Memo and accompanying materials support a pleading-stage inference that the Health and Wellness Division had created a summary of what a nice compliance program would look like, then never did the work to implement one.
He goes further. He recognizes that he cannot draw negative inferences from redactions specifically for attorney-client privilege, but he also holds that a conscientious board, appropriately overseeing the company, would be expected to have at least some discussions of legal compliance that did not involve privileged conversations, and thus the absence of evidence of nonprivileged discussions would also be treated as evidence of absence. As he put it:
Although this decision does not draw inferences from any of the passages or documents for which Walmart has asserted privilege, it does draw inferences from an absence of non-privileged documents containing discussions or decisions about the business issues necessarily involved in (i) taking the steps necessary to comply with the DEA Settlement and the Controlled Substances Act, (ii) responding to red flags of noncompliance, and (iii) assessing the effectiveness of the compliance efforts. Legal advice undoubtedly is an input into those discussions and decisions, but if directors and officers are doing their jobs, then there will be non-privileged discussions and decisions about what are inherently and ultimately business decisions (which the business judgment rule generally will protect). Walmart represented that its Section 220 production was complete, so when there are no indications of non-privileged discussions, the plaintiffs are entitled to an inference that the discussions and decisions did not occur.
The result was:
Walmart produced a copy of the meeting minutes, which comprise seven pages. All of the substantive portions of the minutes were redacted for non-responsiveness and attorney-client privilege with the exception of the following sentence: “Ms. Harris then provided an update to the Committee on the overall status of Health and Wellness Compliance projects.” … There are no non-privileged documents reflecting the Employee Compliance Committee making any business decisions or taking any action. At the pleading stage, the absence of evidence about action by the Employee Compliance Committee supports a plaintiff-friendly inference that the Employee Compliance Committee failed to take action to promote compliance with the DEA Settlement.
Walmart's privilege log contains entries suggesting that the Employee Compliance Committee met on twenty other occasions from 2016 through 2020. Walmart withheld all of the relevant meeting minutes, noting on its privilege log only that the discussions involved “controlled substances,” “opioids,” or Walmart's “Health & Wellness compliance program.” There are no indications that the committee had any business discussions, made any business decisions, or took any type of action. If Walmart's assertions of privilege are to be believed, then as the opioid epidemic raged, Walmart's senior compliance employees did nothing except receive and consider legal advice. They knew about the problem and took no action whatsoever. Although that seems highly unlikely, that is the record that Walmart created through its highly redacted Section 220 production.
The fact that so many meetings took place supports an inference that the officers and employees on the Employee Compliance Committee closely monitored Walmart's compliance with its obligations under the Controlled Substances Act. At the same time, the allegations in the complaint, together with other documents in the record, support an inference that Walmart was failing to comply with its obligations as a dispenser of prescription opioids and, in particular, was undermining its pharmacists’ ability to fulfill the Refusal-To-Fill Obligation. The court therefore must infer that the Employee Compliance Committee knew about Walmart's failure to fulfill its obligations as a dispenser of prescription opioids. The absence of any indication that the Employee Compliance Committee did anything except gather to receive and discuss legal advice, supports a pleading-stage inference that the members of the committee consciously ignored Walmart's compliance failures.
The Board also met in November 2017, and the minutes of that meeting span sixty-eight pages. Ex. 61. Only three sentences of substantive text survived the redaction tool. The first reads: “Timothy P. Flynn, Chair of the Audit Committee, then provided the Audit Committee report.” The following partially redacted text appears on the next page: “He concluded his report by stating that the Audit Committee had received updates from management regarding various other matters including ... [REDACTED] ... enhanced processes and training for pharmacists regarding filling prescriptions of controlled substances.” The redactions were marked for non-responsiveness, attorney-client privilege, and attorney work product. The unredacted text provides no basis to infer that the Board or Audit Committee had any business-oriented discussion about compliance issues or made any business decisions about compliance issues.
And my personal favorite:
Walmart redacted the entire director education presentation on the basis of the attorney-client privilege and work product doctrine. Because of those redactions, the only possible inference is that during a meeting specifically called to address the opioid crisis, Walmart's directors and senior executives and unidentified members of the Walton family did not discuss any business issues, consider any business initiatives, or make any business decisions. All they did was receive and consider legal advice. Although that is hard to believe, Walmart's redactions necessarily lead to that inference.
In more sorrow than anger, he writes:
Reinemund served on the Board during the full term of the DEA Settlement. …He therefore also faces a substantial risk of liability, and there is reason to doubt whether Reinemund could consider a demand.
The court reaches this conclusion reluctantly, because Reinemund is a person of stature who has had an impressive career. He graduated from the United States Naval Academy and served in the Marine Corps, rising to the rank of Captain. After leaving the military, Reinemund enjoyed success in the business world, culminating in the position of Chairman and CEO of PepsiCo from 2001 to 2003. From 2008 to 2014, he served as Dean of the Wake Forest University Business School. In addition to serving as a director at Walmart, he has served on the boards of other major public companies.
Why would an outside director like Reinemund ignore red flags about noncompliance with the DEA Settlement, much less make a conscious decision not to achieve compliance with the DEA Settlement? The answers likely lie in the redacted portions of the documents in Walmart's Section 220 production.
See also id. at *41 (“As with Reinemund, it is hard to believe that an outside director like Flynn would ignore red flags about noncompliance with the DEA Settlement, much less make a decision not to comply with it. Once again, the answers likely lie in the redacted portions of the documents in Walmart's Section 220 production. Unfortunately, because of Walmart's compulsive redacting of documents, the pleading-stage record supports an inference that Flynn knew that Walmart was not in compliance with the DEA Settlement, knew that Walmart could not achieve compliance by the time the DEA Settlement terminated, and did nothing to bring the company into compliance.”).
That’s the headline, but it’s not all that’s of interest here.
I earlier blogged about Caremark and the distinction between taking legal risks and business risks. In Walton, VC Laster articulates the distinction between legal risk and business risk thusly:
- In one hypothetical scenario, the lawyers say: “Although there is some room for doubt and hence some risk that our regulator may disagree, we believe the company is complying with its legal obligations and will remain in compliance if you make the business decision to pursue this project.”
- In the other hypothetical scenario, the lawyers say: “The company is not currently in compliance with its legal obligations and faces the risk of enforcement action, and if you make the business decision to pursue this project, the company is likely to remain out of compliance and to continue to face the risk of an enforcement action. But the regulators are so understaffed and overworked that the likelihood of an enforcement action is quite low, and we can probably settle anything that comes at minimal cost and with no admission of wrongdoing.”
In the former case, the directors can make a business judgment to pursue the project. In the latter case, the decision to pursue the project would constitute a conscious decision to violate the law, the business judgment rule would not apply, and the directors would be acting in bad faith.
Critically, I note that his assessment of good faith in these scenarios permits reliance on legal advice. See also id. at *40. That’s interesting, because – as I blogged when discussing the case of The Williams Companies v. Energy Transfer Equity LP, 159 A.3d 264 (Del. 2017) – there’s been some disagreement at the Delaware Supreme Court over approaches to legal advice. In Williams, then-Chief Justice Strine in dissent recognized that even “good faith” legal advice is malleable, and may be adjusted depending on the desire of the client. The majority, by contrast, treated “good faith” legal advice as something akin to an unwavering North Star, unresponsive to the client’s needs. As recently as Bandera Master Fund LP v. Boardwalk Pipeline Partners, LP, 2021 WL 5267734 (Del. Ch. Dec. 19, 2022), Laster seemed to take more of Strine’s view of the matter, but his opinion was reversed on appeal in Boardwalk Pipeline Partners, LP v. Bandera Master Fund LP, 288 A.3d 1083 (Del. 2022), with a concurrence specifically warning that a great deal of deference ought to be given to good faith legal opinions.
The upshot of which is, going forward, I worry about how easy it will be for boards to satisfy Caremark obligations, despite red flags of illegal conduct, by relying good-faith-but-under-duress legal opinions. And it is particularly ironic to see such a sentiment expressed in an opinion that does not, in the main, evince much confidence in counsel’s good faith advocacy.