Delaware Supreme Court Holds Directors’ Fiduciary Duties Require Monitoring Mission-Critical Risks
In 2015, Blue Bell Creameries USA, Inc., a Delaware subchapter S corporation headquartered in Brenham, Texas (Blue Bell), through subsidiaries made and distributed ice cream tainted with listeria bacteria. As a consequence, eight people were sickened (three of whom died), Blue Bell had to recall its products, suspend operations and lay off over a third of its workforce. To avoid bankruptcy, it entered into a highly dilutive transaction with a private equity investor. Plaintiffs then sued the Blue Bell’s board of directors in a derivative action to recoup their investment losses, alleging that the directors breached their fiduciary duty of loyalty under Delaware’s Caremark doctrine by not establishing and monitoring a system to monitor Blue Bell’s food safety performance or compliance with FDA and state regulatory requirements.
The Court of Chancery dismissed the lawsuit because the board did receive reports from management and outsiders as to the adequacy of the company’s operations, and it found that plaintiff failed to plead any facts to support his claim that the board “utterly failed to adopt or implement any reporting and compliance systems”. Reversing in a unanimous opinion by Chief Justice Leo Strine, the Delaware Supreme Court in Marchand v. Barnhill, No. 533, 2018 (Del. June 19, 2019) held that, while Blue Bell had certain food safety programs in place and “nominally complied with FDA regulations,” “the complaint alleges that Blue Bell’s board had no committee overseeing food safety, no full board-level process to address food safety issues, and no process by which the board was expected to be advised of food safety reports and developments…. Thus, the complaint alleges specific facts that create a reasonable inference that the directors consciously failed ‘to attempt to assure a reasonable information and reporting system exist[ed]’”. To “satisfy their duty of loyalty,” the Supreme Court held, “directors must make a good faith effort to put in place a reasonable system of monitoring and reporting about the corporation’s central compliance risks.” Without more, the existence of management-level compliance programs is not enough for the directors to avoid Caremark exposure in a monoline company that makes a single food product—ice cream—and in which the company’s “mission critical” compliance issue is food safety.
The Supreme Court also found that plaintiff had pled facts adequate to create a reasonable doubt that a demand on the board to bring the claim itself would have been futile as a majority of the directors were not sufficiently independent that they could impartially decide whether to bring the suit.
This decision suggests that boards of directors should have special committees tasked with monitoring the entity’s corporate risks and compliance protocols.
Dallas partner Byron F. Egan is experienced in business entity formation and governance matters, M&A, and financing transactions in a wide variety of industries, including energy, entertainment, financial, insurance, restaurant, and technology. In addition to handling transactions, Byron advises boards of directors and their audit, compensation, and special committees with respect to fiduciary duty and other corporate governance issues, the Sarbanes-Oxley Act, special investigation, and other issues. In 2018, he published the second edition of EGAN ON ENTITIES: Corporations, Partnerships and Limited Liability Companies in Texas, a treatise on the Texas Business Organizations Code.