Securities Regulation Daily  Delaware high court revives Caremark claim against Blue Bell board
Thursday, June 20, 2019

 Delaware high court revives Caremark claim against Blue Bell board

By Anne Sherry, J.D.

Proving a Caremark claim is notoriously difficult, but a Blue Bell shareholder adequately pleaded the absence of any board-level system for monitoring food safety.

A Blue Bell shareholder gets a second chance at bringing a derivative breach-of-loyalty claim against Blue Bell directors under the difficult—but not insurmountable—Caremark standard. The Delaware Supreme Court reversed the chancery court’s dismissal, first holding that demand was excused because of a director’s close personal ties to the chairman’s family. As to the claim’s merits, the plaintiff adequately pleaded that there was no board-level system of monitoring or reporting on food safety, an essential consideration for an ice-cream company (Marchand v. Barnhill, June 19, 2019, Strine, L.).

In 2015, three people died from eating Blue Bell ice cream contaminated with listeria. After Blue Bell recalled its products, shut down production, and laid off over a third of its employees, the company suffered a liquidity crisis that forced it to dilute existing stockholders in order to obtain a private equity investment.

The plaintiff brought a derivative suit against Blue Bell’s CEO-chairman Paul Kruse, its vice president of operations, and its directors. The suit alleged that the executives breached their duties of care and loyalty by knowingly disregarding contamination risks and failing to oversee the safety of Blue Bell’s operations and that the directors breached their duty of loyalty under Caremark. A Caremark claim is premised on a "sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists" (Del. Ch. 1996).

The chancery court dismissed the complaint in its entirety for failure to plead demand futility, holding that the plaintiff only pleaded that seven of 15 directors were unable to consider the demand impartially. The court also dismissed the Caremark claim on the basis that the plaintiff did not plead particularized facts supporting the board’s "utter failure" to adopt or implement any reporting or compliance system. The high court reversed both holdings.

Demand was excused. In contrast to the chancery court’s reasoning, the Supreme Court determined that demand was excused as futile because of close personal ties between an eighth director, W.J. Rankin, and Kruse’s family. Kruse’s father had hired Rankin as his administrative assistant in 1981 and promoted him to CFO five years later. The complaint also alleged that the Kruse family led a campaign that raised nearly half a million dollars to name a university building after Rankin.

The chancery court had concluded that because Rankin voted against a proposal to restore the joint CEO and chairman position after it was split into two roles—thus going against Kruse—the personal connections to Kruse did not prevent him from impartially considering the demand. This ignored the fact that suing someone is on a different level than splitting with him on a vote in a governance matter, the Supreme Court said. The deep and longstanding friendship had to be taken into account when evaluating Rankin’s ability to act impartially toward Kruse. The high court emphasized that the chancery court was bound at the pleading stage to draw all reasonable inferences in favor of the plaintiff.

Caremark claim survives. The court also revived the Caremark claim against the directors, noting that for as much discretion as directors have to exercise their disinterested business judgment, at a minimum the board must try to put in place a reasonable system of monitoring and reporting at the board level. The complaint fairly alleged that prior to the listeria outbreak, there was no board committee addressing food safety; no regular process or protocols requiring management to keep the board apprised as to food safety; and no schedule for the board to consider safety on a regular basis.

Furthermore, management knew of red or at least yellow flags preceding the customer deaths, but the board minutes revealed no evidence that these warning signs were disclosed to the board. The minutes were devoid of any suggestion that the board regularly discussed food safety. The complaint also alleged that the FDA had identified systematic deficiencies in all of Blue Bell’s plants that might have been rectified had there been a reporting system requiring management to relay this information to the board on an ongoing basis.

The court rejected the directors’ counterargument that there was an oversight system by way of Blue Bell’s compliance with FDA and state regulatory requirements for food safety, issuance of employee manuals addressing safety practices, and commissioning of occasional audits. The fact that Blue Bell as a company may have had these efforts in place did not imply that the board implemented a monitoring system at the board level.

The directors’ argument that management reported to the board on operational issues was "telling." The court explained that Caremark claims are usually dismissed because the plaintiffs must concede the existence of board-level systems of oversight such as a relevant committee, a regular reporting protocol, or the use of third-party monitors. If the fact that management discussed general operations with the board were enough to thwart a Caremark claim, it would render the doctrine a "chimera," as management is likely to touch on an operational issue at any board meeting of any company. "If Caremark means anything, it is that a corporate board must make a good faith effort to exercise its duty of care," the court wrote. The plaintiff adequately pleaded that there was no board-level system of overseeing the "mission critical" issue of food safety.

The case is No. 533, 2018.

Attorneys: Robert J. Kriner, Jr. (Chimicles Schwartz Kriner & Donaldson-Smith LLP) for Jack L. Marchand II. Paul A. Fioravanti, Jr. (Prickett, Jones & Elliott, P.A.) for John W. Barnhill, Jr.

Companies: Blue Bell Creameries USA, Inc

MainStory: TopStory CorporateGovernance CorpGovNews GCNNews DirectorsOfficers FiduciaryDuties DelawareNews

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