The Delaware Court of Chancery recently dismissed a derivative lawsuit asserting a Caremark claim for failure to adequately allege demand futility under Court of Chancery Rule 23.1. The opinion, Pettry v. Smith, et al., C.A. No. 2019-0795-JRS (Del. Ch. June 28, 2021), provides a helpful roadmap regarding the assertion of demand futility under Delaware law, and is an important read for any party or practitioner litigating a Caremark claim.
In Pettry, the plaintiff stockholder alleged that the board of FedEx Corporation (the “Company”) failed to oversee compliance with state and federal laws governing the shipment of cigarettes, despite being placed on notice by a report of misconduct in 2012. The lawsuit sought compensation from the director defendants for a $35 million settlement of suits brought by the State of New York and New York City, along with corporate governance reforms and disgorgement of profits.
The plaintiff, Pettry, did not make a demand upon the board. Rather, Pettry argued that demand would have been futile because each board member would face a substantial likelihood of personal liability. Accordingly, Pettry argued demand futility, which would excuse plaintiff’s obligation to make a demand upon the board.
Defendants disagreed and moved to dismiss the Complaint under Court of Chancery Rule 23.1 for failure to plead demand futility. Alternatively, Defendants moved to dismiss under Chancery Rule 12(b)(6) for failure to state a claim.
Vice Chancellor Slights agreed with defendants, and granted their motion to dismiss under Chancery Rule 23.1. Specifically, the Court ruled that plaintiff failed to adequately plead that a majority of the Board faces a substantial likelihood of liability on her claims or were otherwise disabled by interest or lack of independence.
The Court wrote that, under Delaware law, a stockholder must “satisfy the threshold demand requirements of Court of Chancery Rule 23.1” before being permitted to pursue a derivative claim on behalf of a corporation. Slip op. at 15. “To meet the Rule 23.1 requirements, the stockholder must plead with particularity either that she made a demand on the company’s board of directors to pursue particular claims or why any such demand would be futile, thereby excusing the need to make a demand altogether.” Id.
The Court noted that a Caremark claim, which is a claim that corporate fiduciaries breached their duties by failing to monitor corporate affairs, is “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” Slip op. at 19 (quoting Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 967 (Del. Ch. 1996)). The Court addressed what must be plead in order to adequately allege such a claim:
At the pleadings stage, a plaintiff must allege particularized facts that satisfy one of the necessary conditions for director oversight liability articulated in Caremark: either that (1) the directors utterly failed to implement any reporting or information system or controls; or (2) having implemented such a system or controls, [the directors] consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.
Slip op. at 19 (internal quotations and citations omitted).
Plaintiff asserted that the director defendants violated their Caremark duties under the second prong referenced above. In granting defendants’ motion to dismiss, Vice Chancellor Slights held that the Complaint failed to sufficiently plead that the director defendants consciously disregarded “red flags”.
Specifically, the Court noted that the entire board and audit committee were apprised of the ongoing enforcement actions through settlement. Moreover, the board formed a Demand Committee to consider a stockholder demand related to the alleged improper cigarette shipments, which found that that the Company should not bring claims against the director defendants for violation of their duty of oversight because there was no evidence of bad faith. In addition, plaintiff acknowledged that various Company personnel were reprimanded. Finally, the Complaint acknowledged that by 2016, the Company had banned nearly all tobacco shipments, and in 2019, it introduced numerous training programs and implemented measures to increase the detection of illegal cigarette shipments.
This opinion demonstrates the difficulty in sufficiently pleading demand futility under Court of Chancery Rule 23.1 in connection with a Caremark claim. This is especially true if the board has been appropriately apprised of potential issues, formed an independent committee, and has taken appropriate steps to remediate any potential infractions, including reprimanding employees along with other corrective actions. The opinion should be carefully considered by any board member faced with a Caremark claim before the Delaware Court of Chancery.