Horman, et al. v. Abney, et al., C.A. No. 12290-VCS (Del. Ch. Jan. 19, 2017) (Slights, V.C.)

In this memorandum opinion, the Court of Chancery found plaintiff stockholders had failed to plead demand futility in connection with a Caremark claim that conflated bad outcomes with bad faith by the board when implementing and monitoring oversight and governance procedures.  The Court dismissed the action pursuant to Rule 23.1. 

At all relevant times, plaintiffs were stockholders in a package delivery company.  They alleged the company’s directors had breached their fiduciary duties by failing to monitor the company’s compliance with federal and state laws governing tobacco shipments.  Specifically, plaintiffs alleged the directors had breached their fiduciary duties because they either failed to implement a monitoring system or refused to respond to red flags after implementing such a system.  Plaintiffs contended that because the directors faced a substantial likelihood of liability for this Caremark claim, demand was excused. 

The Court recognized plaintiffs could establish demand futility by pleading facts that the directors failed to implement any oversight system or ignored red flags after establishing such a system.  The Court further noted that based on the Delaware Supreme Court’s decision in Stone ex rel. Am South Bancorporation v. Ritter, 911 A.2d 362 (Del. 2006), Caremark claims require a showing of scienter, that is, that the directors knowingly failed to discharge their monitoring duties. 

As to plaintiffs’ claim that no oversight systems had been implemented, the Court found the argument “perplexing.”  Plaintiffs’ complaint detailed monitoring systems such as legal and ethics departments and an audit committee.  Nonetheless, plaintiffs argued that a books and record demand revealed no board-level documents relating to these systems and that the board was merely “going through the motions.”  The Court disagreed, explaining that plaintiffs’ own allegations acknowledged the existence of oversight systems and that an absence of board-level documents, without more, was insufficient to establish that the board was simply going through the motions of overseeing compliance. 

As to plaintiffs’ claim that red flags were ignored, the Court agreed with plaintiffs that a prior agreement with state and federal agencies and audit committee presentations regarding compliance reflected compliance warnings, but concluded these events were not ignored because the directors took action in response to each, such as increasing training, establishing an investigative process, and upgrading software.  The Court rejected plaintiffs’ contention that other events constituted “red flags” because there were insufficient allegations that such information reached the board. 

Plaintiffs also argued that the magnitude and duration of the wrongdoing supported an inference that the board knew of wrongdoing and failed to act.  The Court recognized that the magnitude of wrongdoing might support an inference that a board knew of and failed to rectify wrongdoing but rejected that it did so here.  While plaintiffs failed to provide context to assess the magnitude of the wrongdoing as compared to the company’s overall operation, the company’s SEC filings established that the amount of wrongdoing was comparatively marginal.  The Court therefore concluded plaintiffs had failed to plead particularized facts establishing a substantial likelihood of liability under the second ground of Caremark. 

The Court dismissed the complaint with prejudice under Rule 23.1 for failure to plead demand futility. 

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