The In re: Boeing Decision
In Boeing, the plaintiffs alleged that the board had failed to establish a reporting system for airplane safety and turned a blind eye to safety red flags.3 According to the complaint, none of the company’s board committees was specifically tasked with overseeing airplane safety, and every committee charter was silent with respect to airplane safety.4 The company’s Audit Committee was tasked with overseeing legal and regulatory compliance but allegedly focused principally on financial and production risks and did not routinely discuss airplane safety.5 Compounding the issue, management did not report to the board on safety issues, and the board did not receive internal complaints about safety. Though it acknowledged the high bar to such cases proceeding, the court held that the plaintiffs had made sufficient allegations against the directors and allowed the case to proceed.6
In so doing, the court relied heavily on the Delaware Supreme Court’s recent decision in Marchand v. Barnhill.7 In Marchand, the Supreme Court focused on regulatory risk, and held that board oversight of such risk must be “rigorously exercised” with respect to “mission critical” risks.8 Relying on Marchand’s precedent, the court in Boeing found that the plaintiffs — closely tracking the allegation in Marchand — had alleged that while Boeing’s Audit Committee was charged generally with risk oversight, “no committee [was] charged with direct responsibility to monitor airplane safety”;9 that the board failed properly to monitor, discuss, or address airplane safety issues;10 and that no regular processes or protocols had been implemented for reporting and addressing “red flags.”11
The Boeing Decision Is Grounded in Cases About Healthcare and Life Sciences Companies In Which Suits Were Allowed to Proceed Against Directors for Inadequate Compliance/Safety Oversight
The Boeing case is the latest in a series of cases stemming from the Delaware Chancery Court’s Caremark decision 25 years ago. Many of the cases, starting with Caremark itself, have involved healthcare or life sciences companies involved in caring for patients or producing goods that can affect consumer safety.12 Caremark involved review of a settlement of shareholder derivative claims that were premised on the company’s guilty plea and payment of criminal and civil penalties for violations of federal and state healthcare fraud laws, including the Anti-Kickback statute, which also resulted in the imposition of a Corporate Integrity Agreement.13 The Chancery Court held that directors may face liability in limited circumstances for losses caused by noncompliance with applicable legal standards14 but made clear that the bar for such a claim is high, holding that “only 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 — will establish the lack of good faith that is a necessary condition to liability.”15 In light of that standard, the court approved the settlement, based on its finding that there was a very low probability of a determination that Caremark’s directors breached their duty to monitor.16
A decade later, in Stone v. Ritter,17 the Delaware Supreme Court faced a derivative claim arising out of a civil settlement related to a company employees’ failure to file reports required by federal anti-money-laundering laws. The court held that directors face potential liability for either
- failure to implement any compliance system, including information and reporting systems, or
- having implemented a compliance system, conscious failure to monitor the operation of that compliance system.18
Importantly, the court framed the Caremark decision as implicating the duty of “good faith,” which is “a subsidiary element” of the duty of loyalty, holding that where directors fail to act in the face of a known duty to act, they demonstrate a conscious disregard for their responsibilities.19 (Delaware law does not allow companies to exculpate directors for a breach of the duty of loyalty or to indemnify directors for acts or failures to act that are not in good faith.20) Notwithstanding the fact that the case broke new doctrinal ground, the court affirmed the Chancery Court’s dismissal of the claim.21
The outcomes in a trio of cases decided over the past several years involving companies in the food or life sciences industry have been different, with claims against directors being allowed to proceed (as in the Boeing case):
- Marchand v. Barnhill22 involved a listeria outbreak in ice cream manufactured by Blue Bell Creameries USA, Inc., which resulted in three customer deaths followed by a total product recall, plant shutdowns, layoffs, and resolution of a resulting liquidity crisis through a dilutive private equity investment. The Chancery Court granted the defendant’s motion to dismiss, but the Delaware Supreme Court reversed. The court focused principally on the plaintiff’s allegations that Blue Bell lacked:
- a board committee to oversee food safety
- a full board-level process to address food safety issues
- a protocol for advising the board of food safety reports and developments
- evidence in board minutes of discussion by the board of food safety issues23
Building on its decision in Stone v. Ritter, the Supreme Court held that “[f]ailing to make [a good faith effort to oversee the company’s compliance program] breaches the duty of loyalty and can expose a director to liability.”24 Under this standard, the court concluded that it appeared that no system of board-level compliance monitoring and reporting existed at the company.25 Notably, in so doing, the court acknowledged the directors’ argument that the company had “nominally complied with” certain standard Food and Drug Administration (FDA) requirements and state rules relating to food safety. The court held, however, that “Blue Bell’s compliance with these requirements shows only that management was following, in a nominal way, certain standard requirements of state and federal law [and] does not rationally suggest that the board implemented a system to monitor food safety ....”26 The court went on to state that “[t]he mundane reality that Blue Bell is in a highly regulated industry and complied with some of the applicable regulations does not foreclose any pleading-stage inference that the director lack of attentiveness rose to the level of bad faith indifference required to state a Caremark claim.”27
2. In re Clovis Oncology, Inc. Derivative Litigation28 involved a biotechnology company with a drug in development for the treatment of lung cancer. The company failed to comply with FDA rules for reporting test results and reported results in a manner that overstated the drug’s efficacy and safety.29 When the misleading nature of the company’s test reporting was exposed, the company’s stock price declined dramatically, its application for approval of the drug had to be withdrawn, and a series of securities class actions followed, which the company resolved at a high price.30 Shareholders filed a derivative lawsuit against the directors, alleging (among other things) a failure properly to oversee the reporting of the clinical trials.31
The Chancery Court denied the defendants’ motion to dismiss the duty-of-oversight claim.32 Unlike the board in Marchand, the board in Clovis, though it did not have a separate compliance or risk committee, had an established reporting system in which the board reviewed and discussed detailed information regarding the status of the drug’s clinical trial. During this time, the board was periodically informed of the actual test results and that management was inaccurately calculating and publicly disclosing the results.33 Because the board had oversight and reporting systems in place relevant to the clinical trials, the court held that the plaintiffs had not established the board’s failure to implement these systems.34 The court held, however, that the plaintiffs had stated a claim for the board’s failure to monitor the oversight systems by alleging with particularity that the board consciously ignored multiple red flag warnings that management was inaccurately reporting the drug trial results.35 According to the court, “as fiduciaries, corporate managers must be informed of, and oversee compliance with, the regulatory environments in which their businesses operate.”36
Importantly, the court also emphasized that the board’s responsibilities must be exercised and assessed in relation to the level of risk presented, stating that Marchand “underscores the importance of the board’s oversight function when the company is operating in the midst of ‘mission critical’ regulatory compliance risk.”37 In a mission-critical environment, “the board’s oversight function must be more rigorously exercised.”38
3. In 2020, the Chancery Court allowed yet another Caremark claim against a life sciences company to proceed past the motion-to-dismiss stage, focusing on allegations that the board had failed adequately to oversee mission-critical regulatory risk. Teamsters Local 443 Health Servs. v. Chou39 involved allegations that the directors of the defendant company had failed properly to implement and monitor compliance policies and systems in connection with a subsidiary specialty pharmacy’s failure properly to package and ship prefilled syringes of oncology products, resulting in a guilty plea for violation of the Federal Food, Drug, and Cosmetic Act, criminal penalties and forfeiture of $260 million, and a $625 million civil settlement under the False Claims Act.40 In analyzing the claims, the court acknowledged that the defendant was a more complex organization than the defendant in either the Marchand or Clovis case, but nonetheless held that “that does not mean the concept of mission critical compliance risk is inapplicable here.”41 It went on to conclude that for a manufacturer of drugs, “[l]aws and regulations governing the health and safety of drugs are thus the ‘most central ... safety and legal compliance issue facing the company’” and that “when regulations governing drug health and safety are at issue, [a company’s] Board must actively exercise its oversight duties in order to properly discharge its duties in good faith.”42
The Take-Home Message
The message from these cases is clear: Boards have responsibility to ensure that systems are in place to identify and monitor compliance and safety risks on an ongoing basis, and they must do so “rigorously” with respect to “mission critical” risks. When, on a motion dismiss, the record does not provide evidence that they have done so, the Delaware courts will allow cases against them to proceed. This is particularly important for healthcare and life sciences companies that operate in heavily regulated environments and are engaged in operations that affect patient safety. Such companies may find themselves at substantial risk of regulatory enforcement and hence heightened risk of derivative actions.
To mitigate this risk, boards of all companies, but especially those in the healthcare and life science space, should ensure that mechanisms are in place to support rigorous board oversight of compliance and safety efforts. This should include the following:
- Periodically conduct a review of the business to identify mission-critical operations and risks.
- Review the reporting processes in place to ensure that information about mission-critical risks is brought to the board’s attention in a manner that is not unduly dependent on management discretion.
- Ensure that the board is well positioned to engage in oversight in this area.
- Establish a regular cadence for discussion of compliance and safety at board meetings;
- Consider whether the board has clearly and adequately delegated to a current board committee responsibility for assisting the board in its oversight of compliance and safety risk or whether the board should establish a specialized committee for this task; and
- Be sure committee charters clearly reflect the responsibilities delegated for compliance and safety.
- Document board and committee efforts in this area carefully in meeting minutes.
1In re Boeing Co. Derivative Litigation, 2019-0907 (Dec. Ch. Sept. 7, 2021).
2See, e.g., Marchand v. Barnhill, 212 A.3d 805 (Del. 2019); Teamsters Local 443 Health Servs. v. Chou, C.A. No. 2019-0816-SG (Del. Ch. Aug. 24, 2020); In re Clovis Oncology, Inc. Derivative Litigation, No. CV 2017-0222-JRS, 2019 WL 4850188 (Del. Ch. Oct. 1, 2019).
3In re: Boeing, slip op at 2.
4Id. at 6.
5Id. at 8.
6Id. at 29.
7Marchand v. Barnhill, 212 A.3d 805 (Del. 2019).
8Id. at 822.
9In re: Boeing, slip op at 33.
10Id. at 34.
11Id. at 41.
12In re Caremark Int‘l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996).
13Id. at 965.
14Id. at 971.
16Id. at 961.
17Stone v. Ritter, 911 A.2d 362 (Del. 2006).
18Id. at 30.
19Id. at 370.
20Delaware General Corporation Law, § 102(b)(7).
21Stone v. Ritter, 911 A.2d 362 (Del. 2006).
22Marchand v. Barnhill, 212 A.3d 805 (Del. 2019).
23Id. at 809.
24Id. at 820.
25Id. at 822.
26Id. at 823 (emphasis added).
28In re Clovis Oncology, Inc. Derivative Litigation, No. CV 2017-0222-JRS, 2019 WL 4850188, at *13 (Del. Ch. Oct. 1, 2019).
29Id. at *7.
30Id. at *9.
31Id. at *1.
32Id. at *10.
33Id. at *6.
34Id. at *13.
35Id. at *15.
36Id. at *12.
38Id. at *13.
39Teamsters Local 443 Health Servs. v. Chou, C.A. No. 2019-0816-SG (Del. Ch. Aug. 24, 2020).
40Id. at 23-35.
41Id. at 24.
42Id. Additionally, in Hughes v. Hu, No. CV 2019-0112-JTL, 2020 WL 1987029, at *17 (Del. Ch. Apr. 27, 2020), a nonhealthcare/life sciences case, the Chancery Court denied a motion to dismiss a suit against an electric vehicle parts seller that had repeatedly to revise its financial statements due to failures by its audit committee to oversee financial reporting. The court found that the plaintiff had alleged “chronic deficiencies” that supported a reasonable inference that the directors failed to provide adequate oversight of the company’s financial controls. The court found that “given the persistent and prolonged problems at the Company,” its directors “face[d] a substantial likelihood of liability under Caremark for breaching their duty of loyalty by failing to act in good faith to maintain a board-level system for monitoring the Company's financial reporting.” Hughes, 2020 WL 1987029 at *17.
Sidley Austin LLP provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship. Readers should not act upon this information without seeking advice from professional advisers.
Attorney Advertising—Sidley Austin LLP, One South Dearborn, Chicago, IL 60603. +1 312 853 7000. Sidley and Sidley Austin refer to Sidley Austin LLP and affiliated partnerships, as explained at www.sidley.com/disclaimer.
© Sidley Austin LLP