Delaware Supreme Court Decision Shows Continued Momentum for Caremark Plaintiffs

Perhaps that’s where the story ends. However, technicalities aside, the fact that the Court would permit a Caremark claim alleging intentional non-compliance to proceed in the face of the federal court post-trial opinion that found compliance potentially suggests the Court sees room for Caremark liability even in the absence of an underlying legal or regulatory violation. At minimum, it suggests challenges in getting such claims dismissed at their initial stages. Delaware courts have already been increasingly receptive to Caremark claims since the Delaware Supreme Court’s 2019 decision in Marchand v. Barnhill,² which reversed dismissal of a Caremark claim against the directors of an ice-cream maker for failure to oversee food safety. Indeed, more Caremark claims have survived dismissal in the four years since than in the 23 years pre-2019 dating back to the doctrine’s origin. In light of the Court’s most recent decision, it is likely this trend will only continue. Delaware companies should therefore be on heightened alert of their duties of oversight under Delaware law and sharpen companies’ attention on processes for reducing the risks of Caremark litigation, including creating a record demonstrating the board’s oversight.

Background

As one of the nation’s “big three” opioid distributors, AmerisourceBergen has faced a wave of lawsuits and regulatory scrutiny in recent years arising from the opioid epidemic. In 2021, it shouldered $6 billion of a $26 billion settlement payment made by distributors to resolve claims brought by states and local governments relating to the crisis (the “2021 Settlement”). As increasingly happens following a “corporate trauma” of this scale, these lawsuits and the settlement payment also prompted a derivative Caremark claim in Delaware against AmerisourceBergen’s directors, seeking to recover on behalf of the company for the harm allegedly caused by the board’s failure to oversee systems that could have prevented this liability.

To state a Caremark claim, a plaintiff must allege that the board either failed to implement a system of reporting and controls for key risks facing the company or, having established such a system, failed to monitor it.³ Plaintiffs asserted the latter, alleging that directors fostered “a culture of non-compliance” that knowingly prioritized profits over compliance with law and failed to respond to “red flags” that AmerisourceBergen was not complying with the Controlled Substances Act (the “CSA”). The directors moved to dismiss, arguing that (i) the complaint itself showed the board had adopted and enhanced a monitoring program, and (ii) there was no well-pleaded allegation that they knowingly breached their duties of oversight. While dismissal briefing was ongoing in Delaware, a federal court in West Virginia issued a post-trial decision in City of Huntington v. AmerisourceBergen Drug Corp., in which local governments that did not take part in the 2021 Settlement asserted nuisance claims against AmerisourceBergen and other distributors for allegedly failing to stem the diversion of opioids into their communities (the “Federal Litigation”).⁴ The federal court found that “Defendants substantially complied with their duties under the CSA” and that “Plaintiffs have not proved diversion-control failures by Defendants.”⁵

The Court of Chancery’s Dismissal

The Court of Chancery dismissed the Caremark claim.⁶ It reasoned that the allegations in plaintiffs’ complaint normally would be sufficient to survive a motion to dismiss. Specifically, the court concluded that “[s]tanding alone, the avalanche of investigations without any apparent [board] response until the 2021 Settlement would support a well-pled Red-Flags claim,” and the leaving of an allegedly defective monitoring program in place for years “until the 2021 Settlement[] would support a well-pled … claim.”⁷ However, the Court of Chancery reasoned that both of those theories “depend on an inference that [AmerisourceBergen’s] officers and directors knowingly failed to cause the Company to comply with its anti-diversion obligations,” and such an inference was “not possible” in light of the court’s findings in the Federal Litigation. The Court of Chancery concluded that, “[a]lthough the federal court’s findings are not preclusive, they are persuasive” and they “fatally undermine[d] the [plaintiffs’] complaint.” Thus, demand was not excused because a majority of the current board did not face a substantial likelihood of liability.

The Delaware Supreme Court’s Reversal

The Delaware Supreme Court reversed, holding that the Court of Chancery should have evaluated the sufficiency of the complaint’s allegations without giving effectively decisive weight to the findings in the Federal Litigation. The Delaware Supreme Court concluded that, although a Delaware court can take judicial notice of questions of law from other courts, it cannot adopt another court’s factual findings at the pleading stage through judicial notice.

The Delaware Supreme Court agreed with the Court of Chancery that, setting aside the findings in the Federal Litigation, the complaint had adequately alleged a Caremark claim. The Delaware Supreme Court concluded that allegations of the “paltry number” of suspicious orders identified by the company’s anti-diversion program, when combined with numerous lawsuits and investigations alleging massive diversion of opioids, constituted “red flags” that the program was ineffective, which the directors failed to act on. In light of this discrepancy, the Delaware Supreme Court rejected the directors’ arguments that 1) because AmerisourceBergen had never been found liable or admitted to any liability in the underlying settlements and legal proceedings, their existence did not support an inference of wrongdoing, and 2) the defendants should be shielded from liability because “numerous experts in law… told the Board that the Company’s systems complied with the law.”⁸ The Court also explained that merely reviewing reports that present red flags is not enough unless the board takes action. Because the AmerisourceBergen director defendants faced a substantial likelihood of liability, demand was excused and the case could proceed into discovery.

Takeaways

As the Caremark doctrine from its inception has focused on oversight of legal and regulatory risks, separate legal and regulatory actions often give rise to the underlying “harm,” and the allegations and findings in those actions often provide the Caremark complaint’s factual allegations. At a minimum, the Collis decision underscores just how asymmetrically plaintiffs can use those other actions at the pleading stage of a Caremark action. The plaintiff in Collis successfully supported an inference of a willfully non-compliant anti-diversion program in large part by referencing unproven allegations and settlements that did not concede liability. Yet the defendants were not permitted to refute that inference based on a court determining after a two-month trial that AmerisourceBergen’s program did comply with law. One can rest assured that, had the decision in the Federal Litigation gone the other way, the Caremark plaintiff would have cited it as powerful evidence rather than argue it cannot be considered. In addition, Caremark plaintiffs might use the decision to argue that relevant findings by another court or other competent authority regarding a company’s compliance does not preclude a Caremark claim, effectively giving Caremark plaintiffs a second bite at the apple.

How can boards combat this asymmetry and avoid a plaintiff’s slanted telling of its oversight efforts? The principal defense rests in the board meeting minutes and materials that are typically produced to a Caremark plaintiff in response to a books and records demand and can (by the parties’ agreement) be considered on a motion to dismiss. Collis illustrates the importance of board materials that reflect not only a reporting system that allows the board to exercise oversight of risk management and become aware of significant issues, but that also reflect what actions the board took or directed in response to “red flags.” Just as these materials can provide the documentation necessary to show a good-faith process defeating a Caremark claim, the absence of support in these materials can lead to the opposite inference. For example, in Ontario Provincial Council of Carpenters’ Pension Trust v. Walton,⁹ the Court sustained a Caremark claim against Walmart directors alleging — similar to the claims against AmerisourceBergen’s directors in Collis — that they failed to oversee that their anti-diversion program complied with the CSA. The court stressed that the heavily redacted minutes and materials showed little of substance and reasoned “if the record lacks documentation relating to a particular event, and if it is reasonable to expect that documentation would exist if the event took place, then the plaintiffs are entitled to a reasonable inference that the event did not occur.” The well-worn advice that “less is more” when it comes to board minutes and materials increasingly does not hold up in the Caremark context.

Collis joins several other recent decisions showing that robust processes and board materials are particularly imperative for regulatory risks that go to the core of the company’s business — e.g., food safety for an ice cream maker, airplane safety for an airplane manufacturer, and CSA compliance for a distributor of controlled substances. Additional attention to key risks facing the business can also be provided by a board committee. The Delaware courts’ Caremark jurisprudence reflects an understanding that a board cannot monitor every potential problem or prevent every harm, but the courts are taking an increasingly searching eye toward whether boards are making good-faith efforts to monitor the “mission critical” risks facing their companies.

¹ 2023 WL 8710107 (Del. Dec. 18, 2023).

² 212 A.3d 805 (Del. 2019).

³ Marchand, 212 A.3d at 820–21.

⁴ 609 F. Supp. 3d 408 (S.D.W. Va. 2022).

⁵ Id. at 425, 438.

⁶ 2022 WL 17841215 (Del. Ch. Dec. 22, 2022).

⁷ Id. at *2.

⁸ 2023 WL 8710107, at *20.

⁹ 2023 WL 3093500 (Del Ch. Apr. 26, 2023).