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Supreme Court of Delaware • 2017

City of Birmingham Retirement & Relief System v. Good

177 A.3d 47

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Takeaway

In short, this case underscores that even grave corporate misconduct and regulatory penalties do not excuse derivative-suit demand absent particularized facts tying bad-faith, knowing lawbreaking or conscious disregard to a majority of the board.

Background

Duke Energy stored coal ash, containing toxic substances such as arsenic, mercury, and lead, in unlined ponds at its coal-fired plants. In February 2014, a stormwater pipe beneath the Dan River Steam Station ruptured and released roughly 27 million gallons of coal ash slurry and wastewater into the Dan River. Duke had not inspected the pipe, despite earlier recommendations for inexpensive camera inspections. Duke subsidiaries later pleaded guilty to nine negligence-based misdemeanor violations of the federal Clean Water Act, paid more than $100 million in fines, and incurred cleanup, remediation, and other regulatory costs.

Duke stockholders brought a derivative action on the corporation's behalf against directors and officers. They alleged that the directors consciously ignored environmental-law violations and supported a strategy of working with North Carolina's environmental regulator to prevent more demanding citizen enforcement actions. Because the directors had a Section 102(b)(7) exculpatory provision protecting them from duty-of-care damages, the stockholders sought to excuse pre-suit demand by alleging a substantial likelihood of nonexculpated Caremark oversight liability.

The Court of Chancery dismissed under Rule 23.1. It concluded that the board materials showed directors were informed about coal-ash problems and management's efforts to address them, not that the directors consciously disregarded their oversight duties. The Delaware Supreme Court affirmed.

Issues

Issue #1

Whether the stockholders pleaded particularized facts showing that a majority of Duke's directors faced a substantial likelihood of personal liability for a Caremark oversight violation, thereby excusing demand under Rule 23.1.

Holding

No. The complaint did not support a reasonable inference that the directors acted in bad faith by consciously disregarding known environmental-law violations; at most, it alleged an exculpated duty-of-care claim.

Reasoning

A derivative claim belongs to the corporation, and the board ordinarily decides whether the corporation should sue. Under Rule 23.1, stockholders must either make a demand or plead with particularity that demand would be futile. For an oversight claim based on board inaction, Rales applies: the complaint must create a reasonable doubt that a majority of the board could independently and disinterestedly assess a demand because its members face a substantial likelihood of personal liability.

Because Duke's charter exculpated directors from monetary liability for duty-of-care breaches, the stockholders had to plead scienter: that directors knew their conduct was legally improper. Caremark liability requires bad faith, such as intentional dereliction of duty, conscious disregard of known responsibilities, or an intent to violate positive law. This demanding standard prevents a court from converting a harmful corporate outcome into personal director liability.

The board presentations did not reasonably support an inference of bad faith. The December 2012 presentation reported that metals had leached into groundwater but also reported no indication of drinking-water impacts and described ongoing risk-mitigation efforts, including dry ash conversion, groundwater monitoring, closure design, and regulatory engagement. It was a report on emerging regulation and management's response, not evidence that the board deliberately ignored violations.

Likewise, the August 2013 environmental presentation identified allegations about unpermitted seeps and groundwater exceedances, but it also told the board that Duke routinely inspected and repaired ash structures, acted on state and EPA recommendations, monitored groundwater, reported seeps and monitoring results to regulators, performed site-specific studies, took corrective action where receptors could be affected, and developed measures to address long-term water-quality concerns. Receiving information about both problems and remedial steps is oversight, not conscious disregard.

Duke's criminal guilty pleas did not alter the result. The crimes were negligence-based, and the complaint did not plead particularized facts connecting the directors to the failure to inspect the ruptured pipe or showing that they knew of the underlying criminal violations. As in Stone v. Ritter, the fact that a corporation suffers a serious compliance failure and pays a large fine does not itself establish that directors acted in bad faith.

Issue #2

Whether allegations that Duke improperly colluded with North Carolina's environmental regulator established bad-faith oversight by the board and excused demand.

Holding

No. The allegations of a regulator's lax enforcement and Duke's efforts to resolve enforcement actions did not support a reasonable inference that Duke illegally colluded with a corrupt regulator, much less that the board knowingly ignored such conduct.

Reasoning

To rely on a collusion theory, the stockholders needed to plead more than that Duke cooperated with a regulator they considered too accommodating. They had to allege facts supporting an illegal or deceitful agreement with the regulator and then tie that misconduct to an intentional oversight failure by a majority of the board. The complaint did neither.

The proposed consent decree with the North Carolina regulator did not plausibly demonstrate corrupt collusion. Although its $99,000 fine was modest, the decree also contemplated seep identification, groundwater studies, a compliance schedule, and significant implementation expenses across Duke sites. The regulatory framework was still developing, and the agreement was subject to public comment and judicial approval. A less aggressive settlement than stockholders preferred did not imply bad faith or illegality.

Duke's wish to have the state regulator bring an enforcement action that would preempt citizen suits was not inherently improper. Under the Clean Water Act, government agencies are the primary enforcers, while citizen suits supplement government action. Working with the responsible agency to resolve violations at multiple facilities, minimize costs, and establish a compliance schedule was a permissible business decision on the facts pleaded.

General allegations that the regulator was business-friendly, particularly after the election of a governor formerly employed by Duke, did not establish a corrupt agreement between Duke and the agency or board knowledge of one. Nor did Yadkin Riverkeeper, which found that the regulator had not diligently prosecuted a separate case. A lack of litigation diligence is not equivalent to collusion, corporate bad faith, or knowing board misconduct.

Dissents

Chief Justice Strine

Reasoning

Chief Justice Strine agreed that the complaint did not portray the board as uninformed. But he concluded that, at the Rule 23.1 pleading stage, the particularized allegations supported a rational inference that the board knowingly accepted a corporate strategy of skirting or violating environmental laws to lower operating costs and increase profits. Delaware law does not permit fiduciaries to pursue corporate profit through knowing violations of law.

In his view, the stockholders did not need to prove a completed collusive agreement between Duke and the regulator. They needed only to plead facts supporting an inference that Duke knew it was violating the law, pursued measures insufficient for genuine compliance, and expected favorable treatment from a regulator more concerned with protecting Duke and its jobs than enforcing environmental obligations.

The complaint, he reasoned, described extensive and longstanding violations: illegal contamination of groundwater, unauthorized discharges, missing permits, and hundreds of daily regulatory violations. It also alleged that the board received reports showing contaminated seepage, health-based groundwater exceedances, and the risks posed by third-party enforcement. Those facts could support an inference that directors understood and tolerated a strategy of noncompliance rather than merely receiving reports of problems being responsibly addressed.

Chief Justice Strine also considered the allegations about Duke's political influence and the proposed consent order probative. Duke and affiliated donors allegedly spent heavily to support officials favorable to lax environmental enforcement, including a former Duke employee who became governor. The board allegedly knew that Duke was using the state enforcement action to preempt citizen suits, while the resulting proposed settlement imposed a small fine and did not require meaningful remediation. In his view, these facts supported suspicion that Duke expected regulatory protection while avoiding compliance costs.

The later Dan River disaster and the regulator's retreat from the proposed settlement reinforced, rather than defeated, the pleaded inference. Discovery might ultimately show that the suspicions were unfounded, but the complaint's particularized allegations allowed a rational inference of bad-faith oversight by the board. He would therefore have reversed the dismissal and allowed the derivative claim to proceed.