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Supreme Court of Delaware • 2019

Marchand II v. Barnhill

212 A.3d 805

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Takeaway

In short, this case confirms that a board must build a good-faith, board-level system to monitor mission-critical risks, and that deep personal and professional ties can defeat director independence at the demand-futility stage.

Background

Blue Bell Creameries, a single-product ice cream company, suffered a major listeria outbreak in 2015. The outbreak led to a complete product recall, the shutdown of all production plants, layoffs, a liquidity crisis, and a highly dilutive private-equity investment. Eight people became ill, and three people died.

A stockholder brought a derivative action against Blue Bell’s CEO, Paul Kruse, its Vice President of Operations, Greg Bridges, and the directors. The complaint alleged that management ignored repeated regulatory warnings and positive listeria tests, and that the board breached its Caremark oversight duty by failing to establish a board-level system for monitoring food safety.

After inspecting Blue Bell’s books and records under Delaware General Corporation Law section 220, the plaintiff alleged that the board had no food-safety committee, no regular board process for addressing food safety, and no protocol requiring management to report food-safety risks or test results to the board. The complaint also alleged that management received substantial warning signs for years, while board minutes showed virtually no discussion of listeria or food safety before the crisis.

The Court of Chancery dismissed the suit under Rule 23.1 for failure to plead demand futility. It held that the plaintiff had identified directors holding only seven of the fifteen board votes as unable to consider a demand impartially; it found that director W.J. Rankin was independent. It also held that the plaintiff challenged only the effectiveness of existing monitoring controls, rather than pleading an utter failure to create controls under Caremark. The Delaware Supreme Court reversed and remanded.

Issues

Issue #1

Whether the complaint pleaded particularized facts creating a reasonable doubt that director W.J. Rankin could independently consider a demand to sue CEO Paul Kruse and Vice President Greg Bridges.

Holding

Yes. Rankin’s long-standing professional and personal ties to the Kruse family supported a reasonable inference that he could not impartially decide whether Blue Bell should sue Kruse and Bridges; demand was therefore excused as to the management claims.

Reasoning

Under Rales, demand is excused when particularized facts create a reasonable doubt that a majority of the board could impartially consider a demand. Independence is not confined to financial dependence. A court must account for human relationships, including deep friendship, gratitude, loyalty, and longstanding professional affiliation, while drawing reasonable inferences in the plaintiff’s favor at the pleading stage.

The complaint supported a reasonable inference that Rankin’s career and standing were closely tied to the Kruse family. Ed Kruse hired Rankin as an administrative assistant, Rankin rose over twenty-eight years to become Blue Bell’s CFO, and he later joined the board. The Kruse family also spearheaded a charitable campaign that raised more than $450,000 to name a college agricultural facility after Rankin. Taken together, those facts plausibly suggested substantial gratitude, respect, loyalty, and affection toward the Kruse family.

The Court of Chancery gave too much weight to Rankin’s vote against restoring the combined CEO-chair position to Paul Kruse. A director’s willingness to disagree with an interested person on an ordinary governance question does not establish that the director can objectively authorize litigation against that person. Causing the corporation to sue a longtime benefactor and associate is a far more consequential decision and may threaten the underlying relationship.

Because Rankin’s lack of independence supplied the additional vote needed to show that directors holding a majority of the board’s voting power could not impartially assess demand, the dismissal of the claims against management had to be reversed. Having reached that conclusion, the Court did not address the independence of the other challenged director, Paul Ehlert.

Issue #2

Whether the complaint stated a Caremark claim by pleading that Blue Bell’s board failed to make a good-faith effort to implement a reasonable board-level system for monitoring food safety.

Holding

Yes. The complaint supported a reasonable inference that Blue Bell’s board made no good-faith effort to establish a board-level reporting and monitoring system for food safety, a mission-critical compliance risk for the company.

Reasoning

Caremark and Stone v. Ritter require directors to make a good-faith effort to oversee the corporation’s operations, legal compliance, and viability. A plaintiff may establish bad faith by alleging either an utter failure to implement reporting or information systems and controls, or a conscious failure to monitor an existing system. Although Caremark claims are difficult to plead and prove, the board must at minimum try to establish a reasonable, context-specific oversight system.

Food safety was mission critical to Blue Bell. The company was essentially a monoline producer of ice cream and related frozen products, operating in a heavily regulated industry. Its business depended on consumers believing that its products were safe to eat. This made food safety an especially central compliance issue requiring board-level attention.

The books-and-records-based allegations supported an inference that no meaningful board-level food-safety system existed. The complaint alleged no board committee responsible for food safety, no regular board agenda item or scheduled review of food-safety risks, no protocol requiring management to provide food-safety reports, and no expectation that material compliance information would reach the board. Board minutes also reflected almost no discussion of food safety until the outbreak had already become a crisis.

The alleged facts distinguished a claim that no oversight system existed from a claim that an existing system simply performed poorly. For years, regulators and internal tests identified sanitation failures, positive listeria results, and other warning signs. Yet the board allegedly received only isolated favorable information and was not given the material reports that revealed the growing problem. The absence of information reaching the board supported the inference that the board had failed to create a reporting structure capable of informing it of critical risks.

Blue Bell’s employee sanitation manuals, regulatory inspections, third-party tests, and general management reports on operations did not defeat the claim. Those measures could show that management nominally complied with regulatory requirements, but they did not show that the board itself had created a system to monitor food safety. If generalized operational updates alone were enough, Caremark’s requirement of board-level good-faith oversight would have little practical force.

The complaint therefore adequately alleged that the board’s failure to implement a reasonable monitoring and reporting system concerning its most important compliance risk amounted to bad-faith indifference. The plaintiff was entitled to discovery to attempt to prove that claim.