Chancery Dismisses Oversight Claims Against J.C. Penney Board
As this Court of Chancery decision explains, the Delaware standard for imposing oversight liability on a board of directors under a Caremark theory is “exacting” and requires evidence of bad faith. Combined with the heightened “particularized” pleading requirements of Court of Chancery Rule 23.1, stockholders face an uphill battle when pursuing an oversight theory as the basis for liability and for excusing a pre-suit demand on the board.
This decision arose out of a derivative action brought by a stockholder of J.C. Penney. The plaintiff’s claims related to the company’s non-compliance with consumer protection laws on price-comparison advertising. The defendants moved to dismiss under Court of Chancery Rule 23.1, arguing pre-suit demand on the independent and disinterested board of directors was not excused.
Applying the Rales v. Blasband test for demand futility concerning oversight claims, the Court agreed with defendants that demand was required and not excused. According to the Court, the plaintiff failed to allege facts from which it could reasonably infer that the directors consciously allowed J.C. Penney to violate price-comparison advertising laws so as to show bad faith, thereby expose them to a substantial likelihood of liability, and thus excuse demand. First, the plaintiff’s allegations did not support an inference that J.C. Penney’s directors “utterly failed to implement any reporting or information system or controls” regarding complying with price-comparison advertising laws. Relevant to this issue was the audit committee’s mandate covering such responsibilities and the board’s activities concerning the same. Second, the plaintiff’s allegations likewise did not support an inference that the directors “consciously failed to monitor or oversee” the operations of the company’s established system or controls. In that regard, the Court declined to find that a particular settlement agreement entered into by J.C. Penney put the directors on notice of ongoing illegalities. As the Court explained, while a settlement of litigation or a warning from a regulatory authority may demonstrate that a board knew or should have known of ongoing illegalities, that is not necessarily true, and was not true under the facts of this case.Share