Chancery Reasons That Board’s Decision To Address Alleged “Red Flags” Related To Pending Litigation, After Litigation Is Resolved, Is Not Bad Faith For Caremark Purposes
Pettry v. Smith et al., C.A. No. 2019-0796-JRS (Del. Ch. June 28, 2021)
As discussed in Caremark and its progeny, fiduciary duties require directors to monitor the business and affairs of a corporation. Here, the Court of Chancery addressed the issue of oversight liability in the context of a Board’s decision, despite “red flags,” to delay certain additional remedial actions pending resolution of directly related litigation.
Plaintiff, a stockholder in FedEx Corporation (“FedEx”), filed a derivative suit against FedEx’s Board of Directors, relating to the Board’s alleged failure to monitor FedEx’s compliance with state and federal laws governing the transportation and delivery of cigarettes. Specifically, both New York State and New York City filed enforcement actions against FedEx related to the shipment of cigarettes across state lines, which resulted in a $35.3 million settlement, in 2018. The relevant cigarette shipments dated back to 2012 and the Board was also made aware of their potential illegality at this time. In response, the Board began to receive regular updates regarding ongoing litigation. It also reprimanded employees who permitted certain illegal shipments. In 2014, in response to a stockholder demand, it formed a special committee, which ultimately found years later that no fiduciary duty claims should be brought. But FedEx did not prohibit the cigarette shipments until 2016 and did not institute certain training and compliance systems until after the 2018 New York settlement (in 2019). Because of this, Plaintiff alleged that the Board knew of the illegal activity as early as 2012, but failed to take proper remedial measures until 2016 and 2019.
The directors moved to dismiss under Rule 23.1, citing Plaintiff’s failure to show demand futility. Among other things, the directors argued that they did not face a substantial likelihood of liability from the claims, because their decision to delay further remedial action on the illegal cigarette shipments was not in “bad faith,” particularly given the then-pending enforcement actions against FedEx. The Court agreed, finding that, in the particular circumstances, waiting until after the enforcement actions were resolved to take remedial steps tied directly to the subject matter of the actions “made sense” and was not the product of bad faith. As a result, the Court found that Plaintiff failed to plead a substantial likelihood of liability based on Plaintiff’s oversight liability claim against the directors and granted the directors’ motion to dismiss.