Corporate Boards May Face Higher Legal Hurdle in Risk Oversight

Directors at companies in food, drug, or other highly regulated industries could be forced to ratchet up how they monitor business risks in light of recent Delaware court decisions.

Drugmaker Clovis Oncology Inc.'s directors face a shareholder suit for allegedly ignoring red flags related to a failed lung cancer treatment, after the Delaware Chancery Court let the case proceed. The board of ice cream maker Blue Bell Creameries Inc. failed to dodge a similar suit over a deadly listeria outbreak.

The rulings signal that boards in regulated industries may have a tougher time evading claims of lax oversight, particularly in cases where human lives are at stake.

“When human health and safety are an issue, the implication is that boards need to be directly engaged,” said Kevin LaCroix, an attorney and executive vice president at RT ProExec, an insurance intermediary focused on management liability issues.

Another test of how Delaware judges scrutinize director oversight could come soon in a shareholder suit against plane maker Boeing Co.'s board over fatal crashes involving its now-grounded 737 Max jetliner.

“Boeing is certainly one to watch,” LaCroix said, since he says it could provide another “data point” for boards looking for risk oversight lessons from Delaware courts.

Health, Safety Risks

The courts’ more welcoming attitude toward shareholder suits alleging board failures contrasts with the dismissal of prior suits against JCPenney Co. and Lending Club Corp. Delaware’s Chancery Court rejected both of those suits for failing to prove board misconduct.

The same court let the Clovis suit move forward in October, a few months after Delaware’s Supreme Court revived a suit against Blue Bell’s board following the lower court’s dismissal. The Clovis and Blue Bell cases stand out because of their focus on health and safety-related risks to a company’s main products.

Blue Bell had to recall all its products when 10 people were hospitalized and three died after eating listeria-tainted ice cream. Shareholders claim that company management had received reports flagging food safety issues, but that the board didn’t have a system in place to oversee food safety.

Clovis’s board had an oversight system but is accused of failing to carry it out despite alleged red flags that management wasn’t following required protocols for clinical trials on its lung cancer drug.

Risk Oversight

Traditionally, directors were responsible for showing that an oversight program existed, said Charles Elson, who directs the University of Delaware’s corporate governance center.

Courts have left “how it existed” to a company’s judgment, said Elson, who sits on a Blue Bell board special committee formed to investigate the lawsuit’s claims. But courts could step up their scrutiny after the Clovis and Blue Bell rulings.

Directors following the lawsuits are weighing whether to increase their own risk oversight, attorneys say. That could include forming a panel of directors focused on safety, which Delaware’s top court highlighted as missing in Blue Bell, or recruiting new directors with expertise in areas such as drug testing.

Boeing’s board has done both, adding a new safety committee in August and seeking safety expertise in new recruits.

Steps like those could be especially salient for companies in the same industries as Blue Bell or Clovis, Michelle Lowry, a finance professor who directs Drexel University’s governance institute, said. “It will be interesting to see how other companies react.”

The cases are In re Clovis Oncology, Inc. Derivative Litig., Del. Ch., No. 2017-0222, 10/1/19; Marchand v. Barnhill, Del., No. 533 2018, 6/18/19.