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ESG Pressure Raises Ante on Board Duty Breach Claims in Delaware

Jan. 18, 2022, 11:00 AM

The ESG movement is reverberating through Delaware courts as judges allow more plaintiffs to move forward with claims that boards or corporate officers breached their duty of care.

A handful of recent rulings from the Delaware Chancery Court and others—involving companies including Boeing Co. and ice cream maker Blue Bell Creameries LP—point to a changing tenor on director liability in the state preferred by companies for resolving litigation.

Plaintiffs bringing so-called Caremark claims, which allege failure of board oversight, are finding greater success pressing their arguments at a time of growing shareholder and public scrutiny of corporate citizenship. That’s forcing companies to bolster their defenses against types of claims that were routinely dismissed just a few years ago.

“It’s hard not to notice there’s this reinvigorated Caremark mood at a time when ESG is becoming so important,” said Ann Lipton, a professor at Tulane University Law School, referring to the environmental, social and governance concerns topping shareholder and board agendas in recent years.

“It’s not so much that they’ve literally changed the standards,” Lipton added. The change is manifesting in court rhetoric and case law on issues with an obvious impact on consumers or social issues, she said.

A shareholder suit alleging that McDonald’s Corp. board neglected its duties in awarding its former CEO a multimillion-dollar severance package—instead of firing him outright over alleged workplace sexual misconduct—could be one of the next high-profile rulings on so-called Caremark claims, Lipton said.

Lawyers are also watching developments in a Delaware bankruptcy case in which private equity owners Wellspring Capital Management LLC must face breach of duty of care claims related to the firm’s management of defunct gun retailer SportCo.

Less Leeway

Caremark claims refer to claims against corporate directors and officers over breaches of duty of care, typically related to exercising insufficient due diligence or oversight over the company.

The claims typically involve a two-step test involving whether the board failed to implement reporting or control mechanisms, and whether the board failed to monitor those systems once in place.

“Those types of claims are very difficult for shareholders to make because the business judgment rule is so protective of boards,” said Howard Suskin, co-chair of Jenner & Block’s securities litigation and class action practices.

Courts typically afford boards and executives great leeway in their decisions by deferring to their business judgment.

But plaintiffs have been making significant headway in the past few years. One of the highest profile recent Caremark decisions is the Chancery Court’s September 2021 ruling allowing investors to pursue a Caremark claim against the Boeing Co. board.

The court found the directors failed to exercise sufficient oversight of “mission critical” aspects of the company’s business—aircraft safety—that ultimately led to two fatal crashes of its 737 MAX airplanes.

The ruling allowed the suit to go forward, though the board settled the case for $237.5 million, paid to the company rather than investors, in November.

The Boeing case followed a June 2019 ruling in the Delaware Supreme Court against Blue Bell Creameries. The court found the board failed to exercise proper oversight to avoid a listeria outbreak and allowed investors’ breach of duty of care claims to proceed. The case was settledwith the shareholder who brought the case for $60 million in July 2020.

“Blue Bell was a real shock, and Boeing added to that,” Suskin said.

Rulings in those cases have shown Caremark claims to be viable, Suskin said. “You shouldn’t assume that as a director, just because you’re protected by business judgment, you’re somehow immune from a duty of care claim,” he said.

Gross Negligence?

Not every Caremark claim is a winner. Payments company MoneyGram Inc. and online lender LendingClub Inc. won dismissal of breach of duty claims last year.

But plaintiffs in a lower-profile case notched a rare, initial Caremark win in October that lawyers are watching.

Judge J. Kate Stickles of the U.S. Bankruptcy Court for the District of Delaware ruled that three Wellspring Capital partners can’t duck claims alleging mismanagement of bankrupt firearm distributor SportCo. Wellspring acquired SportCo in 2008 and the private equity firm’s directors served on SportCo.'s board.

Trustee Ronald Friedman of Silverman Acampora LLP accused SportCo’s directors of breaching a fiduciary duty to the company, including the duty of care, when they pursued a money-losing deal to acquire competitor AcuSport Corp. for $7 million.

SportCo justified the 2018 deal on the premise it would immediately realize a $7 million profit on selling AcuSport’s firearms inventory, which it valued at $14 million.

SportCo ultimately sold the inventory assets for just $139,000 and spent millions more integrating the two companies, while defaulting on a $4.7 million interest payment.

The court deemed that the sizable loss and the “speed at which the loss occurred” were palpable enough to potentially constitute gross negligence, said Madlyn Gleich Primoff, a partner in Freshfields Bruckhaus Deringer LLP’s restructuring and insolvency practice.

Next Steps

The case’s next steps will shed light on how independent the Wellspring directors were from those at SportCo, and what sort of guidance the sporting company received from its financial advisers that could speak to their due diligence efforts, Primoff said.

“All those sorts of things would improve the situation from a corporate governance perspective,” she said.

The case could set precedent that greater care is needed on financial projections, “which is often overlooked by boards,” said David Prager, head of Kroll LLC’s U.S. restructuring advisory practice.

“This was not a small or terribly unsophisticated company or set of directors that got into trouble here,” he said of the Wellspring case.

If SportCo.'s wide miss on projected profits is enough to warrant breach of care, “that fact pattern could open up floodgates” for more cases against corporate boards, he said.

To contact the reporter on this story: Lydia Beyoud in Washington at lbeyoud@bloomberglaw.com

To contact the editors responsible for this story: Michael Ferullo at mferullo@bloomberglaw.com; Roger Yu at ryu@bloomberglaw.com

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