Evidence of Lack of Adequate Compliance Systems Sufficient to Plead Bad Faith by Board
Summer is usually the best time of year for ice cream companies, but the season is off to a rough start for Blue Bell Creameries, USA, Inc. The Delaware Supreme Court, in Marchand v. Barnhill, held on June 18 that a suit brought by a stockholder of Blue Bell, in part accusing the company’s directors of violating their duty of loyalty to stockholders in their handling of a listeria outbreak in 2015, could continue based on adequate pleading of facts demonstrating bad faith. The ruling was a reversal of a Court of Chancery decision.
The stockholder claimed that Blue Bell’s board of directors failed to take the necessary steps to monitor and remain informed as the company management received an increasing number of listeria reports – first at its facilities and then later in its ice cream products – between 2013 and 2015. The listeria contamination of the company’s products led to significant product recalls and three deaths. In addition, as the court stated, “[l]ess consequentially, but nonetheless important for this litigation, stockholders also suffered losses because, after the operational shutdown, Blue Bell suffered a liquidity crisis that forced it to accept a dilutive private equity investment.”
The stockholder based his claim on the analysis of a director’s duty of loyalty as analyzed in the landmark case In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996). In Caremark, the Delaware Court of Chancery had held that directors must make a good faith effort to oversee company operations. This includes ensuring that an “information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as a matter of ordinary operations.” Failing to make a good faith effort breaches the director’s duty of loyalty.
The court found that the Blue Bell board may not have met the Caremark standard, as it failed to have in place requirements for management to report to the board regarding food safety – a key area of compliance for one of the country’s largest ice cream manufacturers. The decision places significant emphasis on the lack of evidence in the board’s meeting minutes during the period of the listeria outbreak of (i) any disclosure by management to the board of the numerous yellow and red flags concerning food safety and (ii) a dearth of board discussion on the matter. Other shortcomings in the board’s behavior included failure to create a board committee to address food safety, no process for management reporting to the board on food safety practices and risks and lack of a schedule for the board to consider, on a regular basis, such as quarterly or biannually, food safety risks.
Key takeaways from this case for directors of companies in any industry include:
- establish an ongoing monitoring and reporting system to keep board members adequately informed with respect to legal compliance matters material to the company’s operations;
- ensure that board meetings include reasonable discussion of such matters on at least a quarterly or biannual basis; and
- confirm that the board’s meeting minutes reflect that the foregoing systems are being implemented in good faith such that the board is providing adequate oversight with respect to such matters.