This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.
The Delaware Court of Chancery recently ruled Boeing Company directors must face shareholder charges that they breached their oversight duty by insulating themselves from safety problems with the new 737 MAX and ignoring red flag warnings of deadly stability defects that crashed two of the jetliners within five months. In Re The Boeing Company Derivative Litigation, No. 2019-0907-MTZ opinion issued, (Del. Ch. Sept. 9, 2021).
In her Sept. 9 opinion, Vice Chancellor Morgan Zurn found pension fund plaintiffs’ director oversight claims met the tough pleading standards of the Delaware Supreme Court’s milestone Marchand ruling with well-supported allegations that a majority of the directors are likely liable for Boeing’s billions of dollars in losses and penalties and can’t be entrusted to bring breach-of-duty charges. Marchand v. Barnhill, 212 A.3d 805 (Del. 2019)
Marchand was the high court’s preeminent interpretation of Chancellor William Allen’s 1996 pioneering In re Caremark International ruling that set standards for shareholder plaintiffs to recover on behalf the corporation itself in the rare oversight case where, “directors, otherwise unconflicted, should nonetheless take actions knowingly inimical to the corporate interest, such as ignoring a known duty to act to prevent the corporation from violating positive law.” In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996).
Vice Chancellor Zurn’s ruling repeatedly pointed to the Marchand standards in finding that Boeing’s directors:
1. Got no regular safety information on the 737 MAX or any of its planes due to their “complete failure” to establish a committee or regular board reports on safety issues,
2. After the first crash, did not immediately investigate what caused the 737 MAX to repeatedly push its nose down in a series of disastrous dives at low speeds and instead virtually ignored the problem even though safety was a “mission critical” area,
3. Intentionally misled federal regulators about the scope and seriousness of a computer pilot training program meant to help them use software that would allegedly minimize nose-down dives,
4. Allegedly lied to the public and regulators about how comprehensive, good faith and quickly implemented their post-crash safety program was.
5. Never pressed the CEO for more information or questioned his conclusions when he repeatedly told the board the 737 MAX was safe and blamed the crashes on pilot and maintenance errors.
However, she found insufficient proof for charges that Boeing’s officers stifled defect reports and that the board bought ex-CEO Dennis Muilenburg’s silence about their liability with an overly rich exit package.
Some legal experts have questioned whether Vice Cancellor Zurns’ opinion fits into what they see as a trend of recent rulings that have allegedly made it less difficult to meet what the Delaware courts have traditionally called the “onerous” pleading standards of a Caremark duty claim.
Two public pension funds were the co-lead plaintiffs in a shareholder suit that claimed Boeing’s directors were liable for lax safety that caused two crashes of the new 737 MAX jetliner, killing all aboard both planes — which were grounded by federal regulators for 20 months with large financial losses. They contended that the directors were too conflicted by their likelihood of liability to press claims, giving the shareholders standing as derivative plaintiffs.
Was demand futile?
Defendants’ motion to dismiss argued that plaintiffs could not meet the very high hurdle pleading standards for their Caremark claims but Vice Chancellor Zurn found the amended complaint meets both prongs of the threshold demand requirements of Court of Chancery Rule 23.1 under the seminal Rales v. Blasband, 634 A.2d 927 (Del. 1993) opinion “and is therefore permitted to assume control of a claim belonging to the corporation.” She found demand on the board would have been futile because there was adequate support for charges that a majority of the directors lacked both independence and disinterest.
The directors “face a substantial likelihood of liability for failure to fulfill their oversight duties under the standards set forth in Caremark, as applied by the Delaware Supreme Court in Marchand, the vice chancellor wrote, adding that the complaint adequately alleges bad faith, “a necessary condition to director oversight liability.”
In response to defendants’ argument that they met the Federal Aviation Administration’s requirements for certification of the plane and its accompanying training and operation program, the court said, “under Marchand, minimal regulatory compliance and oversight do not equate to a per se indicator of a reasonable reporting system.”
Legal scholars may debate for some time to come whether Boeing and/or any of its predecessors in the past few years used degraded pleading requirements — and what the resultant effect might have been on the “onerous” Caremark standard. However, readers are referred to a previous synopsis on these pages of another Caremark decision with an interesting similarity. Teamsters Local 443 Health Services & Insurance Plan et al. v. Chou, et al., No. 2019-0816-SG opinion issued (Del. Ch. Aug. 24, 2020).
In that opinion, the Chancery Court found that shareholder plaintiffs also passed the Caremark pre-suit demand test because they adequately alleged that the defendant pharmaceutical company’s directors insulated themselves from bad news and turned a blind eye to red flags concerning a subsidiary’s criminal enterprise of dangerous cancer drug repackaging.
The takeaway from that blog post speculated that, “most may read the ruling as a signal from the nation’s preeminent business court that in this post-Covid world, failure-to-supervise claims involving the director response to red-flagged problems with mission-critical operations at closely-regulated health-related businesses deserve increased scrutiny – especially at the crucial pleading stage.
And some may even see the need to apply that increased scrutiny to director decisions in suits against any closely-regulated business, especially one that impacts human health.”