The Delaware Court of Chancery recently dismissed a derivative action in Ironworkers District Council of Philadelphia & Vicinity Retirement & Pension Plan v. Andreotti et al. One of the many claims alleged was a Caremark claim.
The dispute centered on the attempt by DuPont and its wholly owned subsidiary and seed unit Pioneer Hi-Bred International, Inc. to develop a product to compete with Monsanto Company’s genetically modified seed–a trait known as “Roundup Ready”–which allows beneficial crops to thrive under application of Monsanto’s well-known herbicide, Roundup. Under a 2002 license agreement, DuPont and Pioneer had access to Monsanto’s Roundup Ready technology for corn and soybeans. If DuPont could develop its own competitor to Roundup Ready, it would avoid significant license fees under the agreement. In the mid-2000s, DuPont began development of that competitive product, which it called “Optimum GAT” or “GAT.”
DuPont found, however, a commercially viable GAT difficult to produce. As field trials of GAT continued to be disappointing, DuPont began development of a product that combined, or “stacked,” GAT technology with Monsanto’s Roundup Ready, which was referred to as the GAT/RR Stack. During the development of this product, some DuPont and Monsanto employees believed that commercialization of the stacked product would violate the licensing agreement; nonetheless, development continued. Meanwhile, DuPont continued to tout GAT as a potentially-viable and profitable product. When negotiations between the parties involving the GAT/RR Stack and other licensing issues broke down, Monsanto sued DuPont in federal district court in the Eastern District of Missouri alleging, essentially, breach of the licensing agreement and patent infringement claims. DuPont defended on the ground that the agreement either permitted stacking or should be reformed, and counterclaimed alleging antitrust claims against Monsanto.
The resulting litigation proved disastrous to DuPont. The district court found that DuPont’s defense–that it had the ability to stack under the 2002 licensing agreement–was not only incorrect but that it was based on fabrication and worked a fraud on the court. As sanctions, it struck DuPont’s reformation defense and counterclaims, and awarded attorneys’ fees. Monsanto’s patent infringement claims were then tried to a jury. Despite the fact that DuPont had never sold any of the stacked product, the jury found damages due to Monsanto in the amount of $1.2 billion. DuPont decided it would appeal both the sanctions order and the damages award.
During the pendency of post-trial proceedings, the parties reached a settlement. Among other things, Monsanto agreed to forgo the jury verdict, DuPont released its antitrust claims and DuPont agreed to pay Monsanto $1.75 billion over ten years for access to technology.
Investigation of the Committee
Following the litigation, the plaintiff and others made demands on DuPont’s board of directors to investigate and consider suit against several officers and Board members of DuPont and Pioneer in connection with the development of GAT, the decision to stack, and the conduct of the Monsanto lawsuit, alleging breaches of fiduciary duties. The Board formed a special committee, comprised of directors who had joined the Board after the relevant timeframe at issue, and the Committee conducted a detailed investigation of the subjects of the demands, as set forth in a 179-page report, and determined that a suit against officers and directors was not in the best interest of DuPont. The DuPont Board adopted the recommendation of the Committee, and rejected the stockholders’ demands
The report described in detail DuPont’s processes and controls. The report noted:
- the Board is comprised of all independent directors
- the Board had five standing committees with oversight of various areas
- the role of the Ethics and Compliance Committee and Risk Oversight Committee
- the Company had an internal audit function and
- the Company’s litigation management procedures and disclosure procedures.
The report also discussed DuPont’s regular evaluation of its policies and procedures and improvements made from time to time.
With respect to the litigation, the Committee found that “management made fully informed decisions, in good faith, that they reasonably believed to be in the best interests of the Company.” According to the Committee, the litigation was “well-managed, with thoughtful, reasonable strategic decisions made throughout the litigation.” That the District Court disagreed with the arguments presented did not lead the Committee to conclude that the various setbacks in litigation were the result of gross negligence, bad faith, or other breaches of fiduciary duty.
Committee’s Evaluation of the Caremark Claim
The Committee considered allegations that the Board failed in its duty of loyalty by failing to oversee operations and risk, either by utterly failing to institute and maintain adequate internal controls, or by consciously failing to monitor or oversee existing controls. The Caremark claim was acknowledged by the Committee to be “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” Noting further that a plaintiff must show that the directors knew they were not discharging their fiduciary obligations, the Committee found no basis for an oversight claim.
In considering the first prong of Caremark, which requires a board to implement “information and reporting systems that are reasonably designed to provide to senior management and to the Board itself, timely, accurate information to allow each, within its scope, to reach informed judgments,” the Committee outlined the “five standing committees tasked with overseeing the Company’s operations and evaluating various elements of risk,” as well as the “various structural and reporting mechanisms in place to ensure that issues are raised to senior management and then ultimately to the Board or its Committees.” The Committee also noted that the Company maintains processes to oversee the various reporting and oversight programs, including active oversight by the Board. In considering these factors, as well as other specific policies and procedures outlined in the report, the Committee concluded that, “given the breadth of internal controls maintained at the Company and overseen by the Board,” there was “no basis to suggest that the directors ‘utter[ly] fail[ed] to attempt to assure a reasonable information and reporting system exists,’ as would be required to ‘establish the lack of good faith that is a necessary condition to liability’ pursuant to the first prong of a Caremark claim.”
Turning, then, to the second prong of a Caremark claim, which would require a showing that the Board “consciously failed to monitor or oversee” the Company’s operations, the Committee considered that there were no red flags which would make the Board aware that the “internal controls were inadequate, that these inadequacies would result in illegal activity, and that the board chose to do nothing about problems it allegedly knew existed.” In reaching this conclusion, the Committee found that the “Board reasonably relied on proper business processes . . . that were in place to ensure oversight” of the development of GAT, the GAT/RR Stack, and the Monsanto litigation, and that “[n]o red flags were ever raised to the Board to make it question the adequacy of these processes.” Accordingly, the Committee was unable to find conscious disregard of oversight duties with respect to the development of GAT, stacking, or the Monsanto litigation
To survive a motion to dismiss under Rule 23.1 where demand has been made and refused, a plaintiff must allege particularized facts that raise a reasonable doubt that:
- the board’s decision to deny the demand was consistent with its duty of care to act on an informed basis, that is, was not grossly negligent; or
- the board acted in good faith, consistent with its duty of loyalty.
Otherwise, the decision of the board is entitled to deference as a valid exercise of its business judgment.
The Court noted that the Committee found that the Company’s internal control systems–which, whether or not operating as designed, certainly existed—not sufficiently deficient so as to satisfy the first prong of Caremark, and that there were no “red flags” that would enable a finding that the Board consciously failed to monitor those controls, as required by the second prong of Caremark. The Court noted that the plaintiff merely disagreed with the conclusions of the Committee, which is not enough to state an actionable claim.
The plaintiff recognized that convincing the Court that a disinterested decision to forgo a Caremarkclaim implicates bad faith is a tough row to hoe. According to the Court, the plaintiff cleverly (but unpersuasively) attempted to depict the breach of duty regarding internal controls as a coin flip with both sides heads: either the Board had established no information or reporting system, making the directors liable under Caremark, or employees with fiduciary duties must have failed to comply with that system, making them liable for breaches of those duties. The Court declined to adopt the plaintiff’s analysis, stating that demonstrating that a business plan or system has failed is not the same as demonstrating an actionable breach of fiduciary duty. According to the Court, the Committee informed itself about the Caremark claims and did not find an actionable breach of duty worth pursuing; nothing about the Board’s acceptance of this recommendation implied bad faith.