24 August 2020

Delaware Court of Chancery Reaffirms Heightened Standard for Caremark Claims — But Reminds That Outlier Facts Yield Outlier Results

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On August 24, 2020, Vice Chancellor Sam Glasscock III issued a rare denial of a motion to dismiss so-called Caremark claims in a case against directors of AmerisourceBergen Corporation (the Company). Although the decision reiterates the significant pleading burden that such oversight claims must meet, and exemplifies that only extraordinary facts typically permit a plaintiff’s claims to proceed to discovery, it is also a useful reminder that board-level best practices can, among other things, help address and limit any such liability.

In 2001, the Company acquired Oncology Supply Pharmacy Services (Pharmacy) in a merger, which thereafter operated within the Company’s “Specialty” business. Pharmacy acquired single-dose oncology drugs in vials, which it then re-sold, re-packaged in individual syringes. Each vial, however, contained more drug than was required for each injection. Though this overfill amount was “not intended for patient use,” plaintiffs alleged that Pharmacy pooled the leftover drug from each vial to fill additional syringes — a process that yielded extra revenue, but “was unsterile and led to the contamination of the drugs.” Eventually the contamination was visible but filtered out, and the drugs were sold for patient use. Pharmacy allegedly further “undercut the competition by providing kickbacks to buyers to increase market share” and “used sham prescriptions to make it appear that Pharmacy was, in fact, a pharmacy, and thus shielded from FDA oversight.” The Court described these allegations as amounting to “operating a criminal enterprise.” In fall 2017, Specialty pled guilty to violations of federal law related to its failure to register Pharmacy with the FDA and Pharmacy’s drug pooling program. Specialty ultimately paid $260 million in criminal fines, plus another $625 million to resolve civil claims under the False Claims Act.

Plaintiffs filed a Caremark claim, seeking to recover against the directors that allegedly failed in their corporate oversight duties, which allegedly led to these harmful practices and likewise harmed the Company.

Caremark claims are regularly referred to as being “among the most difficult of claims” to successfully plead, because a plaintiff must allege with particularity that the “directors acted with scienter which, in turn, requires not only proof that a director acted inconsistently with his fiduciary duties, but also importantly, that the director knew he was so acting.” A Caremark claim can take two forms. One arises where directors “utterly failed to provide a corporate reporting system.” The other arises where directors installed such a system, but then “consciously failed to monitor or oversee its operations, thus disabling themselves of being informed of risks or problems requiring their attention.” Plaintiffs levied allegations under both prongs.

The Court denied defendants’ motion to dismiss, finding that plaintiffs adequately alleged that a majority of the board ignored red flags related to “mission critical” issues. As a pharmaceutical company operating in a highly regulated industry, the Court reasoned that compliance with FDA regulations and related laws were central risks for the company, and found Plaintiffs had adequately alleged that although the board had some awareness of these issues, it had not sought to redress them. Among the key allegations here were:

  • In 2006, the Company engaged outside counsel to review its compliance and reporting structures. This report indicated that certain subsidiaries (including Pharmacy) were “operating outside” the Company’s compliance controls and there “were no reporting structures in place to inform the Board” of compliance violations in that area.
  • In 2010, Specialty’s Chief Operations Officer filed a qui tam complaint related to the drug pooling program, which stated that a communication to the Company’s CEO about the program had gone unaddressed. While board-level documents referenced the qui tam lawsuit, the Court found that none reflected “any remedial action taken by the Board in response,” reinforcing plaintiffs’ claims regarding the board’s oversight failures.
  • In 2012, the Department of Justice served a subpoena relating to the drug pooling program. While the Company’s 2012 annual report noted that it was responding to the subpoena, Plaintiffs alleged that there was a lack of discussion about the topic in the Company’s produced board minutes, creating an inference the board did not discuss the subpoena. Again, the Court concluded that the Plaintiffs were entitled to a pleading-stage inference that the board failed to correct the “underlying mission critical compliance shortcomings at Pharmacy.”

The Court’s rejection of defendants’ motion to dismiss reinforces the importance of best practices at the board-level, and compliance practices and procedures across the corporate structure:

  • Review of compliance and other corporate system by third parties — like an external counsel review — can be a powerful tool to remediate issues but can create or increase liability if identified issues are left unabated;
  • Boards should be sure to maintain appropriate minutes, to ensure that deliberations and actions are properly documented;
  • Review and reporting of whistleblower complaints must follow the paths mandated by the law and internal reporting structures; and
  • Reporting and compliance structures should be periodically reviewed to be sure they capture “mission critical” issues.