In a significant decision the week before the Christmas holiday, the Delaware Supreme Court, sitting en banc, reversed the Delaware Court of Chancery’s dismissal of Lebanon County Employees’ Retirement Fund v. Collis et al. (“Lebanon”), reinstating stockholder derivative claims against the directors of AmerisourceBergen Corporation arising out of the Company’s wholesale distribution of prescription opioids in the United States. Interested readers can view our blog’s prior discussion of the Court of Chancery’s dismissal here.
The Supreme Court’s decision, in the important and ever-evolving arena of so-called Caremark claims, clarifies the distinction between Delaware Rule of Evidence (“D.R.E.”) 201, which governs judicial notice of “adjudicative facts,” and D.R.E. 202, which authorizes the state’s courts to “take judicial notice of the common law [and] case law . . . of the United States,” and puts lower courts on notice of the limited role of judicial notice in early stages of litigation.
In Lebanon, the Plaintiffs asserted two theories of breach of fiduciary duty: (i) a “prong-two” Caremark claim, by which the Plaintiffs alleged the defendant directors consciously ignored “red flags” (i.e., congressional investigations, subpoenas, spates of civil lawsuits, and below-average suspicious order reporting) and failed to monitor or oversee anti-diversion control systems, purportedly evidencing the Company’s non-compliance with their obligation to report, and not fill, suspicious opioid prescription orders, or to first conduct sufficient diligence to ensure filled orders would not be diverted for improper means; and (ii) a “Massey Claim”—a separate theory of Caremark liability—by which the Plaintiffs alleged that the Defendants expanded the Company’s prescription opioid distribution networks without devoting comparable resources to anti-diversion control systems.
On the Defendants’ motion to dismiss, the Court of Chancery had concluded that the Plaintiffs’ allegations supported a pleading-stage inference that the Defendants knew the Company was reporting low levels of suspicious orders, but did not take meaningful steps to address the issue. In particular, the court opined that, in the wake of congressional reports, regulatory analyses, and an “avalanche of investigations and lawsuits” against the Company, “the directors did not just see red flags, they were wrapped in them.” Moreover, the court concluded the Plaintiffs’ allegations raised a credible inference that the Defendants improperly adopted a business plan that prioritized profits over compliance with their monitoring and reporting obligations. Finally, it concluded the Plaintiffs’ particularized allegations gave rise to a reasonable inference that a majority of the directors faced a substantial likelihood of liability, and thus the Plaintiffs had derivative standing at the time the complaint was filed.
Notwithstanding these significant threshold conclusions, however, the Court of Chancery took judicial notice of “a final factor that fatally undermine[d]” the Plaintiffs’ case: adjudicative findings in the bench trial decision in City of Huntington v. AmerisourceBergen Drug Corp., a West Virginia federal court case in which two municipalities had alleged a nuisance claim against the Company and other pharmaceutical distributors for failing to comply with their anti-diversion obligations regarding prescription opioid distribution (the “West Virginia Decision”). Following trial, U.S. District Judge David A. Faber concluded the Company did not violate its anti-diversion obligations and that no wrongdoing had occurred. In addition, the federal court “expressly” found that the Company had complied with its anti-diversion obligations. Importantly, the West Virginia Decision was rendered six months after the Lebanon Plaintiffs filed their complaint in the Court of Chancery.
In view of the court’s authority under D.R.E. 202 to take judicial notice of U.S. law, as well as what it deemed the “persuasive” West Virginia Decision, the Court of Chancery concluded it was not possible to infer the Company failed to comply with its anti-diversion obligations, or that the Plaintiffs’ claims posed a substantial threat of liability to the Defendants. Therefore, according to the court, the Plaintiffs (i) could not demonstrate that the directors faced a substantial likelihood of liability, (ii) could not plead a sufficient basis to excuse their failure to make a demand upon the Company’s board to pursue the claims, and (iii) thus lacked standing to pursue their claims derivatively on behalf of the Company.
The Supreme Court’s Reversal
In a matter of first impression, the Delaware Supreme Court held that the Court of Chancery erred by employing D.R.E. 202 to consider post-complaint evidence extrinsic to the complaint, and by giving those findings dispositive weight. It concluded that the court had utilized D.R.E. 202 “to effectively adopt the factual findings of another court in another case,” which reflected “a category error and a departure from the principles that animate the concept of judicial notice.” The Supreme Court explained that Delaware’s evidentiary rules distinguish judicial notice of adjudicative facts (D.R.E. 201)—facts not subject to reasonable dispute because they are generally known or can be readily determined from sources whose accuracy cannot reasonably be questioned—from judicial notice of law (D.RE. 202). Although recorded in “case law,” the West Virginia Decision’s findings—that the Company’s anti-diversion controls were legally compliant and that no wrongdoing had occurred—did not establish or recognize a rule or principle of law “of the kind that is subject to judicial notice under D.R.E 202.” Rather, they were findings of adjudicative fact that were reasonably disputed. The Supreme Court announced that it is improper to take adjudicative notice of factual findings of another court under D.R.E. 201, when the underlying facts are reasonably disputed.
The Supreme Court then observed that the Court of Chancery’s judicial notice of adjudicative findings of fact provided the sole basis for dismissal, and thus “deprived the [P]laintiffs of the opportunity to prove the truth of their well-pleaded allegations.” In other words, the court had improperly relied on findings regarding disputed facts in another case, before another court, made after the Plaintiffs filed their complaint, and thereby failed to assess the Plaintiffs’ derivative standing “as of the time the complaint was filed,” in contravention of the requirements of Rule 23.1.
Finally, following its de novo review of the Plaintiffs’ allegations, the Supreme Court concluded that the Plaintiffs had demonstrated standing to pursue their derivative claims. The Plaintiffs raised a credible inference that the Defendants consciously failed to monitor or oversee Company operations related to opioid distribution and anti-diversion, and pleaded particularized facts that the directors faced a substantial likelihood of liability on the claims, rending the board conflicted from assessing a demand to pursue the claims itself. The Supreme Court also acknowledged that the “pleading-stage record also supported reasonable inferences that cut in the defendants’ favor,” and that further proceedings “will disclose which set of inferences prevails.”
Although the Supreme Court’s reversal of Lebanon does not change the law surrounding Caremark claims, it is consequential in that it removes a pathway to dismissal of such claims under certain circumstances. To sustain a claim for breach of fiduciary duty, a plaintiff still must plead facts that credibly suggest that the defendants failed to implement adequate reporting or information systems or controls, or consciously failed to monitor or oversee such systems or controls. In other words, the burden on a plaintiff to plead an actionable Caremark claim is and remains onerous. But the decision provides helpful insight regarding the doctrine of judicial notice, its attendant nuances, and the roles it may play in litigation, particularly at the pleadings stage. Defendants’ reliance on adjudicative facts from another proceeding to undermine plaintiffs’ derivative claims, especially when the underlying facts are reasonably disputed and when demand futility is otherwise well-pleaded, is likely to be ineffective and should be avoided.
This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.