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City of Birmingham Retirement and Relief System v. Good

Supreme Court of Delaware

December 15, 2017


          Submitted: September 27, 2017

         Court Below: Court of Chancery of the State of Delaware C.A. No. 9682-VCG

         Upon Appeal from the Court of Chancery: AFFIRMED.

          Martin S. Lessner, Esquire, Kathaleen St. J. McCormick, Esquire, Nicholas J. Rohrer, Esquire, and Meryem Y. Dede, Esquire, Young Conaway Stargatt & Taylor LLP, Wilmington, Delaware; Robert A. Hoffman, Esquire, Jeffrey W. Golan, Esquire (Argued), and Julie B. Palley, Esquire, Barrack, Rodos & Bacine, Philadelphia, Pennsylvania; Felipe J. Arroyo, Esquire, Shane P. Sanders, Esquire, and Gina Stassi, Esquire, Robbins Arroyo LLP, San Diego, California; Judith S. Scolnick, Esquire, Donald A. Broggi, Esquire, and Thomas L. Laughlin, Esquire, Scott䧊, Attorneys at Law, LLP, New York, New York, for Plaintiffs-Below, Appellants City of Birmingham Retirement and Relief System, Robert L. Reese, Police Retirement System of St. Louis, Edward Tansey, and Estate of Leatrice Seinfeld.

          Peter B. Andrews, Esquire and Craig J. Springer, Esquire, Andrews & Springer LLC, Wilmington, Delaware, for Individual Plaintiffs-Below, Appellants Robert L. Reese and City of Birmingham Retirement and Relief System.

          Alfred G. Yates, Jr., Esquire, Law Offices of Alfred G. Yates, Jr., P.C., Pittsburgh, Pennsylvania, for Individual Plaintiff-Below, Appellant Robert L. Reese.

          Kenneth J. Nachbar, Esquire (Argued), Susan W. Waesco, Esquire, and Alexandra M. Cumings, Esquire, Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Delaware; Jack B. Jacobs, Esquire, Sidley Austin LLP, Wilmington, Delaware; Steven M. Bierman, Esquire, Andrew W. Stern, Esquire, and Elizabeth A. Espinosa, Esquire, Sidley Austin LLP, New York, New York, for Defendants-Below, Appellees Lynn J. Good, Ann M. Gray, G. Alex Bernhardt, Sr., Michael G. Browning, Harris E. DeLoach, Jr., Daniel R. DiMicco, John H. Forsgren, James H. Hance Jr., John T. Herron, James B. Hyler, Jr., William E. Kennard, E. Marie McKee, E. James Reinsch, James T. Rhodes, Carlos A. Saladrigas, B. Keith Trent, Lloyd M. Yates, James E. Rogers, William Barnet III, and Philip R. Sharp.

          Before STRINE, Chief Justice; VALIHURA, VAUGHN, SEITZ, and TRAYNOR, Justices.

          SEITZ, Justice

         A stormwater pipe ruptured beneath a coal ash pond at Duke Energy Corporation's Dan River Steam Station in North Carolina. The spill sent a slurry of coal ash and wastewater-containing lead, mercury, and arsenic-into the Dan River, fouling the river for many miles downstream. In May 2015, Duke Energy pled guilty to nine misdemeanor criminal violations of the Federal Clean Water Act and paid a fine exceeding $100 million. The plaintiffs, stockholders of Duke Energy, filed a derivative suit in the Court of Chancery against certain of Duke Energy's directors and officers. [1] On behalf of the Company, they sought to hold the directors-a majority of whom were outside directors and were not named in the criminal proceedings-personally liable for the damages the Company suffered from the spill.

         The directors moved to dismiss the derivative complaint, claiming the plaintiffs were required under Court of Chancery Rule 23.1 to make a demand on the board of directors before instituting litigation. The plaintiffs responded that demand was futile because the board's mismanagement of the Company's environmental concerns rose to the level of a Caremark[2] violation, which posed a substantial risk of the directors' personal liability for damages caused by the spill and enforcement action. The Court of Chancery disagreed and dismissed the derivative complaint. According to the court, to hold directors personally liable for a Caremark violation, the plaintiffs must allege that the directors intentionally disregarded their oversight responsibilities such that their dereliction of fiduciary duty rose to the level of bad faith. After giving the plaintiffs the benefit of all reasonable pleading inferences, the court held that the reports from management relied on by the board to address coal ash storage problems negated any reasonable pleading-stage inference of bad faith conduct by the board.

         We agree with the Court of Chancery that the plaintiffs did not sufficiently allege that the directors faced a substantial likelihood of personal liability for a Caremark violation. Instead, the directors at most faced the risk of an exculpated breach of the duty of care. Thus, the stockholders were required to make a demand on the board to consider the claims before filing suit. We therefore affirm the Court of Chancery's judgment dismissing the complaint.


         According to the allegations of the complaint, Duke Energy, a Delaware Corporation based in Charlotte, North Carolina, is the largest provider of electricity in the United States.[3] Duke Energy's coal-fired power plants generate a byproduct known as coal ash, which contains toxic and carcinogenic substances.[4] The plants dispose of the coal ash through wastewater treatment centers composed of unlined ponds where contaminants sink to the bottom and less-contaminated water stays at the top, to be discharged into adjacent rivers.

         Under the Federal Clean Water Act ("CWA"), [5] "the discharge of any pollutant by any person shall be unlawful, "[6] unless granted a permit by the United States Environmental Protection Agency ("EPA") or the applicable state regulatory body[7]-in this case, the North Carolina Department of Environmental and Natural Resources ("DENR").[8] Primary enforcement authority lies with the regulatory body.[9] If third parties wish to sue a company for violating the CWA, they must first file a notice of intent with the applicable regulatory bodies.[10] If a notified regulator does not initiate enforcement within sixty days, the third party litigant may proceed with the suit.[11] If, however, the state or federal regulatory party files suit within the sixty-day limit, the third parties lose standing to sue.[12] Although the third parties lose standing, they can move to intervene in the litigation between the regulator and the defendant.[13] Further, a third party can regain standing if the regulator fails to "diligently prosecute" the alleged violator once suit is filed.[14]

         In 2013, several citizens' environmental groups filed a notice of intent to sue three of Duke Energy's subsidiaries under the CWA for coal ash seepages at ponds in North Carolina.[15] In response, the North Carolina Department of Environmental Quality ("DEQ") filed an enforcement action, which preempted the suits.[16] DEQ and Duke Energy negotiated a consent decree that would require Duke Energy to pay a $99, 000 fine and create a compliance schedule.[17] The consent decree also required Duke Energy to "identify[] and characteriz[e] seeps" and conduct "[g]roundwater studies."[18] The Company planned to use the decree as a "model for resolving litigation" at twelve other sites, [19] and estimated that enforcing the decree at all of its North Carolina locations would cost between $4 and $5 million.[20] The consent decree was subject to a public comment period and court approval.[21]

         DEQ withdrew from the proposed consent order when on February 2, 2014, a stormwater pipe ruptured beneath a coal ash containment pond at Duke Energy's Dan River Steam Station in Eden, North Carolina, releasing twenty-seven million gallons of coal ash slurry and wastewater into the Dan River.[22] Duke Energy had never inspected the pipe, although a Duke Energy station manager recommended the company pay $20, 000 for camera inspections in both 2011 and 2012.[23] Upon investigation, federal and state regulators found that had Duke Energy completed a camera inspection, it likely would have discovered the corroded pipe.[24] The three subsidiaries pled guilty to nine misdemeanor violations[25] of the CWA, paid $102 million in fines, and agreed to restitution, community service, and mitigation.[26] All counts were negligence-based, and none of the defendants in this appeal were alleged to have any knowledge of the violations in the criminal proceedings.[27]

         Duke Energy spent roughly $24 million to clean up the spill and acknowledged responsibility for future costs, including regulatory directives, damage to natural resources, and any additional litigation.[28] It paid a $2.5 million fine to Virginia for damages to the downriver City of Danville and a $6.8 million fine to DEQ, [29] and incurred additional costs to comply with environmental regulations newly enacted by North Carolina and the EPA[30]-regulations that could result in the closure of coal ash ponds for an estimated cost of $4.5 billion.[31]

         On April 22, 2016, the plaintiffs filed derivative suits in the Court of Chancery, [32] alleging that the directors breached their fiduciary duties because they knew of and disregarded Duke Energy's CWA violations and allowed Duke Energy to collude with DEQ to evade compliance with environmental regulations.[33] The plaintiffs sought damages on behalf of the Company of (1) $102 million for the fine resulting from the guilty pleas, (2) $24 million for repairs and remediation of the Dan River spill, (3) $12 million for the fines to North Carolina and Virginia, (4) $7 million for the fine to DEQ, and (5) additional costs associated with environmental litigation filed as a result of the spill.[34]

         The directors moved to dismiss the complaint for failure to plead demand futility, claiming that the plaintiffs did not allege the particularized facts required by Court of Chancery Rule 23.1 to show that the directors faced a substantial likelihood of personal liability. The Court of Chancery agreed and found the facts alleged in the complaint did not lead to the reasonable inference that the directors consciously disregarded environmental problems at the site or improperly colluded with regulators to avoid remediating environmental problems.[35] The court dismissed the complaint under Court of Chancery Rule 23.1 for failure to make a demand on the board. This appeal followed. We review the Court of Chancery's dismissal of a stockholder derivative complaint de novo.[36]


         The board of directors, exercising its statutory authority to manage the business and affairs of the corporation, ordinarily decides whether to initiate a lawsuit on behalf of the corporation.[37] Stockholders cannot shortcut the board's control over the corporation's litigation decisions without first complying with Court of Chancery Rule 23.1. Before stockholders can assert a claim belonging to the corporation, they must first demand that the directors pursue the claim and, if the directors decline, attempt to demonstrate that the directors wrongfully refused the demand. Alternatively, stockholders can allege with sufficient particularity that demand is futile and should be excused due to a disabling conflict by a majority of the directors to consider the demand.[38]

         For alleged violations of the board's oversight duties under Caremark, the test articulated in Rales v. Blasband applies to assess demand futility.[39] Under Rales, the plaintiffs must plead particularized facts raising "reasonable doubt of the board's independence and disinterestedness when the demand would reveal board inaction of a nature that would expose the board to 'a substantial likelihood' of personal liability."[40]

         When, like here, the directors are protected from liability for due care violations under § 102(b)(7) of the Delaware General Corporation Law, the plaintiff must allege with particularity that the directors acted with scienter, meaning "they had 'actual or constructive knowledge' that their conduct was legally improper."[41]In other words, the stockholders must allege "that a director acted inconsistent with his fiduciary duties and, most importantly, that the director knew he was so acting."[42] This is because a Caremark claim "is rooted in concepts of bad faith; indeed, a showing of bad faith is a necessary condition to director oversight liability."[43] A specific example of bad faith is when the director engages in an "intentional dereliction of duty" or "conscious disregard for one's responsibilities, "[44] or acted "with the intent to violate applicable positive law."[45] Because of the difficulties in proving bad faith director action, a Caremark claim is "possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment."[46]At the pleading stage, the court must accept particularized allegations of fact as true, and all reasonable inferences must be drawn in the plaintiffs' favor.[47] But, under Rule 23.1, the plaintiffs have "a heightened burden to plead particularized facts establishing a "reasonable doubt that . . . the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand."[48] "[I]nferences that are not objectively reasonable cannot be drawn in the plaintiff's favor."[49]

         On appeal, the plaintiffs argue the court erred in finding the complaint lacked sufficient facts to establish a substantial likelihood that the individual directors would be personally liable for allowing Duke Energy to violate environmental laws, thus excusing demand. The plaintiffs focus their claims of error on two central points: first, the court improperly discredited the plaintiffs' interpretation of board presentations and minutes, which, according to the plaintiffs, showed Duke Energy was violating environmental laws and avoiding remediation; and second, when considering the plaintiffs' allegation that Duke Energy was exploiting its relationship with a "captive" regulator, the Court of Chancery failed to draw the proper inferences from evidence of what the plaintiffs characterize as collusion between Duke Energy and its regulator.[50] We address each of these arguments in turn.


         The Board Presentations

         The Court of Chancery reviewed the board presentations addressing the ash ponds at Duke Energy's power generation sites, and concluded that the board was both "aware of environmental problems [and] what the company was doing to attempt to address those situations."[51] According to the court, the directors did not consciously disregard the environmental problems. Rather, the presentations informed the board that Duke Energy was working with DEQ "to achieve regulatory compliance in a cost-effective way with limited liability."[52] The court found the board presentations an insufficient basis to raise a reasonable inference of bad faith by the board.

         On appeal, the plaintiffs challenge the Court of Chancery's conclusion, pointing to specific information in the board presentations and minutes that they argue suggested longstanding knowledge and disregard of environmental violations.[53] The plaintiffs first highlight the December 12, 2012 Coal Combustion Residuals presentation, which stated that "[s]ome metals have leached to groundwater from unlined landfills and surface impoundments." [54] Thus, the plaintiffs argue, the board knew Duke Energy was violating the law but did nothing to remedy it.

         The plaintiffs unfairly describe the overall presentation, which we are not required to accept on a motion to dismiss. Jeff Lyash, Executive Vice President of Energy Supply, presented to the board's Regulatory Policy and Operations Committee on the Company's exposure (liability) from coal combustion residuals ("CCR's"), which are different kinds of coal ash. Lyash informed the committee that CCR's were "classified currently as non-hazardous" but the regulatory environment was changing.[55] Although informed that metals had leached into groundwater, the board committee was also informed there was "no indication that drinking water is being impacted."[56] Further, the purpose of the presentation was to chart a future course for addressing proposed EPA regulations governing CCR pollution. The board committee was informed that the EPA had proposed eliminating "wet ash management and un-lined CCR storage "[57] After inventorying Duke Energy's CCR storage sites, and estimating the financial impact of the proposed regulations, Lyash informed the board committee of Duke Energy's work underway to mitigate risks:

. Dry Ash Handling-Converted to dry fly ash handling at most large base load coal units that will operate past 2015. Projects budgeted over next few years to convert bottom ash transport to dry systems.
. Groundwater Monitoring-Voluntarily groundwater monitoring of NC ash basins for several years, providing data to the state. Now a requirement of NC wastewater permits in 2011. No indication that drinking water is being impacted.
. Closure Design-Currently utilizing anticipated closure design that incorporates synthetic/plastic membrane cap and drainage layers. Geo-membrane cap design minimizes rain and surface water in-leakage and resultant leaching.
. Regulatory Engagement-Continuing to advocate efforts to shape the final regulation. Currently closing some basins at Gibson under agreement with [the Indiana Department of Environmental Management]. Evaluating closures at small retired or retiring sites as a part of decommissioning work.[58]

         The presentation is fairly described as a status update to the board committee of the proposed EPA regulations' impact on Duke Energy's ash disposal practices, and its "work underway" for "risk mitigation."[59] As the Court of Chancery found, the board was not only informed of environmental problems, but also the steps being taken to address them. It does not support plaintiffs' central theory that a majority of the board consciously ignored or intentionally violated positive law.

         The plaintiffs next point to the August 27, 2013 Environmental Review Presentation to the board of directors. In the twenty-two pages of slides, Keith Trent, Executive Vice President and Chief Operating Officer of Regulated Utilities, presented a comprehensive review of the history of coal ash ponds and environmental regulation, on-going litigation, and steps Duke Energy was taking to mitigate the financial and environmental risks posed by ash ponds at various Duke Energy sites.[60]

         The plaintiffs focus on one line in a slide stating "[s]eeps are unpermitted discharges; [groundwater] violations."[61] The statement they refer to, however, was reporting allegations against Duke Energy in pending lawsuits.[62] But more to the point, the board was informed that Duke Energy:

. "Routinely inspected and] repair[ed]" ash dike stability;
. "[A]cted on all EPA [and] State inspection and recommendations";
. Conducted "[g]uide monitoring, " and "review[ed] results with state
agency"; . Took action "especially where potential impacts exist with receptors";
. "Advocat[ed for] federal 'non-hazardous' legislation and regulations";
. "Performed] site-specific studies"';
. Submitted "an ash basin closure plan" to state regulators to "review for
approval"; . "Identified seeps to state" and found a "negligible impact to the overall surface water quality"; and
. "Based on routine assessments, " took "proactive actions . . . to mitigate risks and potential impacts."[63]

         As to "Seepage, " the presentation informed the board that Duke Energy:

. Found that the "[v]olume of ash basin seepage . . . is extremely small and has negligible impact to overall surface water quality";
. "Routinely informed the state of seeps"; and
. Identified the seeps "in detail to state agencies during recent water permit renewals."[64] As to "Exceedances of groundwater standards, " the presentation informed the board that Duke Energy:
. Conducted groundwater monitoring "since 2007 or before with results submitted to state agencies";
. Took "corrective action at three sites with receptors where there was a potential impact to neighbors"; . Found "no indication of impacts at other receptor sites";
. "Developed] and implemented] measures ([at] operating and retired sites) to address [groundwater] exceedances, seeps and long-term water quality protection"; and . Submitted groundwater assessment reports at North Carolina's request.[65]

         The August 27, 2013 Environmental Review Presentation is fairly characterized as another update on environmental problems associated with coal ash disposal sites, and steps Duke Energy was taking to address the environmental concerns. It does not lead to a reasonable inference of the board's bad faith conduct by consciously ignoring environmental problems.

         The plaintiffs' allegations here are like those in Stone v. Ritter.[66] In Stone, this Court considered whether a board of directors failed to discharge its oversight duties regarding compliance with the Federal Bank Secrecy Act.[67] Although "[n]either party dispute[d] that the lack of internal controls resulted in a huge fine, " the reports to the board showed that the board "exercised oversight by relying on periodic reports" from the officers.[68] Thus, the court found plaintiffs' complaint unsuccessfully attempted "to equate a bad outcome with bad faith."[69] Similarly, the plaintiffs here conflate the bad outcome of the criminal proceedings with the actions of the board. As in Stone, the board "exercised oversight" by receiving management presentations on the status of environmental problems. The presentations identified issues with the coal ash disposal ponds, but also informed the board of the actions taken to address the regulatory concerns. Thus, we agree with the Vice Chancellor that the board presentations do not lead to the inference that the board consciously disregarded its oversight responsibility by ignoring environmental concerns.[70]


         Collusion with Regulators

         To overcome the motion to dismiss, plaintiffs concede that they must plead sufficient facts showing that the board knew DEQ was a "captive regulator" with whom Duke Energy was "colluding." [71] The Court of Chancery rejected this argument, finding it "a theory at once creative and unsustainable on the facts plead."[72] According to the court, even if DEQ's prosecution of environmental violations was "insufficiently rigorous, or even wholly inadequate, " it fell short of leading to a reasonable inference that Duke Energy illegally colluded with regulators.[73]

         On appeal, the plaintiffs claim the Court of Chancery made several errors in reaching this conclusion. Before addressing the details of these arguments, however, it is important to keep in mind the target the plaintiffs must hit to defeat the motion to dismiss. As the Court of Chancery found, it is not enough to allege cooperation with what plaintiffs describe as a too-friendly regulator. Instead, the plaintiffs must allege in sufficient detail that Duke Energy illegally colluded with a corrupt regulator.[74] And then, plaintiffs must tie the improper conduct to an intentional oversight failure by the board. [75] The complaint falls short of these pleading requirements.


         The Consent Decree

         The plaintiffs first argue the consent decree negotiated with DEQ was a fig leaf because it only imposed a $99, 000 fine and did not require remediation.[76] They allege that the fine was a "meaningless amount" in light of Duke Energy's $2.5 billion yearly earnings [77] and that remediation would not occur because the compliance schedule was not yet established, but was to be "further delineat[ed]."[78]Like their characterization of the board presentations, the plaintiffs isolate one part of a much bigger picture. In addition to the fine, Duke Energy estimated spending $4 to $5 million to enforce the consent decree at all its North Carolina sites, [79] $100, 000 to identify and characterize seeps, and $300, 000 to $500, 000 to conduct groundwater studies and reroute flows or treatment.[80] Duke Energy also expected to negotiate a compliance schedule with regulators. Further, the presentations show the EPA had still not finalized rules regulating CCR, and there were "[i]ndications that final rule may be non-hazardous, "[81] which would impact remediation costs. Regardless, even though DEQ imposed a relatively small fine and gave Duke Energy time to establish a compliance schedule, which was not as aggressive as the plaintiffs would have preferred, those facts do not lead to an inference that the board should have been alerted to corrupt activities between Duke Energy and its regulator. Nor does it lead to a reasonable inference that the board ignored evidence of alleged misconduct with a state regulator.[82]

         Finally, the collusion argument loses its force when another undisputed fact is considered-the consent decree was subject to approval by the North Carolina court.[83] The public and environmental groups who intervened in the enforcement action had the opportunity to comment on and object to the consent decree before a court gave it the force of law. Thus, if the consent decree was as deficient as the plaintiffs claim and resulted from ...

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