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Marchand v. Barnhill

Supreme Court of Delaware

June 18, 2019

JACK L. MARCHAND II, Plaintiff Below, Appellant,
v.
JOHN W. BARNHILL, JR., GREG BRIDGES, RICHARD DICKSON, PAUL A. EHLERT, JIM E. KRUSE, PAUL W. KRUSE, W.J. RANKIN, HOWARD W. KRUSE, PATRICIA I. RYAN, DOROTHY MCLEOD MACINERNEY and BLUE BELL CREAMERIES USA, INC., Defendants Below, Appellee.

          Submitted: April 24, 2019

          Court Below: Court of Chancery of the State of Delaware C.A. No. 2017-0586-JRS

         Upon appeal from the Court of Chancery. REVERSED and REMANDED.

          Robert J. Kriner, Jr., Esquire (Argued), and Vera G. Belger, Esquire, CHIMICLES & TIKELLIS LLP, Wilmington, Delaware; Michael Hawash, Esquire, and Jourdain Poupore, Esquire, HAWASH CICACK & GASTON LLP, Houston, Texas, Attorneys for Appellant, Jack L. Marchand II.

          Paul A. Fioravanti, Jr., Esquire (Argued), and John G. Day, Esquire, PRICKETT, JONES & ELLIOT, P.A., Wilmington, Delaware, Attorneys for Appellees, John W. Barnhill, Jr., Richard Dickson, Paul A. Ehlert, Jim E. Kruse, W.J. Rankin, Howard W. Kruse, Patricia I. Ryan, Dorothy McLeod MacInerney, and nominal defendant Blue Bell Creameries USA, Inc.

          Srinivas M. Raju, Esquire, and Kelly L. Freund, Esquire, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware, Attorneys for Appellees, Greg Bridges and Paul W. Kruse.

          Before STRINE, Chief Justice; VALIHURA, VAUGHN, SEITZ, and TRAYNOR, Justices, constituting the Court en Banc.

          STRINE, CHIEF JUSTICE:

         Blue Bell Creameries USA, Inc., one of the country's largest ice cream manufacturers, suffered a listeria outbreak in early 2015, causing the company to recall all of its products, shut down production at all of its plants, and lay off over a third of its workforce. Blue Bell's failure to contain listeria's spread in its manufacturing plants caused listeria to be present in its products and had sad consequences. Three people died as a result of the listeria outbreak. Less consequentially, but nonetheless important for this litigation, stockholders also suffered losses because, after the operational shutdown, Blue Bell suffered a liquidity crisis that forced it to accept a dilutive private equity investment.

         Based on these unfortunate events, a stockholder brought a derivative suit against two key executives and against Blue Bell's directors claiming breaches of the defendants' fiduciary duties. The complaint alleges that the executives-Paul Kruse, the President and CEO, and Greg Bridges, the Vice President of Operations- breached their duties of care and loyalty by knowingly disregarding contamination risks and failing to oversee the safety of Blue Bell's food-making operations, and that the directors breached their duty of loyalty under Caremark.[1]

         The defendants moved to dismiss the complaint for failure to plead demand futility.[2] The Court of Chancery granted the motion as to both claims. As to the claim against management, the Court of Chancery held that the plaintiff "failed to plead particularized facts that raise a reasonable doubt as to whether a majority of [Blue Bell's] Board could impartially consider a demand."[3] Although the complaint alleged facts sufficient to raise a reasonable doubt as to the impartiality of a number of Blue Bell's directors, the plaintiff ultimately came up one short in the Court of Chancery's judgment: the plaintiff needed eight directors for a majority, but only had seven.

         As to the Caremark claim, the Court of Chancery held that the plaintiff did not plead any facts to support "his contention that the [Blue Bell] Board 'utterly' failed to adopt or implement any reporting and compliance systems."[4] Although the plaintiff argued that Blue Bell's board had no supervisory structure in place to oversee "health, safety and sanitation controls and compliance," the Court of Chancery reasoned that "[w]hat Plaintiff really attempts to challenge is not the existence of monitoring and reporting controls, but the effectiveness of monitoring and reporting controls in particular instances," and "[t]his is not a valid theory under . . . Caremark."[5]

         In this opinion, we reverse as to both holdings.

         We first hold that the complaint pleads particularized facts sufficient to create a reasonable doubt that an additional director, W.J. Rankin, could act impartially in deciding to sue Paul Kruse, Blue Bell's CEO, and his subordinate Greg Bridges, Blue Bell's Vice President of Operations, due to Rankin's longstanding business affiliation and personal relationship with the Kruse family.[6] According to the complaint, Rankin worked at Blue Bell for decades and owes his entire career to Ed Kruse, the current CEO's father, who hired Rankin as his administrative assistant in 1981 and promoted him five years later to the position of CFO, a position Rankin maintained until his retirement in 2014. In 2004, while serving as CFO, Rankin was elected to Blue Bell's board, and has served since then. Moreover, the complaint alleges that the Kruse family showed its appreciation for Rankin not only by supporting his career, but also by leading a campaign that raised over $450, 000 to name a building at the local university after Rankin. Despite the defendants' contentions that Rankin's relationship with the Kruse family was just an ordinary business relationship from which Rankin would derive no strong feelings of loyalty toward the Kruse family, these allegations are "suggestive of the type of very close personal [or professional] relationship that, like family ties, one would expect to heavily influence a human's ability to exercise impartial judgment."[7] Rankin's apparently deep business and personal ties to the Kruse family raise a reasonable doubt as to whether Rankin could "impartially or objectively assess whether to bring a lawsuit against the sued party."[8]

         As to the Caremark claim, we hold that the complaint alleges particularized facts that support a reasonable inference that the Blue Bell board failed to implement any system to monitor Blue Bell's food safety performance or compliance. Under Caremark and this Court's opinion in Stone v. Ritter, [9] directors have a duty "to exercise oversight" and to monitor the corporation's operational viability, legal compliance, and financial performance.[10] A board's "utter failure to attempt to assure a reasonable information and reporting system exists" is an act of bad faith in breach of the duty of loyalty.[11]

         As a monoline company that makes a single product-ice cream-Blue Bell can only thrive if its consumers enjoyed its products and were confident that its products were safe to eat. That is, one of Blue Bell's central compliance issues is food safety. Despite this fact, the complaint alleges that Blue Bell's board had no committee overseeing food safety, no full board-level process to address food safety issues, and no protocol by which the board was expected to be advised of food safety reports and developments. Consistent with this dearth of any board-level effort at monitoring, the complaint pleads particular facts supporting an inference that during a crucial period when yellow and red flags about food safety were presented to management, there was no equivalent reporting to the board and the board was not presented with any material information about food safety. Thus, the complaint alleges specific facts that create a reasonable inference that the directors consciously failed "to attempt to assure a reasonable information and reporting system exist[ed]."[12]

         I. Background[13]

         A. Blue Bell's History and Operating Environment

         i. History

         Founded in 1907 in Brenham, Texas, Blue Bell Creameries USA, Inc. ("Blue Bell"), a Delaware corporation, produces and distributes ice cream under the Blue Bell banner.[14] By 1919, Blue Bell's predecessor was struggling financially. Blue Bell's board turned to E.F. Kruse, who took over the company that year and turned it around. Under his leadership, the company expanded and became profitable.[15]

         E.F. Kruse led the company until his unexpected death in 1951.[16] Upon his death, his sons, Ed F. Kruse and Howard Kruse, took over the company's management. Rapid expansion continued under Ed and Howard's leadership.[17] In 2004, Ed Kruse's son, Paul Kruse, took over management, becoming Blue Bell's President and CEO.[18] Ten years later, in 2014, Paul Kruse also assumed the position of Chairman of the Board, taking the position from his retiring father.[19]

         ii. The Regulated Nature of Blue Bell's Industry

         As a U.S. food manufacturer, Blue Bell operates in a heavily regulated industry. Under federal law, the Food and Drug Administration ("FDA") may set food quality standards, require food manufacturing facilities to register with the FDA, prohibit regulated manufacturers from placing adulterated food into interstate commerce, and hold companies liable if they place any adulterated foods into interstate commerce in violation of FDA rules.[20] Blue Bell is "required to comply with regulations and establish controls to monitor for, avoid and remediate contamination and conditions that expose the Company and its products to the risk of contamination."[21]

         Specifically, FDA regulations require food manufacturers to conduct operations "with adequate sanitation principles"[22] and, in line with that obligation, "must prepare . . . and implement a written food safety plan."[23] As part of a manufacturer's food safety plan, the manufacturer must include processes for conducting a hazard analysis that identifies possible food safety hazards, identifies and implements preventative controls to limit potential food hazards, implements process controls, implements sanitation controls, and monitors these preventative controls. Appropriate corporate officials must monitor these preventative controls.[24]

         Not only is Blue Bell subject to federal regulations, but it must also adhere to various state regulations. At the time of the listeria outbreak, Blue Bell operated in three states, and each had issued rules and regulations regarding the proper handling and production of food to ensure food safety.[25]

         B. Plaintiff's Complaint

         With that context out of the way, we briefly summarize the plaintiff's well-pled factual allegations and the reasonable inferences drawn from them.

         The complaint starts by observing that, as a single-product food company, food safety is of obvious importance to Blue Bell.[26] But despite the critical nature of food safety for Blue Bell's continued success, the complaint alleges that management turned a blind eye to red and yellow flags that were waved in front of it by regulators and its own tests, and the board-by failing to implement any system to monitor the company's food safety compliance programs-was unaware of any problems until it was too late.[27]

         i. The Run-Up to the Listeria Outbreak

         According to the complaint, Blue Bell's issues began to emerge in 2009. At that time, Paul Kruse, Blue Bell's President and CEO, and his cousin, Paul Bridges, were responsible for the three plants Blue Bell operated in Texas, Oklahoma, and Alabama.[28] The complaint alleges that, despite being responsible for overseeing plant operations, Paul Kruse and Bridges failed to respond to signs of trouble in the run up to the listeria outbreak. From 2009 to 2013 several regulators found troubling compliance failures at Blue Bell's facilities:

• In July 2009, the FDA's inspection of the Texas facility revealed "two instances of condensation, one from a pipe carrying liquid caramel [that] was dripping into three gallon cartons waiting to be filled, and one dripping into ice cream sandwich wafers."[29]The FDA reported these observations directly to Paul Kruse, who assured the FDA that "condensation is treated by Blue Bell as a serious concern."[30]
• In March 2010, the Alabama Department of Health inspected the Alabama plant and "found equipment left on the floor and a ceiling in disrepair in the container forming room."[31]
• Two months later, in May 2010, the FDA returned to the Texas plant "and observed ten violations that were cited to Paul Kruse including, again, a condensation drip."[32] While the condensation drip persisted from the FDA's last inspection of the Texas plant, the FDA also observed "ripped and open containers of ingredients, inconsistent hand-washing and glove use and a spider and its web near the ingredients."[33]
• In July 2011, an inspection by "the Alabama Department of Public Health cited drips from a ceiling unit and pipelines, standing water, open tank lids and unprotected measuring cups."[34]
• Nine months later, in March 2012, an inspection of the Oklahoma facility revealed the plant's "'[f]ailure to manufacture foods under conditions and controls necessary to minimize contamination' and '[f]ailure to handle and maintain equipment, containers and utensils used to hold food in [sic] manner that protects against contamination.'"[35]
• That same month, in March 2012, "[t]he Alabama Department of Public Health required five changes" to the Alabama facility, "including instructions to clean various rooms and items, make repairs and [sic] after fruit processing to prevent contamination."[36] A year later, "in March 2013, the Alabama Department of Public Health again ordered cleaning and repairs and observed an uncapped fruit tank."[37] The Alabama Department of Public Health made similar observations in a July 2014 inspection.[38]

         Regulatory inspections during this time were not the only signal that Blue Bell faced potential health safety risks. In 2013, "the Company had five positive tests" for listeria, [39] and in January 2014, "the Company received a presumptive positive [l]isteria result reports from the third party laboratory for the [Oklahoma] facility on January 20, 2014 and the samples reported positive for a second time on January 24, 2014."[40]

         Although management had received reports about listeria's growing presence in Blue Bell's plants, the complaint alleges that the board never received any information about listeria or more generally about food safety issues. Minutes from the board's January 29, 2014 meeting "reflect no report or discussion of the increasingly frequent positive tests that had been occurring since 2013 or the third party lab reports received in the preceding two weeks."[41] Board meeting minutes from February and March likewise reflect no board-level discussion of listeria.[42]

         During the rest of 2014, Blue Bell's problems accelerated, but the board remained uninformed about Blue Bell's problems. In April, "[t]he Company received further positive [l]isteria lab tests regarding [the Oklahoma facility]."[43]That same month, the company had three "positive coliform tests far above the known legal regulator limits."[44] Yet, minutes from the April board meeting reflected no discussion of listeria. Instead, the minutes note only that the Oklahoma and Alabama facilities' "plant operations were discussed briefly" and that Bridges also discussed "a good report from the TCEQ [Texas Commission on Environmental Quality]."[45]

         Over the course of 2014, Blue Bell received ten positive tests for listeria. According to the complaint, these positive tests "included repeated positive results from the Company's third party laboratory in 2014, on consecutive samples, evidencing the inadequacy of the Company's remedial methods to eliminate the contamination."[46]

         Despite management's knowledge of the growing problem, the complaint alleges that this information never made its way to the board, and the board continued to be uninformed about (and thus unaware of) the problem. Minutes from the board's 2014 meetings are bereft of reports on the listeria issues. Only during the September meeting is sanitation discussed, when Bridges informed the board that "[t]he recent Silliker audit [Blue Bell's third-party auditor for sanitation issues in 2014] went well."[47] This lone reference to a third-party audit is the only instance, until the listeria outbreak forced the recall of Blue Bell's products, of any board-level discussion regarding food safety.

         At this stage of the case, we are bound to draw all fair inferences in the plaintiffs favor from the well-pled facts. Based on this chronology of events, the plaintiffs have fairly pled that:

• Blue Bell had no board committee charged with monitoring food safety;
• Blue Bell's full board did not have a process where a portion of the board's meetings each year, for example either quarterly or biannually, were specifically devoted to food safety compliance; and
• The Blue Bell board did not have a protocol requiring or have any expectation that management would deliver key food safety compliance reports or summaries of these reports to the board on a consistent and mandatory basis. In fact, it is inferable that there was no expectation of reporting to the board of any kind.

         In short, the complaint pleads that the Blue Bell board had made no effort at all to implement a board-level system of mandatory reporting of any kind.

         ii. The Listeria Outbreak and the Board's Response

         Blue Bell's listeria problem spread in 2015. Starting in January 2015, one of Blue Bell's product tests had positive coliform levels above legal limits.[48] The same result appeared in February 2015.[49] And by this point, the problem spread to Blue Bell's products and spiraled out of control.

         On February 13, 2015, "Blue Bell received notification that the Texas Department of State Health Services also had positive tests for [l]isteria in Blue Bell samples."[50] The Texas Department of State Health Services was alerted to these positive tests by the South Carolina Health Department.[51] Company swabs at the Texas facility on February 19 and 21, 2015 tested positive for listeria.[52] Yet despite these reports to management, Blue Bell's board was not informed by management about the severe problem. The board met on February 19, 2015, following Blue Bell's annual stockholders meeting, but there was no listeria discussion.[53]

         Four days later, Blue Bell initiated a limited recall.[54] Two days after that, Blue Bell's board met, and Bridges reported that "[t]he FDA is working with Texas health inspectors regarding the Company's recent recall of products. More information is developing and should be known within the next days or weeks."[55]Despite two years of evidence that listeria was a growing problem for Blue Bell, this is the first time the board discussed the issue, according to the complaint and the incorporated board minutes. Instead of holding more frequent emergency board meetings to receive constant updates on the troubling fact that life-threatening bacteria was found in its products, Blue Bell's board left the company's response to management.

         And the problem got worse, with awful effects. "In early March 2015, health authorities reported that they suspected a connection between human [l]isteria infections in Kansas and products made by Blue Bell's [Texas] facility."[56] The outbreak in Kansas matched a listeria strain found in Blue Bell's products in South Carolina. And by March 23, 2015, Blue Bell was forced to recall more products. Two days later, Blue Bell's board met and adopted a resolution "express[ing] support for Blue Bell's CEO, management, and employees and encourag[ing] them to ensure that everything Blue Bell manufacture[s] and distributes is a wholesome and good testing [sic] product that our consumers deserve and expect."[57]

         Blue Bell expanded the recall two weeks later, and less than a month later, on April 20, 2015, Blue Bell "instituted a recall of all products."[58] By this point, the Center for Disease Controls and Prevention ("CDC") had begun an investigation and discovered that the source of the listeria outbreak in Kansas was caused by Blue Bell's Texas and Oklahoma plants.[59] Ultimately, five adults in Kansas and three adults in Texas were sickened by Blue Bell's products; three of the five Kansas adults died because of complications due to listeria infection.[60] The CDC issued a recall to grocers and retailers, alerting them to the contamination and warning them against selling the products.[61]

         After Blue Bell's full product recall, the FDA inspected each of the company's three plants. Each was found to have major deficiencies. In the Texas plant, the FDA found a "failure to manufacture foods under conditions and controls necessary to minimize the potential for growth of microorganisms," inadequate cleaning and sanitizing procedures, "failure to maintain buildings in repair sufficient to prevent food from coming [sic] adulterated," and improper construction of the building that failed to prevent condensation from occurring.[62] Likewise, at the Oklahoma facility, "[t]he FDA found that the Company had been receiving increasingly frequent positive [l]isteria tests at [the Oklahoma facility] for over three years," failed "to manufacture and package foods under conditions and controls necessary to minimize the potential growth of microorganisms and contamination," failed to perform testing to ferret out microbial growth, implemented inadequate cleaning and sterilization procedures, failed to provide running water at an appropriate temperature to sanitize equipment, and failed to store food in clean and sanitized portable equipment.[63]

         Although the Alabama facility fared better, the FDA still found contamination and several issues, including the "failure to perform microbial testing where necessary to identify possible food contamination," "failure to maintain food contact surfaces to protect food from contamination by any source," and inadequate construction of the facility such that condensation was likely.[64] Most of these findings, the complaint alleges, are unsurprising because similar deficiencies were found by the FDA and state regulators in the run up to the listeria outbreak, yet according to the FDA's inspection after the fact, it appeared that neither management nor the board made progress on remedying these deficiencies.

         After the fact, various news outlets interviewed former Blue Bell employees who "claimed that Company management ignored complaints about factory conditions in [the Texas facility]."[65] One former employee "reported [that] spilled ice cream was left to pool on the floor, 'creating an environment where bacteria could flourish.'"[66] Another former employee described being "instructed to pour ice cream and fruit that dripped off his machine into mix to be used later."[67]

         iii. The Aftermath of the Listeria Outbreak

         With its operations shuttered, Blue Bell faced a liquidity crisis. Blue Bell initially sought a more traditional credit facility to bridge its liquidity, but after Blue Bell director W.J. Rankin informed his brother-in-law, Bill Reimann, about Blue Bell's liquidity crunch, Blue Bell ended up striking a deal with Moo Partners, a fund controlled by Sid Bass and affiliated with Reimann.[68] Moo Partners provided Blue Bell with a $125 million credit facility and purchased a $100 million warrant to acquire 42% of Blue Bell at $50, 000 per share.[69] As part of Moo Partners's investment conditions, Blue Bell also amended its certificate of incorporation to grant Moo the right to appoint one member of Blue Bell's board who would be entitled to one-third of the board's voting power (or five votes based on a then-10-member board).

         After investing in Blue Bell, Moo named Reimann to Blue Bell's board, expanding the board to 11 members with Reimann possessing five votes.[70] In February 2016, Reimann suggested that the board separate the roles of CEO and Chairman (both held by Paul Kruse). The board voted to follow Reimann's recommendation at its February 18th meeting, but after Paul Kruse disagreed with the recommendation and threatened to resign as President and CEO if the split occurred, the board held another vote in which all members, except Reimann and Rankin, voted to restore the position of CEO and Chairman of the board.[71]

         C. The Court of Chancery Dismisses the Case

         After requesting Blue Bell's books and records through a § 220 request, the plaintiff, a Blue Bell stockholder, sued Blue Bell's management and board derivatively, asserting two claims based on management's alleged failure to respond appropriately to the red and yellow flags about growing food safety issues and the board's violation of its duty of loyalty, under Caremark, by failing to implement any reporting system and therefore failing to inform itself about Blue Bell's food safety compliance. The Court of Chancery dismissed both claims, holding that the plaintiff failed to plead demand futility.

         As to the first claim, the plaintiff alleges that Paul Kruse, Blue Bell's President and CEO, and Bridges, Blue Bell's Vice President of Operations, had breached their duties of loyalty and care by knowingly disregarding contamination risks and failing to oversee Blue Bell's operations and food safety compliance process.[72] "Because directors are empowered to manage, or direct the management of, the business and affairs of the corporation," the plaintiff's complaint must allege facts suggesting that "demand is excused because the directors are incapable of making an impartial decision regarding such litigation."[73] The plaintiff's complaint claims that "[a] demand upon the Board of the Company to pursue claims against Paul Kruse and Bridges . . . would be futile" because "the Kruse family-of which both Paul Kruse and Bridges are members-ha[s] long dominated Blue Bell" and the majority of directors are "long-time employees and/or otherwise beholden and loyal to the Kruse family."[74]

         But the Court of Chancery held that the plaintiff "failed to plead particularized facts to raise a reasonable doubt that a majority of the [Blue Bell board] members could have impartially considered a pre-suit demand."[75] Without belaboring the details of the Court of Chancery's thorough analysis, which is somewhat complicated due to the unusual structure of Blue Bell's board, we note that the court essentially ruled that the plaintiff came up one vote short. To survive the Rule 23.1 motion to dismiss, the complaint needed to allege particularized facts raising a reasonable doubt that directors holding eight of the 15 votes could have impartially considered a demand, but the court held that the plaintiff had done so for directors holding only seven votes.

         One of the directors who the trial court held could consider demand impartially was Rankin, Blue Bell's recently retired former CFO. Although Rankin worked at Blue Bell for 28 years, the court emphasized that he was no longer employed by Blue Bell, having retired in 2014. As to the allegations that donations from the Kruse family resulted in a building at Blinn College being named for Rankin, the court noted that "the Complaint provide[d] no more specifics regarding the donation (i.e., who gave how much), and ma[de] no attempt to characterize the materiality of the gesture."[76] That failure, the Court of Chancery concluded, fell short of Rule 23.1's particularity requirement. Further, the court noted that Rankin voted against rescinding a board initiative to split the CEO and Chairman positions held by Paul Kruse.[77] In the court's view, that act was evidence that Rankin was not beholden to the Kruse family. Ultimately, the Court of Chancery concluded that the plaintiff's "allegation that Rankin lacks independence falls flat."[78]

         The Court of Chancery also rejected the plaintiff's second claim that Blue Bell's directors breached their duty of loyalty under Caremark by failing to "institute a system of controls and reporting" regarding food safety.[79] In support of this claim, the plaintiff asserted, based on the facts alleged in the complaint and reasonable inferences from those facts, that: (1) the Blue Bell board had no committee overseeing food safety; (2) Blue Bell's board did not have any reporting system in place about food safety; (3) management knew about the growing listeria issues but did not report those issues to ...


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