It may come off as a truism that food safety is the “most central consumer safety and legal compliance issue” facing a food and beverage company. Yet the Delaware Supreme Court’s decision in Marchand v. Barnhill—a shareholder derivative suit that catalogs the fallout from the 2015 Blue Bell listeria outbreak—serves as a reminder of the importance of food safety and reporting controls up to even the highest levels of corporate governance.
We break down the Delaware Supreme Court’s analysis and offer insights into best board practices in a post-Marchand world.
The Blue Bell Listeria outbreak and fallout
In early 2015, Blue Bell Creameries, one of the country’s largest ice cream manufacturers, suffered a listeria outbreak. Ultimately, three people died, and the CDC formally recognized at least 10 related illnesses—although many more were suspected or alleged. The outbreak led to a recall of all Blue Bell products, a shutdown of production at all of its plants, and a layoff of over a third of its workforce. With its operations shuttered, Blue Bell also suffered a liquidity crisis that forced it to accept a dilutive private equity investment.
Not surprisingly, voluminous litigation followed, including Marchand. In Marchand, a Blue Bell shareholder sued Blue Bell’s management and board of directors derivatively. As for the board, the Marchand complaint alleged that the board members “utterly failed to adopt or implement any [food safety] reporting and compliance systems” and therefore breached their duty of loyalty under In re Caremark International Inc. Derivative Litigation. Specifically, “by failing to implement any system to monitor the company’s food safety compliance programs,” Blue Bell’s board was unaware of any “red or yellow flags about the growing food safety issues” at Blue Bell’s plants until it was too late.
Director liability under Caremark
Under Caremark, a director must make a good-faith effort to oversee the company’s operations. Failing to do so breaches the duty of loyalty and exposes a director to liability. In other words, for a plaintiff to prevail on a Caremark claim, the plaintiff must show that a fiduciary acted in bad faith—“the state of mind traditionally used to define the mindset of a disloyal director.”
Caremark claims are difficult to plead and successfully prosecute because the law gives substantial deference to directors in the monitoring and operating of a business. To establish bad faith under Caremark, a plaintiff must allege particularized facts that the directors (1) failed to implement any reporting or information system or controls; or (2) having implemented such a system or controls, consciously failed to monitor or oversee its operations. In short, under Caremark “the board must make a good faith effort—i.e., try—to put in place a reasonable board-level system of monitoring and reporting.”
The Delaware Chancery Court’s dismissal
Discounting the allegations that Blue Bell’s board had no supervisory structure in place to oversee “health, safety, and sanitation controls and compliance,” the chancery court concluded that the plaintiff failed to meet this exacting standard. The court noted that Blue Bell operated in an industry highly regulated by the FDA, that Blue Bell had food safety controls and policies in place throughout the company, and that the CEO and VP of operations regularly reported on operational issues and facility audits to the board. Reframing the issue, the court concluded 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,” which “[i]s not a valid theory under … Caremark.”
For food companies, food safety is a board-level issue
On appeal, the Delaware Supreme Court sharply disagreed with the chancery court’s reasoning. Crediting the plaintiff with conducting a proper investigation that included a Section 220 request for Blue Bell’s books and records, the Delaware Supreme Court concluded that the complaint supported a Caremark claim. The court specifically emphasized the complaint’s allegations that:
- There was no board committee that addressed food safety.
- There were no regular board-level “process[es] or protocols that required management to keep the board apprised of food safety compliance practices, risks, or reports.”
- There was no schedule for the board to consider any food safety risks, on a regular basis or otherwise.
- “During a key period leading up to the deaths of three customers, management received reports” from various third-party auditors and regulatory officials containing “what could be considered red, or at least yellow, flags” regarding potential food safety issues—including positive tests that listeria was present at certain plants—but the board meeting minutes “revealed no evidence that these were disclosed to the board.”
- The board meeting minutes were bereft of “any suggestion that there was any regular discussion of food safety issues.”
Given these allegations, the Delaware Supreme Court found that the complaint supported a reasonable inference that Blue Bell did not have board-level controls over one of the “most central issues at the company: whether it is ensuring that the only product it makes—ice cream—is safe to eat.” Accordingly, it reversed the trial court’s dismissal.
With this ruling, the court rejected the board’s arguments that it satisfied its oversight obligations because Blue Bell operates in an industry tightly regulated by the FDA and implemented policies, procedures, and audits consistent with those regulations. As the court explained, that “Blue Bell nominally complied with FDA regulations does not imply that the board implemented a system to monitor food safety at the board level.” At best, Blue Bell’s compliance with these requirements showed only that management—not the board—was nominally following certain standard requirements of state and federal law. The “mundane reality” that Blue Bell operates in a highly regulated industry did not bar a claim “that the directors’ lack of attentiveness rose to the level of bad faith indifference required to state a Caremark claim.”
A Checklist for mitigating risk
Marchand serves notice to the food industry: food safety is mission-critical and must have board-level visibility and attention. But Caremark claims remain difficult to plead and prosecute, and the Marchand Court offers a blueprint for food and beverage industry boards to avoid exposure under Caremark:
- Form a board committee addressing food safety.
- Adopt processes and protocols requiring management to keep the board apprised of food safety compliance practices, risks, or reports.
- Establish a regular schedule (quarterly or biannually) for the board to consider food safety compliance and risks.
- Approve resolutions requiring full disclosure by management to the board of all material food safety threats.
- Implement an anonymous food safety reporting system with board visibility to reports raising significant food safety concerns.
- Document board food safety compliance discussions, committee meetings, and board efforts in board resolutions and board meeting minutes.
With Caremark’s bottom line requirement that the “the board must make a good faith effort—i.e., try—to put in place a reasonable board-level system of monitoring and reporting,” the Marchand Court may very well have affirmed the dismissal had the board undertaken any of these steps. Nevertheless, we recommend implementing a robust compliance strategy that addresses at least these items. Corporate boards and in-house counsel should treat Marchand as a cautionary tale.
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