Opinion ID: 781551
Heading Depth: 4
Heading Rank: 2

Heading: Second prong — business judgment

Text: 52 The business judgment rule is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. Aronson, 473 A.2d at 812 (citations omitted). To determine whether the complaint raises a reasonable doubt that the directors exercised proper business judgment, the second prong of the Aronson test requires us to look at both the substantive due care (substance of the transaction) as well as the procedural due care (an informed decision) used by the directors. Starrels, 870 F.2d at 1171 (citing Grobow v. Perot, 539 A.2d 180, 189 (Del.1988), overruled on other grounds by Brehm, 746 A.2d at 253). 53 Under Aronson, the mere threat of personal liability for approving a questioned transaction, standing alone, is insufficient to challenge either the independence or disinterestedness of directors .... 473 A.2d at 815. However, demand may be excused if in rare cases a transaction may be so egregious on its face that board approval cannot meet the test of business judgment, [resulting in] a substantial likelihood of director liability, id., or if the directors exhibited gross negligence in breaching their duty of care. Brehm, 746 A.2d at 259 (citing Aronson, 473 A.2d at 812). 54 Delaware law imposes three primary fiduciary duties on the directors of corporations; the duty of care, the duty of loyalty, and the duty of good faith. Emerald Partners v. Berlin, 787 A.2d 85, 90 (Del.2001) (citing Malone v. Brincat, 722 A.2d 5, 10 (Del.1998)). The shareholders of the corporation are entitled to rely upon their board of directors to discharge each of their three primary fiduciary duties at all times. Id. 55 The chairman of the board received copies of the two Warning Letters in 1994 and another in early 1999. Although the district court described the language in the Warning Letters as boilerplate and stated that the plaintiffs ascribe much greater importance to the warning letters than they probably deserve, In re Abbott, 141 F.Supp.2d at 949, continuing violations of federal regulations over a period of six years cannot be minimized. Several of the directors were members of the Audit Committee, which was charged with assessing any risks involved in regulatory compliance. In addition, the directors had a fiduciary duty under the SEC to comply with comprehensive government regulations and signed SEC forms attesting to knowledge and responsibility for government regulation compliance, noting that [the] Company is involved in various claims and legal proceedings regarding these regulations, as stated in the 1996 10-K. 56 The FDA met at least ten times with Abbott representatives, including White and other senior officers, concerning the continuing violations. The WALL STREET JOURNAL published information about Abbott's FDA problems in 1995. By 1999, even a third-party analyst questioned why Abbott continued to drag[] their feet fixing the [FDA] problems. Although Abbott sought to negate the effects of this news in its press release of 1999, the release itself substantiates the fact that the company, and, correspondingly, the board of directors, knew of the problems and were aware that the FDA had threatened to file an injunction against Abbott. 57 Delaware law states that director liability may arise for the breach of the duty to exercise appropriate attention to potentially illegal corporate activities from an unconsidered failure of the board to act in circumstances in which due attention would, arguably, have prevented the loss. In re Caremark, 698 A.2d at 967 (citation omitted) (emphasis in original). The court held that a sustained or systematic failure of the board to exercise oversight ... will establish the lack of good faith that is a necessary condition to [director] liability. Id. at 971. In Caremark, there was a claim of fraud with no evidence to indicate that the Caremark directors knew of the violations of law and the directors' liability was predicated upon ignorance of liability-creating activities which resulted in unconsidered failure to act. See id. Given the extensive paper trail in Abbott concerning the violations and the inferred awareness of the problems, the facts support a reasonable assumption that there was a sustained and systematic failure of the board to exercise oversight, in this case intentional in that the directors knew of the violations of law, took no steps in an effort to prevent or remedy the situation, and that failure to take any action for such an inordinate amount of time resulted in substantial corporate losses, establishing a lack of good faith. We find that six years of noncompliance, inspections, 483s, Warning Letters, and notice in the press, all of which then resulted in the largest civil fine ever imposed by the FDA and the destruction and suspension of products which accounted for approximately $250 million in corporate assets, indicate that the directors' decision to not act was not made in good faith and was contrary to the best interests of the company. See Aronson, 473 A.2d at 812. 58 We also note that in McCall v. Scott, 239 F.3d 808 (6th Cir.2001), amended on denial of rehearing by McCall v. Scott, 250 F.3d 997 (6th Cir.2001), although the court's decision was based upon allegations of the directors' unconsidered inaction, id. at 817, the Sixth Circuit held that the directors' sustained failure to act against a corporation's systematic health care fraud occurring from at least 1994 to 1996 alleged sufficient facts to present a substantial likelihood of liability. Id. at 814, 819. The plaintiffs in McCall alleged that intentional or reckless disregard could be inferred from the directors' failure to act in the face of audit information, ongoing acquisition practices, allegations brought against the corporation in a qui tam action, a federal investigation, and an investigation by the NEW YORK TIMES into the company's billing practices, based on the board's inaction prior to 1997. Id. at 819-20. While we recognize that there were many more specific allegations to support individual director liability in the McCall case, the court also noted that the magnitude and duration of the alleged wrongdoing is relevant in determining whether the failure of the directors to act constitutes a lack of good faith. Id. at 823. The magnitude and duration of the FDA violations in Abbott were so great that it occasioned the highest fine ever imposed by the FDA. We also take into consideration that evidently neither FDA censures nor public notice motivated the directors to take any action concerning the problems over a six-year period, as opposed to an approximate two-year period in McCall. Id. at 814. 59 With respect to demand futility based on the directors' conscious inaction, we find that the plaintiffs have sufficiently pleaded allegations, if true, of a breach of the duty of good faith to reasonably conclude that the directors' actions fell outside the protection of the business judgment rule. Aronson, 473 A.2d at 812. The totality of the complaint's allegations need only support a reasonable doubt of business judgment protection, not a judicial finding that the directors' actions are not protected by the business judgment rule. Grobow, 539 A.2d at 186. Under the demand futility doctrine, demand should therefore have been excused. Aronson, 473 A.2d at 815; see In re Baxter Int'l, Inc. S'holders Litig., 654 A.2d 1268, 1270-71 (Del.Ch.1995). 60 We note that this holding applies only with respect to demand futility and reflects no opinion as to the truth of the allegations or the outcome of the claims on the merits.