Court Opinion

ID: 2995704
Source: CourtListenerOpinion
Date Created: 2015-09-24 19:21:51.794706+00
Date Added: 2024-06-11T11:38:53.464353
License: Public Domain

In the
United States Court of Appeals
For the Seventh Circuit

No. 01-1952

IN RE: ABBOTT LABORATORIES DERIVATIVE
SHAREHOLDERS LITIGATION

Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 99 C 7246--James B. Moran, Judge.

ARGUED October 23, 2001--DECIDED June 6, 2002

  Before HARLINGTON WOOD, JR., CUDAHY, and
KANNE, Circuit Judges.

  HARLINGTON WOOD, JR., Circuit Judge. This
shareholder derivative suit arises from a
consent decree between Abbott
Laboratories ("Abbott") and the Food and
Drug Administration ("FDA"). The action
was brought in federal court on behalf of
Abbott shareholders against Abbott’s
board of directors alleging that the
directors breached their fiduciary duties
and are liable under Illinois law for
harm resulting from a consent decree
which required Abbott to pay a $100
million civil fine to the FDA, withdraw
125 types of medical diagnostic test kits
from the United States market, destroy
certain inventory, and make a number of
corrective changes in its manufacturing
procedures after six years of federal
violations. The district court dismissed
the original complaint for failure to
plead demand futility with particularity
under Fed. R. Civ. P. 23.1 and has now
dismissed the amended complaint for the
same reason. We reverse and remand for
further proceedings.

I.   BACKGROUND

  Abbott, an Illinois corporation, is a
diversified health care company that
develops and markets pharmaceutical,
diagnostic, nutritional, and hospital
products. Abbott’s Diagnostics Division
("ADD") manufactures hundreds of
different kinds of diagnostic kits and
devices, including tests which indicate
the safety of donated blood, detect heart
attacks, and identify cancerous tumors.
These products are heavily regulated by
the FDA and must be manufactured in
accordance with the "Quality System
Regulations" ("QSR"), 21 C.F.R. sec. 820,
and the requirements of the "Current Good
Manufacturing Practice" ("CGMP"), as
defined in 21 C.F.R. sec. 820.1. These
regulations expressly assign corporate
management the responsibility to assure
compliance with CGMP. 21 C.F.R. sec.
820.20. The FDA periodically inspects
manufacturing plants to ensure
compliance.

  During a six-year period from 1993 until
1999, the FDA conducted thirteen separate
inspections of Abbott’s Abbott Park and
North Chicago facilities. The
inspections, some lasting for two months
or longer, were conducted under a program
designed not only to ensure that data and
information concerning the in vitro
diagnostic products are scientifically
valid and accurate, but to ensure that
the human subjects are protected from
undue hazard or risk during the course of
the scientific investigations. After each
inspection, the FDA first sends a Form
483 to the manufacturer which notes any
deviations under the CGMP, then discusses
the findings with the manufacturer’s
representative, and requests a plan for
correcting the violations.

  In addition to the Form 483s and the
ensuing follow-up after each inspection,
the FDA sent four formal certified
Warning Letters to Abbott. The first was
sent by the FDA’s district director to
David Thompson, president of ADD, on
October 20, 1993, noting that an FDA on-
site inspection at the North Chicago
facility from April 7 through May 4, 1993
had found adulterated/1 in vitro
diagnostic products not in conformance
with the CGMP. The letter stated,
"Failure to correct these deviations may
result in regulatory action being
initiated by the Food and Drug
Administration without further notice.
These actions include, but are not
limited to seizure, injunction, and/or
civil penalties." All of the Warning
Letters and follow-up letters contained
that statement. A second Warning Letter
from the district director was sent on
March 28, 1994 to Thompson and copied to
Duane Burnham, chairman of the board of
directors and Chief Executive Officer
("CEO") of Abbott. After an inspection at
the Abbott Park facility, the FDA
reiterated that certain in vitro
diagnostic test kits had failed to comply
with the CGMP. A follow-up letter from
the FDA’s acting director to the manager
of ADD, again copied to Burnham, was sent
by overnight mail on October 11, 1994
which detailed the continuing
deficiencies of certain diagnostic test
kits. This letter also noted that the FDA
had reviewed Abbott’s responses to the
483s issued on June 10, 1994 and July 13,
1994, and requested "written
documentation of any other specific steps
you have taken or will be taking to
correct these violations and to prevent
the recurrence of similar violations in
current and future studies."

  On January 11, 1995, the Wall Street
Journal published an article discussing
the fact that the FDA had "uncovered a
wide range of flaws in Abbott
Laboratories’ quality-assurance
procedures used in assembling medical-
diagnostic products, including kits to
test for hepatitis and AIDS." The article
also noted that Abbott stock had fallen
fifty cents to $31.25 a share.

  In July 1995, the FDA and Abbott entered
into a comprehensive Voluntary Compliance
Plan to work "together to achieve
compliance in areas recognized by FDA and
Abbott to be problematic" at the Abbott
Park and North Chicago facilities. On
February 26, 1998, the FDA district
director sent the equivalent of a Warning
Letter to Abbott, stating that although
the FDA "recognize[d] Abbott
Laboratories’ efforts to meet all of the
Compliance Plan commitments," after
finding continued deviations from the
regulations, the FDA was closing out the
Compliance Plan.
  On March 17, 1999, the FDA district
director sent the fourth and final
certified Warning Letter to Miles White,
a member of Abbott’s board of directors
and current CEO./2 This letter
discussed the findings of adulterated in
vitro diagnostic kits and other problems
after an inspection at the Abbott Park
facility from September 8 to November 4,
1998. The letter stated that the FDA
would be conducting a re-inspection to
determine the adequacy of Abbott’s
compliance.

  On April 13, 1999, White sold thirty
percent of his Abbott stock, totaling
89,895 shares sold at $52.72 per share,
receiving $4,739,264. On June 15, 1999,
the March 17 Warning Letter was reported
in Bloomberg News. The article stated that
Abbott was working with the FDA to
resolve the problems and noted that
Abbott shares had risen slightly to close
at $43.25.

  On September 28, 1999, Abbott issued a
press release disclosing that it had been
notified by the FDA of alleged
noncompliance of the CGMP and QSR. The
release stated that "[a]lthough Abbott
believes that it is in substantial
compliance with these regulations, the
FDA disagrees," and noted that if the
discussions were not successful, the FDA
had advised the company that it would
"file a complaint for injunctive relief
which would include the cessation of
manufacturing and sale for a period of
time of a number of diagnostic products."

  On September 29, 1999, Bloomberg News
reported that shares of Abbott
Laboratories "fell 6.3 percent [to
$37.25] after U.S. regulators threatened
to halt sales of some Abbott diagnostic
products on concerns about quality
controls," stating this was the latest
setback "in a string of manufacturing
problems for Abbott" dating from 1998 and
that "the FDA has given them a swift kick
to prod them into fixing things." The
article noted that ADD represented
approximately 22 percent, or $2.79
billion, of Abbott’s total sales in 1998,
with an operating profit of $448 million,
or 13 percent of the company’s total
profit. Although the article quoted a
stock analyst as having a "buy" rating on
the stock, the analyst also stated that
he did not understand "why [Abbott] seems
to have dragged their feet fixing the
problems. Wall Street punishes companies
that have run-ins with the FDA."

  On September 30, 1999, Abbott filed a
disclosure form with the Securities and
Exchange Commission ("SEC"),
acknowledging it had received
notification by the FDA of noncompliance
with the QSR at two of its facilities.
Abbott also reported they disagreed with
the findings of noncompliance and would
fight any legal suit. On November 2,
1999, the FDA filed a complaint for an
injunction, detailing its problems with
Abbott over the prior six-year period. On
the same date, both parties signed a
consent decree which prohibited Abbott
from the continued manufacture of certain
in vitro diagnostic devices until
independent experts and FDA inspectors
deemed the two facilities in conformity
with the CGMP and FDA regulations. The
decree also stated that Abbott would pay
a $100 million fine, the largest penalty
ever imposed for a civil violation of FDA
regulations.

  In addition, under a proposed master
compliance plan, Abbott was ordered to
destroy under FDA supervision certain
inventories of specific in vitro
diagnostic kits and withdraw those kits
from the U.S. market until compliance had
been achieved. The suspension of these
kits would result in a loss of
approximately $250 million in annual
revenue. In a press release following the
consent decree, Abbott announced that it
would take a $168 million charge against
Abbott’s earnings in the third quarter of
1999 to cover the FDA fine and the loss
from the unmarketable test kits.

  Plaintiffs also maintain that these
problems with the FDA caused the collapse
of Abbott’s acquisition of Alza
Corporation ("Alza"), a drug delivery
company, in a planned acquisition valued
at approximately $7.3 billion, which
plaintiffs assert was in the best
interest of Abbott. Alza shareholders
were to exchange 1 share of Alza stock
for 1.2 shares of Abbott stock.
Plaintiffs allege that the directors had
a motive to conceal Abbott’s quality
problems because disclosure of the
continuing pattern of violations over a
six-year period would have possibly
doomed the buyout or, at the very least,
jeopardized the agreed-upon price. On
December 11, 1999, Abbott announced it
was abandoning the acquisition. On
December 17, 1999, the Wall Street Journal
reported, "Wall Street and industry
officials widely viewed the transaction
as being in jeopardy in recent weeks
because the value to Alza shareholders
had fallen" following a decline in the
price of Abbott’s stock after the FDA
filing and consent decree.

  Shortly thereafter, several Abbott
shareholders brought derivative actions
which have been consolidated in this
case. These plaintiffs seek to hold
Abbott’s directors personally liable for
the losses incurred as a result of the
consent decree. At the time the
litigation was initiated, Abbott had
thirteen directors. Two of those
thirteen, Miles White, Abbott’s chairman
and CEO, and Robert Parkinson, president
and Chief Operating Officer, were "inside
directors" who are both corporate
officers and full-time Abbott employees.
The remaining eleven were "outside" or
"independent" directors who received a
monthly stipend for their services but
were not Abbott employees.

  In their claim for breach of fiduciary
duty, plaintiffs maintain that the
directors were or should have been aware
of the six-year history of noncompliance
problems with the FDA and that they had a
duty to take necessary action to correct
these problems in a division of Abbott
which accounted for 20 percent of the
company’s annual revenues. They allege
that the directors demonstrated gross
negligence by ignoring the FDA problems
for six years. Plaintiffs also maintain
that the directors had a duty of due
diligence by signing the SEC forms, which
specifically address in part government
regulations in the development,
manufacture, sale, and distribution of
products. These forms were signed by the
directors every year during the six-year
period in question. As the 1996 10-K
illustrates, the directors signed off on
statements such as, "[Abbott’s products]
are subject to comprehensive government
regulation [which] substantially
increases the time, difficulty, and costs
incurred in obtaining and maintaining the
approval to market newly developed and
existing products," "[t]he FDA’s . . .
approach to regulations . . . will
increase the cost of compliance with
those regulations," "[t]he Company’s
facilities [including Abbott Park and
North Shore] are deemed suitable," "[t]he
Company is involved in various claims and
legal proceedings . . . [and] management
is of the opinion that their disposition
should not have a material adverse effect
on the Company’s financial position, cash
flows, or results of operations."

  The plaintiffs allege that the directors
met officially seven times in 1996, six
times in 1997, eight times in 1998, and
ten times in 1999. Plaintiffs maintain
that the directors received relevant
information concerning regulatory actions
and that the Warning Letters, several of
which were sent to the chairman of the
board, and Form 483s were "clearly
information that was required to be
brought to the attention of the Board
members by the Chairman . . . who had a
duty to [do so]." Plaintiffs also note
that the Audit Committee, which included
several members of the board, "is charged
with communicating regularly with Abbott
management" concerning management’s
assessment of business risks facing
Abbott, and that one of the functions of
the Audit Committee was to familiarize
themselves with any risks involving the
legal and regulatory framework which
would affect Abbott’s operations.
Plaintiffs also stated that during the
relevant time period, Abbott’s proxy
statements noted that the Audit Committee
"met with Abbott’s internal auditors to
evaluate the effectiveness of their work
in ensuring that Abbott’s various
departments, including its Regulatory
Affairs Department [which was responsible
for Abbott’s compliance with FDA
regulations], operated properly."

  Plaintiffs, however, did not make any
demand on Abbott’s board of directors to
institute an action against themselves
for breach of their fiduciary duties,
stating that such a demand would have
been futile. Plaintiffs maintain that the
facts as alleged in the complaint
demonstrate that the directors

knew of the continuing pattern of
noncompliance with FDA regulations and
knew that the continued failure to comply
with FDA regulations would result in
severe penalties and yet ignored repeated
red flags raised by the FDA and in media
reports and chose not to bring a prompt
halt to the improper conduct causing the
noncompliance, nor to reprimand those
persons involved, nor to seek redress for
Abbott for the serious damages it has
sustained . . . .

  The district court dismissed the
complaint for failure to plead demand
futility with particularity under Fed. R.
Civ. P. 23.1, stating that the complaint
did not plead facts to show Abbott’s
directors faced a substantial likelihood
of liability for their actions.
Plaintiffs appeal.

II.   ANALYSIS
A.   Standard of Review

  Seventh Circuit precedent indicates that
a district court’s determination as to
whether or not a demand upon the board of
directors would have been futile,
assuming no error of law has been made,
is reviewed for abuse of discretion. See
Starrels v. First Nat’l Bank of Chicago,
870 F.2d 1168, 1170 (7th Cir. 1989);
Powell v. Gant, 556 N.E.2d 1241, 1245
(Ill. App. Ct. 1990) (holding that trial
court’s determination of whether demand
is excused may only be reversed for
"manifest abuse of discretion"). Because
Abbott was incorporated under the laws of
Illinois, Illinois law applies in
determining whether a demand may be
excused when shareholders file a
derivative complaint on behalf of the
company. See Kamen v. Kemper Fin. Servs.,
Inc., 500 U.S. 90, 98-99 (1991). Illinois
case law follows Delaware law in
establishing demand futility requirements
and uses the test to determine demand
futility set forth in Aronson v. Lewis,
473 A.2d 805 (Del. 1984). See Spillyards
v. Abboud, 662 N.E.2d 1358, 1366 (Ill.
App. Ct. 1996). Both parties agree
Delaware law controls.

  However, the Delaware Supreme Court
recently stated that in a motion to
dismiss a derivative suit for demand
futility, "our review of decisions of the
Court of Chancery applying Rule 23.1 is
de novo and plenary." Brehm v. Eisner,
746 A.2d 244, 253 (Del. 2000) (en banc),
overruling in part Aronson v. Lewis, 473
A.2d 805 (Del. 1984) (overruling abuse of
discretion standard for demand futility
in derivative action). The court in Brehm
stated that its review was the same
analysis applied by the trial court in
making its decision and that decision is
not a discretionary ruling such as an
administrative agency’s findings of fact
or a credibility determination which
would be accorded deference. Id. The
court noted, "In a Rule 23.1
determination of pleading sufficiency,
the Court of Chancery, like this Court,
is merely reading the English language of
a pleading and applying to that pleading
statutes, case law and Rule 23.1
requirements. To that extent, our scope
of review is analogous to that accorded a
ruling under Rule 12(b)(6)." Id. at 254;
see Conley v. Gibson, 355 U.S. 41, 45-46
(1957) (holding that because district
court’s grant of a motion to dismiss for
failure to state a claim is a question of
law, review is de novo); see also McCall
v. Scott, 239 F.3d 808, 817 (6th Cir.
2001) ("we review de novo the question of
whether plaintiffs alleged with
sufficient particularity facts that
create a reasonable doubt as to disinter
estedness and independence of a majority
of directors"). We agree with this
reasoning and, because we are required to
make a determination based on Aronson,
will review de novo the dismissal of this
derivative shareholder’s complaint based
on failure to plead demand futility. And,
as in a Rule 12(b)(6) motion to dismiss,
any inferences drawn from the factual
allegations of the complaint must be
viewed in the light most favorable to the
plaintiffs. Brehm, 746 A.2d at 255; In re
Healthcare Compare Corp. Sec. Lit., 75
F.3d 276, 279 (7th Cir. 1996).

B.   Demand Futility

  In a derivative suit, an individual
shareholder seeks to enforce a right that
belongs to the corporation. See Kamen,
500 U.S. at 95. However, given "the basic
principle of corporate governance that
the decisions of a corporation--
including the decision to initiate
litigation--should be made by the board
of directors or the majority of
shareholders," most jurisdictions require
a pre-suit demand be made of the
corporation’s board of directors. Id. at
96. This allows the directors to exercise
their business judgment and determine
whether litigation is in the best
interest of the corporation. Id.

  Rule 23.1 requires the plaintiff "to
allege with particularity the efforts, if
any, made by the plaintiff to obtain the
action the plaintiff desires from the
directors . . . and the reasons for the
plaintiff’s failure to obtain the action
or for not making the effort." However,
the requirement of a shareholder demand
is more than a pleading requirement, it
is a substantive right of the shareholder
and the directors. See Kamen, 500 U.S. at
97. It is the law of the state of
incorporation which controls these
substantive rights and governs what
excuses are adequate for failure to make
demand. See id. at 98-99, 101; Boland v.
Engle, 113 F.3d 706, 710 (7th Cir. 1997).
  The "futility" exception establishes the
circumstances in which the shareholder is
allowed to circumvent the directors’
authority to manage corporate affairs.
See Kamen, 500 U.S. at 102. Whether a
shareholder should be allowed to proceed
without making demand "is based on the
application of the State’s futility
doctrine . . . ." Id. at 104. Illinois
law requires that a demand be made or
excuses demand when the request would be
futile as a prerequisite to a derivative
action. 805 Ill. Comp. Stat. 5/7.80(b)
(1999) (also referred to as sec. 7.80(b)
of the Business Corporation Act of 1983);
see also Schnitzer v. O’Connor, 653
N.E.2d 825, 829 (Ill. App. Ct. 1995)
(stating that demand rule 7.80(b) is "al
most identical" to Fed. R. Civ. P. 23.1).
The shareholder must state with
particularity why a demand would have
been futile. Starrels, 870 F.2d at 1170
(citations omitted). However, it is not
sufficient for the shareholder to simply
state "in conclusory terms that he made
no demand because it would have been
futile." Id. (citation omitted). Although
plaintiffs have a conclusory paragraph in
their claim of demand futility, they have
also incorporated all of the detailed
factual allegations. A review for demand
futility "is factual in nature," and the
alleged facts are reviewed "to decide
whether they raise a reasonable doubt . .
. that the protections of the business
judgment rule are available to the
board." Aronson, 473 A.2d at 814-15. Our
review is applied to the particularized
facts, taking into consideration "the
presumption of regularity of the Board’s
process." Brehm, 746 A.2d at 259.

1.   Aronson test

  To determine whether demand is futile
under Illinois law, the Illinois courts
have applied the standard set forth by
the Delaware Supreme Court in Aronson,
473 A.2d at 808, holding that "demand can
only be excused where facts are alleged
with particularity which create a reason
able doubt that the directors’ action was
entitled to the protections of the
business judgment rule." See Spillyards,
662 N.E.2d at 1366; Powell, 556 N.E.2d at
1245; see also Starrels, 870 F.2d at
1170-71; Silver v. Allard, 16 F. Supp. 2d
966, 969 (N.D. Ill. 1998). The Aronson
test is applied in cases where there is a
conscious decision by the board of
directors to act or refrain from acting.
See 473 A.2d at 813. It is not applied
"where directors have either abdicated
their functions or . . . failed to act,"
although "a conscious decision to refrain
from acting may nonetheless be a valid
exercise of business judgment . . . ."
Id.

  The plaintiffs allege that the directors
"knowingly" in an "intentional breach
and/or reckless disregard" of their
fiduciary duties "chose" not to correct
the FDA problems in a timely manner,
indicating a conscious decision not to
act. As the court in Brehm stated,

This is a case about whether there should
be personal liability of the directors of
a [ ] corporation to the corporation for
lack of due care in the decisionmaking
process and for waste of corporate
assets. This case is not about the
failure of the directors to establish and
carry out ideal corporate governance
practices.
746 A.2d at 255-56. Given the facts of
the instant case, where FDA notices were
sent to the chairman of the board, where
the directors had a duty under the SEC to
comply with "comprehensive government
regulations," where the ongoing
violations lasted over an extended period
of six years, and where information
concerning the violations was made known
to the general public beginning in 1995,
we do not disagree with the plaintiffs’
allegations that the facts indicate the
directors purposefully took no action and
will, therefore, apply the Aronson test./3

  The court in Aronson stated that "the
entire question of demand futility is
inextricably bound to issues of business
judgment and the standards of that
doctrine’s applicability," explaining
that 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." 473 A.2d at 812. Plaintiffs
have the burden of establishing facts to
rebut this presumption. Id.

  The two-pronged test in Aronson provides
that demand futility is established if,
accepting the well-pleaded facts as true,
the plaintiffs raise a reasonable doubt
with alleged particularized facts that
either (1) the directors are
disinterested or independent or (2) the
challenged transaction was the product of
a valid exercise of the directors’
business judgment. 473 A.2d at 814;
Starrels, 870 F.2d at 1171.

a. First prong--disinterest or
independence

  A disinterested director "can neither
appear on both sides of a transaction nor
expect to derive any personal financial
benefit from [the challenged transaction]
in the sense of self-dealing, as opposed
to a benefit which devolves upon the
corporation or all stockholders
generally." Aronson, 473 A.2d at 812.
Plaintiffs have not offered any specific
facts to indicate that any of the
directors had divided loyalties. There
were no allegations of improper motives
or conflicts of interest. Nor, with the
exception of White’s sale of stock prior
to the FDA’s legal action, have
plaintiffs presented allegations that any
of the other directors profited in any
way by their actions, or lack thereof.
See In re Gen. Instr. Corp. Sec. Litig.,
23 F. Supp. 2d 867, 874 (N.D. Ill. 1998)
(using Aronson test in finding eight
directors [out of thirteen] who sold
their company stock at inflated price for
over $500 million while concealing
adverse financial information about
company raised reasonable doubt as to
directors’ disinterest).

  In addition, plaintiffs have not pleaded
facts to raise reasonable doubt as to the
directors’ independence. Independence
exists when "a director’s decision is
based on the corporate merits of the
subject before the board rather than
extraneous considerations or influences."
Aronson, 473 A.2d at 816. There are no
specific allegations as to how each
individual director was influenced by
outside sources or considerations in
making decisions about the board’s
actions, or their failure to take action.

  We find the plaintiffs have not pleaded
specific allegations to create a
reasonable doubt as to the majority of
the directors’ disinterestedness or
independence.
b.   Second prong--business judgment

  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).

  In order to invoke the protection of the
business judgment rule, Aronson holds
that "directors have a duty to inform
themselves, prior to making a business
decision, of all material information
reasonably available to them." 473 A.2d
at 812. Demand will be excused in a
derivative suit only if the trial court
and the appellate court, upon de novo
review, "conclude that the particularized
facts in the complaint create a
reasonable doubt that the informational
component of the directors’
decisionmaking process, measured by
concepts of gross negligence, included
consideration of all material information
reasonably available." Brehm, 746 A.2d at
259 (emphasis in original) (citing
Aronson, 473 A.2d at 812).

  We find that the facts alleged are
sufficient to show that although
corporate governance practices were in
place, the directors were grossly
negligent in failing to inform themselves
of all reasonably available material
information. See Brehm, 746 A.2d at 259.
The chairman of the board received copies
of the two Warning Letters in 1994 and
another in early 1999, and even though
the language in the Warning Letters is
described as "boilerplate," 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 addressed any
risks involved in regulatory compliance.
In addition, given their responsibilities
under the SEC filings, the directors knew
of the ongoing violations and knew of the
1995 compliance plan and its subsequent
failure in 1998. The FDA met at least ten
times with Abbott representatives,
including White and other senior
officers, concerning the continuing
violations of the regulations. 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. All of the above was "material
information reasonably available to [the
directors]." Aronson, 473 A.2d at 815.

  Delaware law also 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
Int’l, Inc. Derivative Litig., 698 A.2d
959, 967 (Del. Ch. 1996). 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.
Although the present case does not deal
with a claim of fraud like that in In re
Caremark, with the extensive paper trail
concerning the violations and the implied
awareness of the problems in the SEC
filings, it is clear that the directors
either knew or should have known 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 the substantial losses
incurred by the consent decree. See id.

  Plaintiffs have alleged the directors
ignored obvious problems concerning the
continuing federal violations and that
"the directors must have known of it."
See In re Baxter Int’l, Inc. Shareholders
Litig., 654 A.2d 1268, 1271 (Del. Ch.
1995). Plaintiffs have pleaded with
particularity "what obvious danger signs
were ignored" and that the directors
failed to take any measures. Id. We find
that obvious danger signs, as
particularized in six years of
noncompliance, inspections, 483s, Warning
Letters, notice in the press, 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 are sufficient facts to indicate
that the directors failed to reasonably
inform themselves and that their failure
to act was not made in good faith and was
contrary to the best interests of the
company. See Aronson, 473 A.2d at 812,
818.

  With respect to demand futility,
plaintiffs have sufficiently pleaded
allegations to reasonably conclude that
the directors’ actions fall outside the
protection of the business judgment rule;
allegations which demonstrate conduct "so
egregious" that there is a substantial
likelihood of director liability.
Aronson, 473 A.2d at 815. Demand is
therefore excused. Id.; see In re Baxter,
654 A.2d at 1270-71. 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.

c.   Directors’ exemption clause

  Abbott’s certificate of incorporation
exempts the directors from liability. The
Articles of Amendment to Abbott’s
Articles of Incorporation dated April 29,
1994, includes the following provision:

A director of the corporation shall not
be personally liable to the corporation
or its shareholders for monetary damages
for breach of fiduciary duty as a
director, except for liability (i) for
any breach of the director’s duty of
loyalty to the corporation or its
shareholders, (ii) for acts or omissions
not in good faith or that involve
intentional misconduct or a knowing
violation of law, (iii) under Section
8.65 of the Illinois Business Corporation
Act,/4 or (iv) for any transaction from
which the director derived an improper
personal benefit . . . .

This language is identical to that of the
Illinois Business Corporation Act. See
805 Ill. Comp. Stat. sec. 5/2.10(b)(3).
When the certificate of incorporation
exempts directors from liability, the
complaint must plead non-exempt conduct
with sufficient particularity to permit
the court to reasonably conclude the
directors’ conduct falls outside the
exemption. See In re Baxter, 654 A.2d at
1270. As previously discussed,
plaintiffs’ complaint sufficiently
alleges "omissions not in good faith" and
"intentional misconduct" concerning
"violations of law," which conduct falls
outside of the exemption.

  In McCall, where the duty of care claims
arose from the board’s failure to act,
the Sixth Circuit held that with a
certificate of incorporation which
exempts the directors from personal
liability (with language identical to the
Abbott provision), a breach of the duty
of care did not require intentional
conduct on the part of the directors to
overcome a waiver of liability pursuant
to the certificate of incorporation. 239
F.3d at 818. The court held that it is
possible that reckless acts, which are
arguably acts not taken in good faith,
may overcome the certificate’s waiver.
Id. 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, an investigation
by the New York Times into the company’s
billing practices, and inaction by the
board. Id. at 819-20.

  The court in McCall held that the
directors’ failure to act against a
corporation’s systematic health care
fraud from at least 1994 to 1996 alleged
sufficient facts "to present a
substantial likelihood of liability." Id.
at 819. Although 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 the
present case 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 the two-year period in McCall.

III.   CONCLUSION

  For the above-stated reasons, the order
of the district court is REVERSED and the
case is REMANDED for further proceedings
consistent with this opinion. Circuit
Rule 36 shall not apply on remand.
FOOTNOTES

/1 Under 12 U.S.C. sec. 351(h), a device is deemed
"adulterated" if the product is not manufactured,
processed, packed, or held in accordance with
"current good manufacturing practices."

/2 White replaced Burnham as chairman of the board
of directors in April 1999.

/3 A different analysis for demand futility is used
in situations where the directors did not make a
business decision which was challenged in the
derivative suit. See Rales v. Blasband, 634 A.2d
927, 933-34 (Del. 1993). The court in Rales held
that where there is "[t]he absence of board
action," the plaintiffs need not demonstrate a
reasonable probability of success on the merits,
but must present "particularized factual
allegations [which] create a reasonable doubt
that, as of the time the complaint is filed, [a
majority of] the board of directors could have
properly exercised its independent and
disinterested business judgment in responding to
a demand." Id. at 934. In McCall, the shareholder
plaintiffscharacterized the board’s failure to
take action with respect to systematic fraud
occurring in the corporation as a conscious
decision, i.e., knowingly, intentionally. 249
F.3d at 813. But the Sixth Circuit held that
where the plaintiffs’ "duty of care claims . . .
arise out of allegations of nonfeasance by the
Board (i.e., "intentional ignorance of," or
"willful blindness to" the "red flags" that were
signs of potentially fraudulent practices) and
challenge the Board’s failure to take action or
investigate under the circumstances," and which
do not allege a conscious decision to refrain
from acting, the Rales test must be applied. Id.
at 816.

  However, even if the Rales test had been
applied in the instant case, the results would be
the same, as detailed in the above-stated
analysis concerning reasonable doubt as to the
directors’ independent and disinterested status
under the business judgment rule, given the fact
that at the time demand would have been made, it
would have been to a majority of the same
directors who were in control during the six-year
period and when the consent decree was imposed.
See id. at 819 (finding that factual allegations
and reasonable inferences drawn in plaintiffs’
favor sufficient to "create a reasonable doubt as
to the disinterestedness and independence of a
majority of the directors").

/4 805 Ill. Comp. Stat. sec. 5/8.65 details
particular circumstances other than those
specified in sec. 5/2.10(b)(3), and not pertinent
to this case, when a corporate director may be
held liable.