Over the past couple of blog posts, we have considered the guilty pleas by Blue Bell Creameries to charges that they distributed adulterated ice cream products and paid a criminal fine and forfeiture amount totaling $17.25 million and agreed to pay an additional $2.1 million to resolve civil False Claims Act allegations regarding ice cream products manufactured under insanitary conditions and sold to federal facilities. We also reviewed the criminal charges against former President and Chief Executive Officer (CEO) of the company, Paul Kruse, as laid out in the Information filed against him. As bad as both of these sets of allegations and agreed facts are, I can only say they pale in comparison with the total failure of the Blue Bell Board of Directors in its role in this catastrophe.
Today, I conclude this short exploration of the total failure of Blue Bell by considering the Board’s failure in its Caremark duties. In its Opinion, the Delaware Supreme Court, stated, “The plaintiff also challenges the Court of Chancery’s dismissal of his Caremark claim. Although Caremark claims are difficult to plead and ultimately to prove out, we nonetheless disagree with the Court of Chancery’s decision to dismiss the plaintiff’s claim against the Blue Bell board. Under Caremark and Stone v. Ritter, a director must make a good faith effort to oversee the company’s operations. Failing to make that good faith effort breaches the duty of loyalty and can expose a director to liability.”
But it is more than simply not doing your job as a Board, it is doing so in bad faith. The Court states, “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.” Bad faith is established, under Caremark, when “the directors [completely] fail to implement any reporting or information system or controls[,] or … having implemented such a system or controls, consciously fail[ ] to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.” In short, to satisfy their duty of loyalty, directors must make a good faith effort to implement an oversight system and then monitor it.”
As we noted yesterday a majority of Board members were so beholden to the Kruse family in general and CEO and Board Chairman Paul Kruse particularly that they could not exercise independent judgment. It was so bad that the Board actually passed a Resolution in the middle of the crisis, after there were public notifications of the listeria outbreak “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.””
The job of every Board member is to represent the shareholders, not the incumbent CEO and Chairman of the Board. To do so, the Board must oversee the risk management function of the organization. Blue Bell was and to this day is a single-product food company and that food is ice cream. This sole source of income would mandate that the highest risk the company might face is around food. But as the underlying compliant noted, “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.”
The plaintiffs reviewed the Board records and made the following allegations:
- there was no Board committee that addressed food safety;
- there was no regular process or protocols that required management to keep the Board apprised of food safety compliance practices, risks, or reports which existed;
- there was no schedule for the Board to consider on a regular basis, such as quarterly or biannually, any key food safety risks which existed;
- during a key period leading up to the deaths of three customers, management received reports that contained what could be considered red, or at least yellow, flags, and the Board minutes of the relevant period revealed no evidence that these were disclosed to the Board;
- the Board was given certain favorable information about food safety by management, but was not given important reports that presented a much different picture; and
- the Board meetings are devoid of any suggestion that there was any regular discussion of food safety issues.
The Board’s several responses to the plaintiffs’ allegations can only be characterized as pathetic. The Opinion stated, “the directors largely point out that by law Blue Bell had to meet FDA and state regulatory requirements for food safety, and that the company had in place certain manuals for employees regarding safety practices and commissioned audits from time to time. In the same vein, the directors emphasize that the government regularly inspected Blue Bell’s facilities, and Blue Bell management got the results.”
The Delaware Supreme Court made short shrift of this argument, stating “fact 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. Indeed, these types of routine regulatory requirements, although important, are not typically directed at the board. At best, Blue Bell’s compliance with these requirements shows only that management was following, in a nominal way, certain standard requirements of state and federal law. It does not rationally suggest that the board implemented a reporting system to monitor food safety or Blue Bell’s operational performance.”
The Board’s next defense was even more inane and was so preposterous, the Delaware Supreme Court labeled it as “telling.” It was that because the Board had received information on the company’s operational issues and performed oversight on operational issues, it had fulfilled its Caremark obligations. This is basically the same argument that every paper-pushing argument for compliance program. We have something on paper so we have complied is the clarion call of such practitioners. The Delaware Supreme Court also saw through the flimsiness of this argument stating, “if that were the case, then Caremark would be a chimera.” [emphasis in original] This is because operational issues are always discussed at the Board level. Finally, “Although Caremark may not require as much as some commentators wish, it does require that a board make a good faith effort to put in place a reasonable system of monitoring and reporting about the corporation’s central compliance risks. In Blue Bell’s case, food safety was essential and mission critical.”
The bottom line is that the Blue Bell Board did nothing to fulfill its Caremark obligations. Every CCO needs to read and understand this case so they can present it to their Board. I am not sure how much D&O coverage the Blue Bell Board carries but I hope it is quite a bit as they are going to need it.
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© Thomas R. Fox, 2020