Board members who neglect risk oversight, in turn, risk exposure to lawsuits via Director and Officer (D&O) Claims in the fallout of a major safety lapse. Boeing’s Board of Directors learned that firsthand in a settlement stemming from Caremark claims reached late last year.
Last year, the Delaware Court of Chancery handed down a warning to directors and officers of any companies where safety is mission critical.
In the case titled In re The Boeing Company Derivative Litigation, 2021 WL 4059934 (Del. Ch. Sept. 7, 2021), the Court permitted a claim to proceed against the directors of The Boeing Co. The stockholder plaintiffs sued Boeing’s board of directors, seeking to be compensated for financial losses related to the crash of two 737 MAX jetliners. The plaintiffs’ complaint asserted that Boeing’s directors neglected to monitor aircraft safety before the crashes and failed to implement proper oversight and monitoring procedures over “mission critical” airplane safety risks.
The significance of the Boeing decision is that board oversight and monitoring of “mission critical” safety risks form a fundamental part of a director’s responsibilities. When a board fails to adequately monitor and to oversee such risks, there is potential D&O liability – which may be a source of recovery (often the only source) for unsecured creditors in a bankruptcy proceeding. Risk management should not be the sole province of management.
Foregoing Risk Oversight Can Carry Personal Consequences
Imagine the following: A company recalls goods due to product defects or mislabeling. A federal agency inspection related to poor manufacturing processes is pending, inventory reserves are growing, and hefty product returns are occurring. Or worse yet, a safety lapse has happened and there has been a tragedy. The debtor could be in any business where safety is paramount, such as health care, pharmaceuticals, toys with small parts that a child can choke on, or aviation.
The Boeing decision highlights a cardinal principle of corporate governance: when crisis strikes, directors promptly must engage.
In many instances, the foregoing events are accompanied by outside director resignations. However, resignations do not absolve directors of liability that occurred prior to their resignation.
When a company suffers a traumatic event due to a safety lapse and where a traumatic event is likely to materially impact the company’s valuation, shareholders and creditors often seek to hold someone liable in order to be compensated for their financial losses. Further, if the traumatic event has caused a Chapter 11 case to be commenced, a creditors’ committee may investigate and seek to pursue “director and officer” claims.
No Boeing Board Member Was Accountable for Board Risk Oversight
In its decision, the court found that Boeing’s Audit Committee was charged generally with risk oversight, but “no committee [was] charged with direct responsibility to monitor airplane safety”; that the board failed to properly monitor, discuss, or address airplane safety issues; and that no regular processes or protocols had been implemented for reporting and addressing “red flags.”
The court in Boeing opined that airplane safety is essential and mission critical to Boeing’s business. Consequently, the court found that airplane safety must be specifically provided for in oversight protocols and that blanket language typically found in many board committee charters relating to monitoring risk generally was inadequate.
Claims that directors failed to make “a good faith effort to oversee the company’s operations” are referred to as “Caremark claims” after the case titled In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996). Caremark claims can be difficult to prove, though. In fact, the Delaware courts have said that, with respect to a board’s oversight obligation, only a “sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to [personal] liability [of directors].” In a series of Delaware decisions, the court has said that directors have liability if they either (i) completely failed to establish a system of reporting to the board with respect to the company’s “mission critical” risks or (ii) having established such a system, failed to monitor it, including, for example, if they knew of, and consciously ignored, “red flags” indicating that there were problems.
According to the court, when Boeing developed the 737 MAX plane, no directors inquired about product safety. Instead, the board’s “primary concern was how rapidly and inexpensively the company could develop the MAX 737.” The board delegated to the CEO “all authority over the multi-year effort to approve the MAX 737’s final specifications, and deliver and build it, without having to return to the board.”
The court found that Boeing did “not implement or prioritize safety oversight at the highest level of the corporate pyramid. None of Boeing’s board committees were specifically tasked with overseeing airplane safety, and every committee charter was silent as to airplane safety.” Nor was airplane safety “a regular set agenda item or topic at board meetings.” Management did not periodically report to the board about airplane safety, nor did the board receive internal whistleblower complaints about airplane safety.
Good Faith Efforts to Monitor Risk
The Boeing court cited to another case titled, Marchand v. Barnhill, 212 A.3d 805 (Del. 2019), where it was found that directors of Delaware corporations have an obligation to make good faith efforts to implement and monitor a risk oversight system. It was alleged in the Boeing complaint that the board received occasional, discretionary “management-initiated communications” that “were not safety-centric,” and “when safety was mentioned to the board, it did not press for further information, but rather passively accepted management’s assurances and opinions.”
The Boeing ruling affirms the courts’ increasing willingness to subject directors to suit for corporate trauma. Equally important, the Boeing decision highlights a cardinal principle of corporate governance: when crisis strikes, directors promptly must engage.
In a case where financial losses are largely due to a traumatic event caused by a safety failure, shareholders outside of a Chapter 11 case and a creditors’ committee in a Chapter 11 case are likely to investigate the record of the debtor’s board related to risk management. If the investigation yields information that the board was lax in overseeing safety and where a safety lapse had a ruinous impact on the debtor, then D&O claims are highly likely to be pursued.
*The views expressed herein are those of the author and are not necessarily shared by other persons at Lowenstein Sandler LLP. Each case is unique. The law is subject to interpretation. This article is not intended to provide legal advice.