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City of Birmingham Retirement and Relief System v. Good, C.A. No. 9682-VCG (Dec. 15, 2017) (Seitz, J.)

December 15, 2017

In a 4-1 decision, the Delaware Supreme Court affirmed the Court of Chancery’s dismissal of a derivative complaint that sought to hold the directors of Duke Energy Corporation personally liable for fines, repairs, and remediation costs levied against the company as a result of a 2014 environmental spill, agreeing with the Court of Chancery’s conclusion that the plaintiff stockholders had failed to plead demand futility in connection with their Caremark-style claim for failure of oversight.

In 2014, a stormwater pipe ruptured beneath a Duke Energy coal ash containment pond, sending a slurry of ash and wastewater into North Carolina’s Dan River.  Federal and state investigations ensued, and company subsidiaries ultimately pled guilty to nine misdemeanor criminal violations of the Federal Clean Water Act and paid a fine exceeding $100 million.  Plaintiffs, stockholders of Duke Energy, filed a derivative suit in the Court of Chancery against certain of Duke Energy’s directors and officers for breach of their fiduciary duties.  Asserting a claim for the directors’ purported failure of oversight, Plaintiffs alleged that the directors knew of and disregarded the company’s Clean Water Act violations and allowed the company to collude with the North Carolina Department of Environmental Quality (“DEQ”) in order to evade compliance with environmental regulations.

The directors moved to dismiss the suit under Court of Chancery Rule 23.1 for failure to plead demand futility.  The Court of Chancery granted the motion, holding that plaintiffs failed to allege with the necessary particularized facts that the directors intentionally disregarded their oversight responsibilities such that their dereliction of duty rose to the level of bad faith and that they therefore faced a substantial likelihood of personal liability that would preclude their ability to independently and disinterestedly assess and respond to a demand on the board to take action. 

The plaintiffs focused their appeal on two main points: first, they argued that the Court of Chancery improperly discredited their interpretation of certain board presentations that, in the plaintiffs’ opinion, provided evidence that Duke Energy was violating environmental laws and avoiding remediation prior to the spill; and second, the plaintiffs argued that the Court of Chancery failed to draw the proper inferences from evidence provided to show collusion between Duke Energy and the DEQ.

The Supreme Court rejected both of plaintiffs’ arguments.  As the Court noted in its analysis, when assessing demand futility for an alleged failure of oversight claim under In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), a plaintiff must plead particularized facts sufficient to reveal board inaction of a nature that would expose the directors to a substantial likelihood of personal liability.  When directors are also exculpated from liability for violations of the duty of care under 8 Del. C. § 102(b)(7), as was the case for defendants, the plaintiff must allege with particularity that the directors acted with actual or constructive knowledge that their conduct was improper.  Here, the Court concluded, the directors faced at most the risk of an exculpated breach of the duty of care.  Therefore, the stockholders were required to make a demand on the board to consider the claims before filing suit.

Regarding the board presentations, the Court, relying on both the allegations in the complaint and documents it incorporated by reference, concluded that plaintiffs unfairly described the presentations, which did not support plaintiffs’ central theory that a majority of the board consciously ignored or intentionally violated positive law but, rather, showed the opposite—that the board was provided with appropriate status updates regarding impending environmental problems as well as the steps being taken to address them.  Turning to the alleged collusion, the Court noted that, to defeat a motion to dismiss, the plaintiffs must not only have alleged in sufficient detail that Duke Energy illegally colluded with a corrupt regulator but also tie that improper conduct to an intentional oversight failure of the board.  Here, the Court concluded, plaintiffs alleged merely that Duke Energy cooperated with a too-friendly regulator. 

Among other things, the Court disagreed with plaintiffs’ characterization of a consent decree negotiated between Duke Energy and DEQ in 2013, some months before the 2014 spill.  The decree preempted several then-pending civil suits brought by environmental groups seeking redress for ongoing environmental violations and subjected Duke Energy to what the plaintiffs characterized as merely nominal, ineffective penalties.  Plaintiffs alleged that the decree reflected a collusive effort between the company and DEQ to prevent any real remedy or prevention of Duke Energy’s unlawful practices.  The Court similarly rejected the plaintiffs’ more general allegations that DEQ’s lax enforcement of environmental laws supported a claim of collusion with the company, stating that general allegations regarding a regulator’s business-friendly policies and lack of aggressiveness do not lead to an inference in this case that Duke Energy illegally conspired with DEQ or, importantly, that the board was complicit in any such illegal activities. 

Chief Justice Strine dissented in the decision, opining that the facts alleged by the plaintiffs raised a pleading stage inference that it was Duke Energy’s business strategy—accepted and supported by its board of directors—to run the company in a manner that “purposely skirted, and in many ways consciously violated, important environmental laws.”  In rejecting the majority’s analysis under Rule 23.1, the Chief Justice stated that, even where particularized pleading is required, plaintiffs need not have conclusive proof of all their contentions.  Rather, they must plead particularized facts that support a rational inference of non-exculpated breaches of fiduciary duty by a majority of the board of directors.  Here, the Chief Justice concluded, the complaint provided sufficient particularized facts to support such an inference.

The full opinion is available here