Teamsters Local 443 Health Services & Insurance Plan v. Chou, et. al., No. 2019-0816-SG (Del. Ch. Aug. 24, 2020) (Glasscock, V.C.)
In this memorandum opinion, the Delaware Court of Chancery denied a motion to dismiss Caremark claims, finding that plaintiff stockholders adequately pled that officers and directors failed in their duty to oversee company operations, in bad faith, and also adequately pled demand futility. In so ruling, Vice Chancellor Glasscock provided an insightful analysis of the duty of oversight, highlighting the difficulty in successfully pleading a failure to comply with those duties, as articulated in In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996).
Plaintiffs are stockholders in nominal defendant AmerisourceBergen Corporation (“ABC”), a pharmaceutical sourcing and distributing company. Defendants are directors and officers of ABC. AmerisourceBergen Specialty Group (“Specialty”) is one of ABC’s pharmaceutical distribution operating segments and is the parent entity of a group of companies serving the specialty pharmaceuticals market, including ASD Specialty Healthcare, LLC d/b/a Oncology Supply (“Oncology”). Oncology’s subsidiary is Medical Initiatives, Inc. d/b/a Oncology Supply Pharmacy Services (“Pharmacy”), a company whose sole function was to create pre-filled syringes of oncology drugs for sale and distribution to healthcare providers through a program known as the Pre-Filled Syringe Program. ABC closed Pharmacy’s business in 2014.
As part of the Pre-Filled Syringe Program, Pharmacy created pre-filled syringes by removing FDA-approved drug products from their original glass vials and repackaging them into single-dose syringes. When Pharmacy removed the desired dosage of oncology drug from its original glass vial a small amount of drug product would be left over, known as “overfill.” Overfill is not intended for patient use. Plaintiffs alleged that Pharmacy systematically extracted the overfill from FDA-compliant vials and combined the contents from multiple vials, in a process known as “pooling.” The pooled excess drug product was then allegedly repackaged into new syringes. Thus, by pooling overfill, the Pre-Filled Syringe Program was able to create more doses than it bought from the original drug manufacturers. Neither Oncology nor Pharmacy were registered with the FDA as a drug manufacturer or repackager. Additionally, plaintiffs alleged that neither entity obtained valid prescriptions, performed checks for harmful potential drug interactions, saw or counseled patients, or maintained records of pertinent information for the patients to whom pre-filled syringes were administered. Moreover, plaintiffs alleged that the vials were prepared in an unclean environment and that the vials were not submitted for required sterility testing. Importantly, plaintiffs further alleged that Pharmacy had an incentive program whereby Pharmacy technicians who produced more syringes using overfill received higher bonuses.
In 2017, Specialty entered a guilty plea in connection with a Department of Justice investigation of Pharmacy’s Pre-Filled Syringe Program. ABC also announced via an SEC filing that Specialty had reached an agreement in principle with the United States Attorney’s Office for the Eastern District of New York to resolve civil claims under the False Claims Act. The allegations specific to the False Claims Act were that by harvesting overfill, ABC was able to bill multiple healthcare providers for the same vial of drug, causing excess billing of federal health care programs, and that the Pre-Filled Syringe Program made it possible for ABC to provide drugs at a discount, enabling ABC to increase its market share.
On October 11, 2019, plaintiffs filed a complaint in the Delaware Court of Chancery, which pleads two counts of breach of fiduciary duty. Count I alleges that the director defendants consciously failed to implement and monitor compliance policies and systems and failed to exercise their oversight responsibilities. Count II alleges that the officer defendants consciously breached their fiduciary duties and violated corporate responsibilities by knowingly operating and maintaining an illegal business model, and the officers failed to inform the ABC’s board of directors about the Pre-Filled Syringe Program’s regulatory compliance issues. Plaintiffs also alleged unjust enrichment against ABC’s CEO/Chairman.
Factually, plaintiffs alleged that during the years the Pre-Filled Syringe Program was active, no portion of any the meetings of the board of directors was devoted to drug safety and compliance. Moreover, no reports concerning the Pre-Filled Syringe Program or its compliance with applicable legal requirements were submitted to the Audit Committee, which was charged with such oversight responsibilities. Indeed, plaintiffs alleged that Pharmacy and Oncology were kept out of ABC’s compliance programs for the entire period of the Pre-Filled Syringe Program’s existence, despite a 2007 independent report identifying compliance deficiencies and a 2010 regulatory review by a law firm doing the same. Plaintiffs further alleged that even after a qui tam suit was filed by Specialty’s chief operating officer, ABC never took corrective actions.
Defendants moved to dismiss the complaint pursuant to Court of Chancery Rule 23.1 for failure to make a demand on the board of directors and failure to plead demand futility. They also moved to dismiss under Chancery Court Rule 12(b)(6) for failure to state a claim upon which relief may be granted. In denying the motion to dismiss, the Court first determined that plaintiffs adequately pled demand futility. Because plaintiffs challenged board inaction, and not a specific board action or decision, the Court analyzed demand futility under the test articulated in Rales v. Blasband, which requires plaintiffs to adequately plead facts that “create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.” Rales, 634 A.2d 927 (Del. 1993). As it related to Count I against the directors, the Court found that a majority of the Demand Board could not exercise independent business judgment because they faced a substantial likelihood of liability under both prongs of Caremark. Specifically, plaintiffs adequately pled that, under prong one of Caremark, the board of directors made no good faith effort to ensure that the company had a system of controls in place and, that under prong two of Caremark, the board of directors consciously ignored red flags rising to the level of bad faith.
In so ruling, the Court recognized that under prong one of Caremark, it was likely that no effective reporting system was in place, but for purposes of evaluating the motion to dismiss under Rule 23.1, the Court chose to focus mostly on prong two of Caremark, emphasizing the many red flags defendants consciously disregarded. The Court explained that because ABC operates in a highly regulated industry and is subject to regulation governing health and safety, ABC’s board of directors should have rigorously exercised its oversight function. Instead, the Court determined that the board of directors ignored numerous obvious red flags. For example, the Court found plaintiffs adequately pled that the Audit Committee never received the 2007 independent report on compliance failures, and otherwise ignored the recommendations stemming from that report. Moreover, after Specialty’s former COO filed a qui tam suit in 2010 alleging multiple compliance failures, the board of directors, with knowledge of these allegations, ignored those concerns in bad faith by failing to take action regarding the operation of the Pre-Filled Syringe Program. The Court also found that plaintiffs adequately pled that the DOJ subpoena on Specialty constituted a red flag, and that after receiving the subpoena, the board of directors did nothing to correct the compliance shortcomings at Pharmacy.
The Court further held that plaintiffs adequately pled facts to support a Caremark claim against the officers of ABC. The Court explained that the factual allegations underlying the alleged breaches of the officer defendants’ fiduciary duty obligations were congruous with those underlying the alleged breaches by the directors. Thus, with regard to demand futility, the Court determined that the director defendants similarly could not have brought their valid business judgment to bear on a demand to prosecute the claims against the officers because such litigation would implicate the directors’ own wrongdoing.