The Most Difficult Theory to Prove, Remains Unproven: Don’t Bypass the Board of Directors

Adesola Adegbesan

In City of Birmingham Ret. & Relief Sys. v. Good, No. 16, 2017, (Del. Dec. 15, 2017), the Delaware Supreme Court affirmed the Delaware Court of Chancery’s decision dismissing shareholder’s derivative complaint and finding that (1) Duke Energy Corporation’s (“Duke”) shareholders did not sufficiently allege that the company’s directors faced a substantial likelihood of personal liability for a Caremark violation and (2) a lack of diligence in pursuing litigation did not lead to a reasonable inference that the North Carolina Department of Environmental Quality was a corrupt regulator colluding with Duke, nor that Duke’s board of directors knew about any corrupt activities and consciously ignored them.  Duke, a Delaware Corporation based in Charlotte, North Carolina, produces coal-fired power plants that generate a toxic byproduct (coal ash), which the plants dispose of through wastewater treatment centers.  Under the Federal Clean Water Act (“CWA”), it is unlawful for anyone to discharge a pollutant, unless permitted to do so by the Environmental Protection Agency (“EPA”) or the applicable state regulatory body.

In 2013, several citizens’ environmental groups filed a notice of intent to sue three of Duke’s subsidiaries under the CWA for coal ash that was discharged into ponds in North Carolina.  As a result, the North Carolina Department of Environmental Quality (“DEQ”) filed an enforcement action, and DEQ and Duke negotiated a consent decree.  This consent decree required Duke Energy to pay a $99,000 fine and create a compliance schedule, which Duke enforced at all of its locations in North Carolina, costing between $4 and $5 million. DEQ withdrew from the consent decree on February 2, 2014, when a pipe burst under a pond at one of Duke’s North Carolina locations, releasing 27 million gallons of coal ash into the Dan River.  All three subsidiaries pled guilty to several violations of the CWA, paying $102 million in fines and agreeing to restitution, community service, and mitigation.  Duke spent millions in fines to clean up the spill and pay Virginia and DEQ for damages, plus approximately $4.5 billion to comply with newly enacted federal and state environmental regulations.

On April 22, 2016, Plaintiffs, shareholders of Duke, filed a derivative suit in the Delaware Court of Chancery, alleging that the directors breached their fiduciary duties because they knew of and disregarded Duke’s CWA violations and allowed Duke to collude with DEQ to evade compliance with environmental regulations.  The directors moved to dismiss the derivative complaint, arguing that Plaintiffs were required to make a demand on the board before instituting litigation, pursuant to Delaware Court of Chancery Rule 23.1.  Plaintiffs responded that such demand was futile because the board’s mismanagement of Duke’s environmental concerns rose to the level of a Caremark violation, which posed a substantial risk of the directors’ personal liability for damages caused by the spill and enforcement action.  The court dismissed the derivative complaint, reasoning that the board’s reliance on reports to address coal ash storage problems negated any reasonable pleading-stage inference of bad faith by the board.

On appeal, Plaintiffs argued that the court (1) improperly discredited their interpretation of board presentations and minutes and (2) failed to draw the proper inferences from evidence of what the Plaintiffs characterized as collusion between Duke and its regulator.  The Delaware Supreme Court rejected both arguments, first pointing out that the presentations actually informed the board that Duke was working with DEQ to achieve regulatory compliance and addressing the environmental problems.  Furthermore, the Delaware Supreme Court reasoned “even if DEQ’s prosecution of environmental violations was ‘insufficiently rigorous, or even wholly inadequate,’ it fell short of a reasonable inference that Duke Energy illegally colluded with regulators.”   Since Duke’s directors did not face a substantial likelihood that they would be found personally liable for intentionally causing Duke to violate or consciously disregard the law, and since the evidence provided an insufficient basis to raise a reasonable inference of bad faith by the board, Plaintiffs were required to first demand that the board of directors address the claims they wished to pursue on behalf of the company.

Moving forward in the world of corporate law, City of Birmingham Ret. & Relief Sys. v. Good is a fresh and constant reminder for those with a stake in any business—particularly shareholders—to follow the simple rules and requirements before rushing to litigation.  Since it is difficult to prove that a corporation has risen to the level of a Caremark violation, the best way to play is the safest way, meaning that shareholders should make a demand on the board first, even if they wish to point the blame toward the board itself.  This decision creates a precedent where corporations are given the green light to merely “be in the process” of mitigating damage, while shareholders could potentially suffer a financial loss that is essentially out of their control.

Adesola is a 3L staff member on the Delaware Journal of Corporate Law graduating this May.  Adesola will be clerking next year for the New Jersey Superior Court.

Suggested Citation: Adesola Adegbesan, The Most Difficult Theory to Prove, Remains Unproven: Don’t Bypass the Board of Directors, Del. J. Corp. L. (Mar. 25, 2018), www.djcl.org/blog.

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