In a recent post (here), I reviewed the steps that well-advised companies can take in light of the current coronavirus outbreak to try to mitigate their risk of management liability claims arising out of the pandemic. In the following guest post, Brent Ashley of the Hirschler law firm takes a look at the steps corporate boards can take in light of the COVID-19 pandemic to try to insulate themselves against claims based on alleged breaches of the duty of oversight. I would like to thank Brent for allowing me to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is Brent’s article.
A corporate director is obligated to make a good faith effort to oversee company operations, legal compliance and financial performance. This obligation involves more than reviewing general operational reports from management. To satisfy the duty of oversight—a tenet of corporate governance cabined within the fiduciary duty of loyalty—directors must attempt to ensure a reasonable, board-level system of monitoring and reporting is in place, and monitor it. Where directors fail to make that good faith effort, or consciously ignore the proverbial red flag signaling material noncompliance, they breach the duty of loyalty to the company and expose themselves to liability.
Marchand v. Barnhill: A Cautionary Tale
In 2019, the Delaware Supreme Court issued a decision elaborating on the standard of conduct required by a director under her duty of oversight. Marchand v. Barnhill involved an action against the board of Blue Bell Creameries USA, Inc. Blue Bell, an ice-cream manufacturing company, suffered a listeria outbreak in early 2015, causing the company to recall all of its products, cease production at all of its plants and lay off a significant portion of its workforce. Based on the unfortunate consequences that followed, including financial fallout and consumer deaths, a stockholder sued the company’s directors for breach of their fiduciary duties of loyalty by “knowingly disregarding contamination risks and failing to oversee the safety of Blue Bell’s food-making operations.”[i]
In their defense, the directors argued that a reasonable reporting system had been in place, along with routine monitoring protocols. They highlighted the fact that the Blue Bell board met monthly; regularly reviewed reports relating to manufacturing operations from the company CEO and VP of Operations; engaged a third-party laboratory and food safety auditor to test facilities for dangerous contaminates; and had distributed a sanitation manual with standard operating and reporting procedures. In addition, the directors asserted that the company was subjected to regular and intense regulatory inspections.
Failure to Monitor “Intrinsically Critical” Compliance Issues
Despite these protocols, the Court ruled that the plaintiff had alleged facts at the pleading stage sufficient to establish the board’s bad faith conduct in failing to try to implement a reasonable system to oversee issues “intrinsically critical to the company’s business operation.” For Blue Bell, this meant board-level oversight of the company’s food safety compliance. The decision noted that Blue Bell board minutes reflected “no board-level discussion” of the negative contamination reports received from the third-party laboratory and food safety auditor. Further, the fact that “Blue Bell nominally complied with FDA regulations,” and management discussed general operations with the board, “does not imply that the board implemented a system to monitor food safety at the board level.” The Court emphasized that no board committee had been commissioned to address food safety, and no regular process had been established to require management to update the board as to food safety compliance and risks. Despite management’s knowledge of the listeria contamination, the “information never made its way to the board, and the board continued to be uninformed about (and thus unaware of) the problem.”
Your Checklist for Ensuring Oversight of Mission Critical Issues during the COVID-19 Pandemic
The Marchand decision includes a number of lessons for corporate boards operating in today’s uncertain environment. Of utmost importance, is the requirement that a board attempt to implement a reasonable system of monitoring and reporting about the company’s “central compliance risks” and “mission critical” issues in light of the COVID-19 outbreak. To satisfy this obligation, directors should consider taking the following, proactive steps related to oversight and monitoring:
- Identify, evaluate and regularly update “intrinsically critical” compliance issues specific to the company. This is especially important for a company that operates in an environment subject to external regulations that govern its “mission critical” operations, and monoline companies, who rely on a single product.
- Designate a board committee specifically charged with overseeing pandemic-related matters and evaluating how these concerns impact the company’s “central compliance” issues.
- Confirm the implementation of protocols requiring senior management to provide regular updates and reporting to the board about the impact of the novel coronavirus on the company’s operations, financial position, compliance risks and COVID-19 response. As an example, directors should have a firm understanding of the company’s capital structure and liquidity position, upcoming debt service requirements, compliance with shut-down orders, the status of company workforce and facilities, cybersecurity risks associated with working remotely and employment law compliance.
- Develop a crisis response plan centered on preventative measures. Include pre-crisis guidelines, as well as post-crisis evaluation of the plan’s effectiveness.
- Hold virtual board meetings often. Add discussions of COVID-19 concerns to the agendas for regularly scheduled and special board and committee meetings. Invite management to participate.
- Record detailed COVID-19-related actions and deliberations in board committee and full-board meeting minutes. Brief minutes on general topics of discussion are not sufficient. Thoughtful consideration should be reflected in the minutes, without having them read like a transcript.
- Maintain documents relevant to and evidencing the existence of a reasonable reporting and monitoring system. If the Company plans to participate in a governmental relief program, such as the Paycheck Protection Program (PPP), the board should document the information on which it relied in reaching its decision to apply, as well as the appropriate board resolutions. The board should review routine payroll reports to monitor the probability of loan forgiveness.
Though Marchand was decided under Delaware law, it serves as prudent guidance for corporate governance best practices. Retaining outside legal advisors to assess a company’s reporting and monitoring protocols is also best practice.
Brent A. Ashley is an attorney at Hirschler in Richmond, Virginia. A member of the Virginia and Delaware Bars, Ashley’s practice focuses on mergers and acquisitions involving privately-held middle market companies across the U.S., and corporate counseling. He can be reached at firstname.lastname@example.org.
[i] Marchand v. Barnhill, 212 A.3d 805 (Del. 2019).