Among the significant constraints in the current business and financial environment is the continuing disruption of corporate supply chains. The disruption is a side-effect of the pandemic that has been exacerbated by weather events and other developments. I have been concerned that supply-chain disruption could not only interfere with ongoing business operations but could, for companies experiencing significant setbacks, lead to D&O claims, including securities class action lawsuits. There have in fact been prior securities suits filed this year arising out of supply chain issues.

 

The latest securities suit to reflect this phenomenon is the securities class action lawsuit filed on December 14, 2021 against bed and mattress manufacturer Sleep Number Corporation, whose supply sources for mattress foam was disrupted by the Texas winter storms earlier this year. This latest lawsuit illustrates how supply chain issues can translate into D&O claims. As discussed below, this new lawsuit raises a number of interesting questions about possible future claims.

 

Background

Sleep Number Corporation designs and manufactures beds and mattresses. According to the company, one of the company’s distinctive features is its “vertical integration” strategy which the company claims allows it to manage its inventory and meet customer demand. The company touted its integrated supply chain to assuage investor concerns about the company’s ability to meet surging customer demand during the COVID-19 pandemic and cited its contingency and backup plans which could minimize supply chain disruptions.

 

One of the important components of the company’s mattresses is foam. The foam the company uses in its mattresses is made from petrochemicals. The manufacturing plants where the foam is made are primarily located in Texas and Louisiana. On February 14, 2021, winter storm Uri hit Texas and Louisiana. Among other things, the storm and its aftermath significantly disrupted the petrochemical plants’ operations.

 

The subsequently filed securities class action lawsuit alleges that the company “experienced a significant undisclosed supply chain disruption at the start of the Class Period that hindered the Company’s ability to meet surging customer demand.” The complaint alleges that during the Class Period the company made numerous statements calculated to try to reassure investors about the supply chain issues, among other things, alleging that the disruption was temporary and would soon ease.

 

On July 20, 2021, the company issued a press release announcing its second quarter 2021 financial results. Among other things, the complaint alleges, the press release disclosed that the company had, according to the complaint, “missed consensus estimates on the to and bottom line for the quarter and blamed the disappointing results in significant part on ‘near-term supply constraints’ and component shortages.” According to the complaint, the company’s share price fell nearly 13% on the news.

 

The Lawsuit

On December 14, 2021, a plaintiff shareholder filed a securities class action lawsuit in the District of Minnesota against the company, its CEO, and its CFO. A copy of the complaint can be found here. The complaint purports to be filed on behalf of a class of investors who purchased the company’s securities between February 18, 2021 (the day the company released its fourth quarter 2020 financial results) and July 20, 2021 (the day the company released its second quarter 2021 financial results.).

 

The complaint alleges that the during the class period the defendants failed to disclose: “(a) that Sleep Number continued to suffer from debilitating supply chain disruptions across multiple suppliers; (b) that Sleep Number did not have in place the supply chain flexibility, redundancies and fail-safes, as had been represented to investors, sufficient to offset such disruptions; (c) that as a result of (a)-(b) above, Sleep Number was unable to meet surging customer demand for the Company’s products; and (d) that, as a result of (a)-(c) above, Sleep Number had been forced to delay mattress shipments to end customers, pushing millions of dollars’ worth of sales into subsequent quarters and negative impacting the Company’s financial results.”

 

The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the class.

 

Discussion

The new lawsuit against Sleep Number has only just been filed and it is far too early to speculate about how the suit might fare. That said, the new lawsuit does show how supply chain issues can lead not just to business disruption but also to D&O claims. The critical issue is not that the company experienced supply chain disruption; the supply chain disruption alone did not trigger the lawsuit. Instead, what triggered the lawsuit was what the company allegedly said about the impact of the disruption and about the company’s ability to continue to operate and even prosper despite the disruption.

 

I have long thought that various second-level effects from the pandemic that are currently affecting the business environment and the economy might translate into D&O claims. The kind of second level effects I had in mind include not just pervasive supply-chain disruption, but also labor shortages and inflation. These second-level effects may yet lead to further D&O claims.

 

Interestingly, the supply chain disruption involved in this lawsuit is not related to the pandemic at all. Rather, the development that disrupted the supply of foam for the company’s mattresses is due to the massive Texas winter storm – which among other things shows how the kind of second level effects I identified in the preceding paragraph are the result of myriad factors, and are not merely knock-on consequences of the pandemic alone.

 

Which is not to say that the pandemic has nothing to do with this lawsuit. The twist in the tail of this situation is that, at least according to the plaintiff’s complaint, the company was, due to the supply chain issues, unable to fully exploit the pandemic-related surge in demand for the company’s products, causing loss of revenue or at least the shift of revenue to later reporting periods.

 

This alleged link between the pandemic and the plaintiff’s claims here illustrate how, as time goes by, it is going to be increasingly difficult to maintain a clear and distinct separation between claims that are pandemic-related and claims that are not pandemic-related. Among other things, it will definitely become more challenging to maintain a precise count of pandemic-related lawsuits, as I have been trying to do since the outset of the coronavirus outbreak.

 

It would be easier to say this case was pandemic-related if the supply chain disruption had been caused by the pandemic; but the disruption was due to the Texas winter storms, not the pandemic. To be sure, the disruption allegedly prevented the company from being able to fully exploit pandemic-related surge in demand for its products. But does an alleged inability to fully exploit pandemic-related demand surge make a lawsuit pandemic-related? It clearly would be pandemic-related if the inability to exploit the demand was itself due to the pandemic. However, in my mind, the fact that the disruption was not pandemic-related removes this case from the category of pandemic-related claims; accordingly, I have not counted this case as pandemic-related and I have not included in my count of pandemic-related claims. I recognize that this is a close question and I am interested to know what readers may think.

 

In any event, this lawsuit is not the first securities suit filed this year relating to supply chain issues. As discussed here, the recently SPAC-merged company Romeo Power was sued in April 2021 after a disruption in its supply of fuel cells disrupted the company’s ability to manufacture its principal product, batteries for electric vehicles.

 

I strongly suspect that the lawsuits against Romeo Power and Sleep Number will not be the last supply-chain related D&O claims we will see. To the contrary, it seems likely that there will be further supply-chain-related lawsuits in the weeks and months ahead, at least until the supply chain issues finally get sorted out.

 

Here’s a final thought problem: Is this case a climate change-related D&O lawsuit? There is a good case that the extreme weather event that caused the supply chain-related issues here was a result of climate change. Certainly supply chain disruption is one of the consequences feared from climate change. It could be argued that this case does belong on any list of climate change-related D&O lawsuits. I intend to keep this case in mind to have at the ready to try to illustrate how climate change-caused disruptions can lead to D&O claims. I welcome readers’ thought on this climate change question as well.