The Race to the Courthouse: La. Mun. Police Emples. Ret. Sys. v. Pyott (Part 7)

We are discussing La. Mun. Police Emples. Ret. Sys. v. Pyott, 46 A.3d 313 (Del. Ch. 2012) and its potential impact on Caremark style derivative suits.

We would be remiss if we did not consider the Caremark analysis employed by the court in Pyott.  In what has to be more unusual than a finding that the board violated the Blasius standard, the court concluded that the shareholders in Pyott sufficiently alleged a Caremark violation.  Such a claim could arise where the alleged conduct involved conscious behavior to cause a violation of the law.  As the court explained:

by consciously causing the corporation to violate the law, a director would be disloyal to the corporation and could be forced to answer for the harm he has caused. Although directors have wide authority to take lawful action on behalf of the corporation, they have no authority knowingly to cause the corporation to become a rogue, exposing the corporation to penalties from criminal and civil regulators. Delaware corporate law has long been clear on this rather obvious notion; namely, that it is utterly inconsistent with one's duty of fidelity to the corporation to consciously cause the corporation to act unlawfully. The knowing use of illegal means to pursue profit for the corporation is director misconduct.

The plaintiffs in Pyott sufficiently alleged this type of behavior.  The plaintiffs alleged that the board approved business plans "premised on illegal activity."  According to the court:  "The Board kept Allergan's business plan in place even after the . . . FDA inquiries illustrated the extent of Allergan's regulatory exposure."  These and other allegations were sufficient to "reasonably infer that the Board knowingly approved and monitored a business plan that contemplated illegality." As the court concluded:  "At the pleadings stage, I believe the plaintiffs are entitled to the reasonable inference that the Board oversaw company-wide efforts to promote off-label use of Botox for treating migraine headaches, which was not an FDA-approved use at the time."

The facts, therefore, look to be unusual.  It will be a decidedly rare case where plaintiffs can present sufficient allegations that a board knowingly approved a business plan that "contemplated illegality."   Nonetheless, the court took the same allegations examined by the California court and reached a different outcome.  Moreover, the court did so in a manner that benefited shareholders.  Were there to be a few more cases with similar outcomes, this Blog might have a harder time justifying the management friendly appellation usually given to the Delaware courts. 

Primary materials can be found at the DU Corporate Governance web site.