South v. Baker, C.A. No. 7294-VCL (Del. Ch. Sept. 25, 2012) (Laster, V.C.)

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In this Opinion, the Court of Chancery granted defendant’s Rule 23.1 motion to dismiss for plaintiffs’ failure to make demand or adequately plead demand futility, and dismissed the complaint with prejudice and without leave to amend.  The Court additionally found that plaintiffs had not adequately represented the interests of the company by hastily asserting a Caremark claim without conducting a sufficient investigation to support their Complaint.  The Court held that the dismissal would therefore not be preclusive as to other stockholders.

Hecla Mining Company (“Hecla” or the “Company”) is a Delaware corporation headquartered in Idaho.  Hecla engages in the discovery, acquisition, development, production, and marketing of precious and base metals such as silver, gold, lead, and zinc.  In April 2011, Hecla experienced the first of several accidents to occur at one of the Company’s mines.  On April 15, a rock fall occurred more than a mile below the surface at the Lucky Friday mine where two Hecla employees were working.  The United States Mine Safety and Health Administration (“MSHA”) conducted an investigation and issued a report citing the failure of “principal operating officials” to have policies and procedures that provided for safe mining.  On November 17, 2011, a second accident occurred at the Lucky Friday mine, which resulted in the death of one of Hecla’s contractors.  On December 14, 2011, a rock burst injured seven miners at that same mine.  Following the rock burst, MSHA issued a press release noting that it had issued 59 citations and 15 orders to Hecla in connection with the rock burst.

One week after the MSHA press release, the first of two securities class actions were filed in the District Court for the District of Idaho, claiming that Hecla’s disclosures about its safety procedures were materially misleading.  The class actions were followed by seven stockholder derivative actions in state and federal courts, including this litigation in the Delaware Court of Chancery.  Plaintiffs sued derivatively to recover damages that the Company had suffered and will suffer from the federal securities actions and the safety violations.  Plaintiffs invoked the legal theory first recognized in In re Caremark International Inc. Derivative Litigation, under which directors can be held liable for knowingly causing or consciously permitting the corporation to violate positive law, or for failing utterly to attempt to establish a reporting system or other oversight mechanism to monitor the corporation’s legal compliance.    

Defendants moved to dismiss the Complaint under Court of Chancery Rule 23.1.  Conceding that they had not made demand on the Board, Plaintiffs were required to plead demand futility in defense of the motion.  Demand is futile when the particularized factual allegations of a derivative stockholder complaint create a reasonable doubt that the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.  In the specific context of a Caremark claim, plaintiffs must plead facts establishing a sufficient connection between the corporate trauma and the board such that at least half of the directors face a substantial likelihood of personal liability.  The Court noted four ways that plaintiffs could have met this burden: (1) alleging actual director involvement in a decision or series of decisions that violated positive law; (2) pleading that the board consciously failed to act after learning about evidence of illegality; (3) pleading that a board of directors is dominated or controlled by key members of management, who the rest of the board unknowingly allowed to engage in self-dealing transactions; or (4) alleging that the board did not meet its obligation to adopt internal information and reporting systems that are reasonably designed to provide to senior management and to the board itself timely, accurate information sufficient to allow management and the board to reach informed judgments concerning both the corporation’s compliance with law and its business performance.
  
The Court found that plaintiffs failed to plead facts suggesting liability under any of these scenarios.  The Complaint did not cite any statute, regulation, or other provision of positive law that the Hecla board allegedly decided to consciously violate, nor facts from which such a decision could be inferred.  Moreover, the Court found plaintiffs’ invocation of the MSHA report unavailing as each of the violations indicated by the MSHA related to day-to-day operational issues in the Lucky Friday mine and not Board-level decisions.  Plaintiff’s additional argument that the series of incidents at the Lucky Friday mine amounted to “red flags” sufficient to put the Board on notice of safety issues, was also rejected by the Court.  The Court reasoned that the complaint nowhere alleged anything that the directors were told about the incidents, what the Board’s response was, or even that the incidents were connected in any way.  Finally, the Court found that the complaint did not contain allegations from which it could infer a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure that a reasonable information and reporting system exists.  The Court found that the Complaint in fact contained a number of allegations that suggested the exact opposite, including that the Board established a Safety Committee charged with, among other things, reviewing health, safety and environmental policies, and discussing annually with management the scope and plans for conducting audits of Hecla’s performance in health and safety.  For these reasons, the Court held that Plaintiffs had not pled demand futility and their complaint was subject to dismissal under Rule 23.1. 

In making this determination the Court repeatedly noted that plaintiffs could have met their pleading burden had they first pursued a Section 220 demand, as the Delaware courts have continually advised others to do.  In light of plaintiffs’ failure to do so, and their admission that they in fact filed hastily in response to procedural concerns relating to the other simultaneously filed suits, the Court determined that the dismissal should not prevent a more diligent stockholder from bringing its own suit.  The Court affirmed recent decisions that have suggested an evidentiary presumption that a plaintiff who files a Caremark claim hastily and without using Section 220 or otherwise conducting a meaningful investigation has acted disloyally to the corporation and served instead the interests of the law firm who filed suit.  The Court held that the circumstances supported an inference of disloyalty and a finding of inadequate representation.  As a result, the dismissal of plaintiffs’ complaint was preclusive solely as to the named plaintiffs and not to other stockholders.

The full opinion is available here.