The use of robust pre-litigation discovery is paving the way for more duty of oversight cases to survive motions to dismiss in the closely watched Delaware Court of Chancery, although this doesn’t mean the hurdle that these cases face to go to trial is any lower, Ryan Philp of Hogan Lovells says.

Since 2019, a handful of duty of oversight cases have survived motions to dismiss, a trend for corporate counsel to keep an eye on, Philp told Legal Dive.

Since the landmark Caremark case in 1996 that created a two-prong test for determining if directors can be held liable as fiduciaries when a company crisis leads to big shareholder losses, virtually no cases until this latest handful survived a motion to dismiss. 

That’s because of a high standard, based on the duty of loyalty, that’s in place to help ensure directors are protected against personal liability unless they can be shown to have acted in bad faith.  

“Delaware courts had typically regarded duty of oversight as possibly the most difficult type of claim to prove in all of Delaware’s law,” said Philp, who helps prepare Hogan Lovells’ quarterly snapshot of key Delaware decisions, which are important due to the Court of Chancery’s closely followed role in business law. 

The trend toward more cases surviving a motion to dismiss doesn’t necessarily suggest the standard is getting easier to meet, but it appears to follow a more aggressive use of the pre-litigation discovery process under Section 220 of the Delaware General Corporation Law.

“I think admonitions from the court that 220 is a tool at hand that should be used and for plaintiffs to bring real complaints to the court” is helping to drive more robust pre-filing discovery, Philp said.

Big data breach

In a case against Marriott, the plaintiff’s attorneys gathered some 3,000 documents in the pre-filing discovery process as part of an effort by a group of shareholders to hold directors liable for a failure to deal with a vulnerable data system stemming from the company’s 2016 acquisition of Starwood Hotels. Although the company knew from its due diligence data protection was at risk, management kept the system in place, resulting in the 2018 exposure of some 133 million guest records, considered one of the worst breaches ever.   

The derivative suit ended up being dismissed by the Court of Chancery last year because the plaintiff wasn’t able to meet Caremark’s two-pronged test for pleading liability: whether a process is in place for directors to catch problems and whether they fail to act on red flags. 

“That highlights we have a very difficult standard” to hold directors personally liable for oversight failures, Philp said. 

But even though the case was dismissed, it’s an example of the kind of “document intensive” information gathering that plaintiffs are using early in the process rather than waiting for a case to proceed, although here they gathered less than in other cases, he said, and that might have impacted the outcome.

Devastating plane crashes

A shareholder suit filed in 2020 against Boeing’s directors for the two widely reported 737 Max jetliner crashes is a case that made even more extensive use of pre-litigation discovery and, unlike Marriott, this one survived the motion to dismiss, although it ended up being settled not long afterward.

“The Boeing decision in particular is incredibly fact intensive in a way that a motion to dismiss opinion typically is not,” Philp said. 

In the case, the plaintiffs’ attorneys gathered hundreds of thousands of documents, including board books and minutes as well as email communications, before filing their action. They then relied heavily on that robust documentation to support their contention that Boeing had no process in place for keeping the board in the loop on something as mission-critical as airplane safety and that the board had ignored red flags. The court found that plaintiffs had alleged sufficient facts to satisfy both prongs of the Caremark test and denied Boeing’s motion to dismiss the case in substantial part.

“Airplane safety is naturally a mission-critical risk for a company like Boeing and the court noted that Boeing had no board committee or board-level process focused on monitoring airplane safety,” Philp said. “But, to boot, the court found that the board had ignored red flags that arose, including the first 737 crash.”

The case was settled for $237 million plus governance reforms quickly after the motion to dismiss was denied, illustrating the crucial role extensive pre-filing discovery can play in the ultimate outcome of a Caremark claim. 

“It’s hard to plead those process failures without gathering extensive documentary evidence, so early discovery was key to the plaintiff’s success,” he said.

The bottom line for corporate counsel is to be aware of the trend toward more robust early discovery through Section 220 requests, which can put companies on the defensive and heighten the risk to their directors, although the hurdle to hold them personally liable for a crisis that tanks shareholder returns remains high.