Chancery Court Sustains Derivative Action Alleging Caremark Claims

By Scott Waxman and Claire Suni

In Teamsters Local 443 Health Services & Insurance Plan, et al. v. John G. Chou, et al., C.A. No. 2019-0816-SG (Del. Ch. August 24, 2020), the Delaware Court of Chancery (the “Court”) held that stockholders of AmerisourceBergen Corporation (“ABC”), a pharmaceutical sourcing and distribution company, adequately pled facts supporting the inference that certain ABC officers and directors breached fiduciary duties and acted in bad faith to consciously disregard a variety of red flags of illegal activity in connection with ABC’s packaging and distribution of cancer medications. The Court denied in full the defendants’ motion to dismiss for failure to state a claim for relief.

ABC is a publicly-traded pharmaceutical sourcing and distribution company incorporated in Delaware.  ABC has several business units and subsidiaries, and at issue in this case was a program that created pre-filled syringes of oncology drugs for sale and distribution to healthcare providers (referred to herein as “Pharmacy”).  Among a litany of unsafe practices, Pharmacy removed FDA-approved drug products from their original glass vials and repackaged them into single-dose plastic syringes, all in an unclean and unsterile environment. Pharmacy would then combine any leftover drug product from the original glass vials and repackage it into new syringes, in order to create additional doses of medication. Rather than measuring such doses, Pharmacy technicians would “eyeball” them. These practices resulted in syringes containing “floater” debris, and Pharmacy devised its own mechanism for filtering such debris. The filtering did not successfully remove all contaminants from the product, and the syringes that were analyzed by outside laboratories tested positive for bacteria. Additionally, Pharmacy was not registered with the FDA as a drug manufacturer or repackager. Finally, Pharmacy and its affiliates distributed product without obtaining valid prescriptions or maintaining mandatory records with respect to administration of the product. 

The complaint named nine defendants, including seven directors and two officers. The complaint pleaded four separate instances of red flags that, it argued, were ignored by the defendants in this context: (i) a 2006 capital expenditure request for the pre-filled syringe program that presented no indication of a regulatory or compliance system in place at the facility, (ii) a 2007 report commissioned by ABC from a well-known law firm that indicated Pharmacy and its affiliates had inadequate structures in place with respect to compliance, reporting and documentation, (iii) a 2010 lawsuit with respect to the pre-filled syringe program by a whistleblower who was the former chief operating officer of an affiliate of Pharmacy, and (iv) a 2012 FDA search warrant executed at Pharmacy’s operating facility and a concurrent Department of Justice subpoena.

An affiliate of Pharmacy and ABC pleaded guilty to violating the Food and Drug Commission Act in 2017 with respect to these activities, and paid $260 million in fines and forfeitures to the Department of Justice at that time.  In 2017, the affiliate also resolved civil claims under the False Claims Act for $625 million. The shareholders brought this derivative class action in 2019.

Plaintiffs brought this claim under the theory of fiduciary duty articulated in In re Caremark Int’l Inc. Derivative Litigation, stating that the officers and directors either failed to institute an appropriate oversight system for the pre-filled syringe program, or else consciously disregarded a series of red flags of the illegal activities thereof. The defendant officers and directors moved to dismiss the plaintiffs’ claims for (i) failure to make a pre-suit demand and (ii) failure to state a claim upon which relief could be granted. The Court disagreed and found that (a) the pre-suit demand was excused because plaintiffs pleaded particularized facts to support a reasonable inference that the ABC officers and directors faced a substantial likelihood of liability under a Caremark theory of liability, thus excusing plaintiffs’ failure to make a pre-suit demand, and (b) plaintiffs stated a Caremark claim by making well-pleaded allegations that the ABC officers and directors acted in bad faith by consciously disregarding red flags that arose during the course of the pre-filled syringe program’s tenure.  

Here, the Court found that plaintiffs successfully pleaded that defendants ignored red flags that revealed a mission-critical failure to comply with drug health and safety regulations. In particular, of the prospective red flags identified in the complaint, the Court agreed that there was sufficient evidence to reasonably infer that each of the law firm report, the lawsuit and the Department of Justice subpoena constituted red flags that were ignored by defendants. The Court did not agree that the absence of a compliance component in the 2006 capital expenditure request sufficiently constituted a red flag. However, the Court noted that the capital expenditure request and the law firm report both would have been important factors in considering whether defendants faced a substantial likelihood of liability for failure to ensure that a company has in place an appropriate system of controls, under an alternative Caremark theory (a theory the Court did not decide upon).

The Court noted that the officers’ and directors’ oversight obligations are enhanced with respect to mission-critical products while operating in a heavily regulated industry.  In particular, the audit committee of ABC’s board had responsibility for compliance with legal and regulatory requirements, including obtaining reports from management with respect to such compliance. However, even once put on notice of potential concerns by the red flags cited in the complaint, neither ABC’s board nor its audit committee ever received information regarding compliance by Pharmacy or its pre-filled syringe program.  The Court emphasized the importance of the officers’ and directors’ oversight function when a company is operating in the midst of a “mission-critical” regulatory compliance risk, suggesting that oversight of such impactful business risks may be subject to greater scrutiny than oversight of less-critical business risks.