Chancery Rejects Dismissal of Caremark Claims Against Walmart’s Officers and Directors

In Ontario Provincial Council of Carpenters’ Pension Trust Fund v. Walton (Apr. 12, 2023), the
Delaware Court of Chancery, at the pleading stage of litigation, rejected dismissal of Caremark
claims brought against Walmart Inc.’s officers and directors in connection with the company’s role in the national opioid epidemic. The decision is a narrow one in that the court, at this early
stage of the litigation, addressed only the issue whether the claims were timely made. Notably,
however, the decision is another in a recent trend of decisions indicating increased judicial
receptivity to Caremark claims at the early pleading stage of litigation—although in most cases the court has continued ultimately to dismiss Caremark claims at the pleading stage, even in the context of arguably egregious factual situations.

Key Points

• Although this and other recent decisions have indicated increased judicial receptivity to Caremark claims, it remains very difficult for plaintiffs ultimately to achieve success on such claims. The court has moved away from its historical trend of almost invariable dismissal of Caremark claims at the early pleading stage; and recent decisions, including Walton, have expanded the parameters for potential liability under Caremark. Nonetheless, it remains very difficult for plaintiffs to achieve ultimate success on Caremark claims—primarily because they must demonstrate that the defendants acted knowingly and intentionally in violating their oversight duties, and must establish that it would have been futile to bring demand on the board to bring the derivative litigation. However, the court’s increased receptivity to Caremark claims over the past few years has provided plaintiffs with more leverage to negotiate settlement of such claims.

• The court indicated a negative view of the Walmart officers’ and directors’ compliance efforts. The court acknowledged that Walmart had established new policies and procedures to achieve compliance with the company’s opioid-related legal obligations, but emphasized that the company did not then “create an infrastructure that would enable Walmart’s pharmacists and other personnel to follow the policies and procedures.” For example, the budget allotted for compliance, the database capacity purchased to enable compliance, and the timetable to achieve compliance, all appeared to have been obviously insufficient. We note that, in other recent cases (such as Boeing and McDonald’s), while the court indicated an egregious factual context, the court nonetheless dismissed Caremark claims at the pleading stage (on the basis of lack of bad faith and/or demand futility).
• The court established, in a ruling of first impression, that the “separate accrual” approach applies to determine when an “Information-Systems claim” under Caremark accrued. This approach makes it less likely that a claim will be time-barred. With the court, in its recent Collis decision, having applied the separate accrual approach to “Red-flags claims” and “Massey claims” under Caremark, the court now has established that this approach may be applicable to each of the three types of Caremark claims. The court also indicated that, because Caremark claims implicate the duty of loyalty, in many cases equitable tolling would apply and render timely even claims otherwise accrued outside the actionable period.
• Of note, the court drew pleading-stage inferences against the defendants on the basis that the company’s minutes of meetings provided no substantive information about relevant discussions that took place. Walmart produced heavily redacted minutes that indicated only that a relevant topic had been discussed, and indicated nothing substantive about the discussion. In every such instance, the court found it reasonable to infer, at the pleading stage, that the discussions that occurred supported the plaintiffs’ claims.

Background. Walmart, until August 2017, operated one of the largest pharmacy chains in the U.S. The company dispensed prescription opioids through its pharmacies and acted as a wholesale distributor of opioids for its pharmacies. The company incurred significant liabilities from its involvement with prescription opioids. In 2016 and 2017, numerous lawsuits were brought, claiming that the company was not complying with its obligations under the federal Controlled Substances Act. (These litigations were later consolidated into multidistrict litigation—which Walmart settled in November 2022, agreeing to pay $3.1 billion to various state, local and tribal governments.) In March 2020, a ProPublica article detailing Walmart’s involvement in the national opioid crisis revealed that, in 2011, the company had entered into an undisclosed Settlement Agreement with its primary regulator, the U.S. Drug Enforcement Administration (DEA), and that the company may not have complied with the terms of that agreement, which had expired in 2015.

Following a books and records investigation, the plaintiffs brought suit claiming that Walmart’s directors and officers had breached their fiduciary duties of oversight under Caremark by having knowingly caused the company to fail to comply with (i) its legal obligations with respect to its dispensing of opioids (the “Pharmacy Issues”); (ii) its legal obligations with respect to its distribution of opioids (the “Distributor Issues”); and (iii) the terms of the DEA Settlement (the “DEA Settlement Issues”). The defendants moved for dismissal of the claims on the basis that they were not timely made (i.e., a laches defense). Vice Chancellor Laster held that the claims were not untimely and rejected dismissal on that basis.

Discussion

The Caremark claims. The plaintiffs claimed that Walmart’s officers and directors had (i) utterly
failed to establish a monitoring and information reporting system to oversee the company’s compliance with the federal Controlled Substances Act and with the terms of the DEA Settlement (the “Information-Systems claims”); (ii) consciously ignored red flags of such noncompliance (the “Red Flags claims”); and (iii) made a conscious decision to prioritize profits over legal compliance (the “Massey claims”). The gravamen of the complaint was that, over a period of years, contrary to applicable law and regulations, Walmart’s officers and directors had permitted sales of opioids to suspicious customers and had systematically failed to report suspicious orders for opioids to the DEA.

“Separate accrual” approach applies to determining when Caremark claims accrue. The separate accrual approach “considers each day that the defendants’ ongoing course of conduct continues [as] constitut[ing] a separate violation for purposes of claim accrual”—and thus makes it less likely that claims will be time-barred than would be the case under the alternative “discrete act” method of determining claim accrual. In Collis (which involved Caremark claims against officers and directors of AmerisourceBergen for alleged failure of oversight of compliance risks relating to the manufacture of opioids), Vice Chancellor Laster had held that the “separate accrual” approach was appropriate to determining when Red Flag claims and Massey claims accrue, as such claims relate to “a sequence of wrongful acts, each of which [acts] gives rise to a separate limitations period.” In Walton, Vice Chancellor Laster held that the separate accrual approach is also the appropriate method for determining when Information-Systems claims accrue, given “the developing and ongoing nature of the claim.” When fiduciaries “on day one” have committed a knowing failure to act to address the company’s legal noncompliance, they “continue to engage in the same knowing failure on day two and on each day thereafter until they make a good faith attempt to create a monitoring system,” the Vice Chancellor wrote. He reasoned that the “discrete act” approach would be inappropriate in this context as it identifies the timing of “a finite quantum of conduct that causes all of the harm” and presumes that the continuation or repetition of the wrongful act does not increase the damage caused. The “continuing wrong” approach also would be inappropriate, the Vice Chancellor contended, as it “treat[s] an Information-Systems claim as viable until the fiduciary takes action to address the compliance risk,” and thus “goes too far in the other direction[,] afford[ing] full significance to the ongoing nature of the decision not to implement an information system, while eliminating an opportunity for repose.”

Determining the “actionable period” under the separate accrual approach. When applying the separate accrual approach, first, the court chooses a “lookback date,” based on when the plaintiffs began pursuing their claims. The lookback date usually would be when the plaintiffs filed suit, but could be tied to “diligent efforts” by the plaintiffs to obtain books and records. In this case, the plaintiffs filed suit on September 27, 2021, but had “started making diligent efforts to pursue books and records” on May 4, 2020. The court determined May 4, 2020 to be the lookback date. Second, to determine the “actionable period,” the court measures back from the lookback date, “using a statute of limitations for a closely analogous legal claim.” For a breach of fiduciary duty claim, the analogous statute of limitations is three years—thus, in this case, the actionable period started on May 4, 2017. Third, the court determines whether “any of the ongoing conduct that gives rise to the claim occurred during the actionable period.” If so, the claim is timely; and, if not, the court must determine whether any asserted tolling doctrines apply.

Timeliness of the claims relating to the Pharmacy Issues and the Distributor Issues. The court found the timeliness analysis “straightforward” with respect to these issues. Regarding the Pharmacy Issues, in August 2022 a federal court had ordered Walmart to remediate deficient company controls and reporting systems; and in November 2022 Walmart had agreed to a nationwide settlement of multidistrict litigation which required it to implement extensive procedures and controls. Thus, the court found, there was a reasonable inference that the Pharmacy Issues had continued throughout the actionable period. Regarding the Distributor Issues, management had decided to exit that business in November 2017 and the wind-down was over by April 2018. Thus, there was overlap between the alleged wrongdoing and the actionable period. “Just as a filing under a discrete act is timely if it beats the statute of limitations by one day, so too is a plaintiff’s suit timely under the separate accrual approach if some overlap exists between the conduct and the actionable period,” the court wrote.

Timeliness of the claims relating to the DEA Settlement Issues. The timeliness analysis with respect to the DEA Settlement Issues was more complex. The DEA Settlement Agreement had expired on March 11, 2015, so any violations of that agreement ceased on that date. Thus, there was no overlap between the alleged wrongdoing relating to the DEA Settlement Issues and the actionable period, and the claims would be untimely unless tolling applied. Under the doctrine of equitable tolling, however, a court, based on notions of fairness and equity, has discretion to extend a deadline when a litigant was prevented from complying with the deadline through no fault of its own. In this case, the court stated that the pleading-stage record supported an inference that the DEA Settlement was not disclosed by the company, and that there had been no information available about the DEA Settlement Issues, until the publication in March 2020 of the ProPublica article detailing Walmart’s role in the opioid epidemic. The court held that equitable tolling would apply in these circumstances “because the defendants [were] fiduciaries,” and, as stockholders, the plaintiffs had been “entitled to rely on the presumption that their fiduciaries were acting loyally….”

The defendants argued that tolling should not be available. They noted that tolling cannot preserve an otherwise untimely claim after the point of “inquiry notice” (i.e., after the plaintiffs had knowledge of facts or circumstances that would lead a reasonable person to believe that further investigation was warranted). They contended that the barrage of lawsuits brought against Walmart in 2016 and 2017 had put stockholders on inquiry notice that Walmart might not be complying with its obligations under the Controlled Substances Act, which, in turn had put the stockholders on inquiry notice that Walmart might not be complying with other legal obligations, such as under the DEA Settlement. The court stated that, without further information, it could not infer from the lawsuits that the stockholders had inquiry notice of the DEA Settlement Issues. Thus, the court concluded, “[a]t this stage of the case, it appears that equitable tolling is available for the DEA Settlement Issues until March 2020, which means that the plaintiffs have advanced timely claims” with respect to the DEA Settlement Issues. The court added that it could become clear at a later stage in the case that the plaintiffs were on inquiry notice at an earlier date (and, if so, the claims would then be held not to have been timely made)—but, “[a]t present, the defendants cannot rely on inquiry notice to render the plaintiffs’ claims untimely,” the court wrote.

Determining which issues are “central compliance risks” to which Caremark duties attach. In Collis, Vice Chancellor Laster had clarified that it is not only “mission-critical risks” that give rise to potential Caremark liability, but, instead, a broader category of “central compliance risks.” In Walton, the Vice Chancellor observed that “[s]ometimes the inherent nature of the issue will support a reasonable inference that it qualifies as a central compliance risk, such as food safety for an ice cream company or airplane safety for an airplane manufacturer”—however, “[o]ther times…will be less clear.” Ambiguity may arise, the Vice Chancellor explained, because “risks evolve over time.” For example, when Caremark was decided in 1996, “the idea that cybersecurity might be a central compliance risk would not have registered[; and,] even today the relative importance of cybersecurity risk has not yet led to a Caremark claim surviving a motion to dismiss, although someday it might,” the Vice Chancellor wrote. Another reason for ambiguity “is that time and attention are precious commodities, and with limited supplies of each, officers and directors must make judgments about what risks to monitor.” The Vice Chancellor stated that “[t]he business judgment rule protects the decisions that officers and directors make about how and where to devote their time and resources.” Indeed, he wrote: “Outside of what intuitively registers as a central compliance risk, a plaintiff will have difficulty rebutting the business judgment rule when officers or directors have used a rational process to identify risks and made a good faith decision about the level of monitoring resources to deploy.” At the same time, the court observed that “it may be difficult for the court not to draw a pleading-stage inference that an issue could qualify as a central compliance risk” if a company “[h]as an enterprise risk management system and has identified [the] risk as central”; a company “has a mission statement or set of policies that call out [the] issue as a priority for the company”; or a company has “touted the importance of and its proficiency in [the] particular area.”

Impact of redacted minutes. The court noted that the minutes of meetings of Walmart compliance executives that the company had produced were heavily redacted. The unredacted portion of the minutes only identified a relevant topic that had been discussed, and indicated nothing as to the substantive discussion. In each case, the court stated that “without any other substantive text to draw on,” one possible inference was that the substance had been favorable to the defendants (for example, where the topic was the status of the company’s compliance projects, the discussion may have reflected that good progress had been made), and the other possible inference was that the substance had been favorable to the plaintiffs (for example, that poor progress had been made on the projects). The court held that, at the pleading stage, the plaintiffs were entitled to the benefit of the latter inference.

Negative view of the company’s compliance efforts. The court acknowledged that Walmart had taken “ some steps” to meet its compliance obligations; and the decision recites numerous instances of reports being made to Walmart’s board about the status of the company’s compliance efforts. However, the court concluded, at the pleading stage, that “the plaintiffs were entitled to inferences that (i) Walmart did not achieve compliance with its legal obligations under the DEA Settlement, (ii) Walmart’s directors and officers knew that Walmart was not complying with its legal obligations, and (iii) Walmart’s directors and officers did not take action to cause Walmart to achieve compliance.” The court’s narrative of the factual background emphasizes the limitations and behind-schedule nature of the directors’ and officers’ efforts. The court noted the following, for example:

• Budget. Walmart established policies and procedures to enable compliance with the DEA Settlement. The team responsible for creating and implementing the compliance program had estimated that it would require $40 million to complete all of the team’s projects. But Walmart provided them with a budget of $11 million—an amount that could fund Walmart’s existing compliance projects, but would not cover the cost of any new programs.
• Database capacity. Walmart’s ability to track and report suspicious prescriptions depended on an expansion of the company’s database capacity. But Walmart “had purchased only a limited amount of database capacity,” however, which could not support several critical compliance initiatives.
• Timetable. In January 2012 (nine months into the term of the DEA Settlement), management reported to the board on development of a new plan to achieve compliance with the DEA Settlement by January 2017—which would be nearly two years after the DEA Settlement would expire. The court stated that, on this basis, at the pleading stage, the plaintiffs were entitled to the inference that the directors knew that Walmart was not on track to comply with the DEA Settlement and would not achieve compliance during its term.
• No report on DEA Settlement compliance. A May 2014 report from management to the board outlined the status of the company’s compliance efforts, including various successes. But the report did not mention at all the DEA Settlement or the status of Walmart’s efforts to comply with those obligations—although only ten months remained before it would expire.
• Focus on profit. Three years into the four-year term of the DEA Settlement, Walmart announced a new “anti-diversion” compliance program, designed to detect theft and loss of control over controlled substances. The court noted that the “new system only monitored for theft and loss of controlled substances within Walmart,” without addressing other aspects of the company’s anti- diversion obligations. The court wrote: “Walmart notably took a step to meet a compliance obligation that helped its bottom line, while not taking steps that didn’t.” In addition, in response to a pharmacist’s February 2015 inquiry expressing concern about a possible “pill mill” doctor’s opioid prescriptions, Walmart’s compliance director responded that the DEA Settlement, which required the reporting of refusals to fill opioid prescriptions, would be expiring soon and, thus, management’s time would be better spent on “driving sales and patient awareness.” The court wrote: “That statement openly prioritized profits (‘driving sales’) over compliance.”

Practice Points

• A board and management should establish a rational process for determining what the central compliance risks facing the company are; and should establish and implement a monitoring and information reporting system to provide oversight of these risks. Most critically, boards—supported by management, the audit committee, the company’s outside auditors, and legal counsel—should stay focused on, and be apprised of key developments with respect to, issues and risks that are central to the business. The board and management should maintain a record (such as in meeting minutes) of their risk monitoring and oversight efforts. Legal compliance generally should receive particular attention—and perhaps especially if relating to social issues of particular moment and notoriety (such as the opioid crisis and, as in the McDonald’s case, sexual harassment). See here our detailed practice points on Caremark -related best practices.
• A board and management should provide the resources and take other actions necessary to enable the company’s personnel to implement its compliance plans and policies. In the recent
  McDonald’s decision, the court, after trial, dismissed the Caremark claims brought against the McDonald’s board, on the basis that the board, once it became aware of the compliance problem relating to rampant sexual harassment at the company, took steps to address the problem. The court emphasized that a board must simply act in good faith to try to address central compliance risks, which it found the McDonald’s board had done, even though, the court conceded, the steps taken arguably were insufficient and not taken on a timely basis. Walton underscores that simply establishing plans and policies to achieve legal compliance may not alone be sufficient to satisfy Caremark duties. Careful consideration should begiven to such items as the budget provided for compliance, and to database capacity or other infrastructure needed for successful implementation of the compliance programs.
• A board and management should keep in mind that the court may look to the company’s own disclosure as to what the company’s key risks or priorities are when determining whether a given risk qualifies as a critical compliance risk for Caremark purposes. Any identification of specific issues as “critical” or “key” risks or as “priorities” should be carefully considered. In addition, the court indicated that touting the company’s “proficiency” in an area may be interpreted as indicating a critical compliance risk to which Caremark duties would attach. The court provided as an example that the McDonald’s public claims that it provides “America’s best first job” supported an inference that the company viewed “protecting employees” as a critical compliance risk to which Caremark oversight duties applied.
• A board and management should avoid statements that may be interpreted as prioritizing profits over legal compliance. Such statements can support Massey claims under Caremark. A board and management should, in their statements and in substance, make effective management of key compliance risks a corporate priority; and should integrate risk management considerations into the company’s corporate strategies and decision-making generally.
• Minutes should include substantive information reflecting the board’s and management’s compliance with their Caremark duties. A series of recent Court of Chancery decision has brought new focus to the issue of preparation of meeting minutes. As reflected in Walton, minutes stating only that a topic was discussed, without indicating the substance of the discussion, may provide the basis for an inference by the court, at the pleading stage of litigation, that the substance of the discussion supported the plaintiffs’ claims. Moreover, in other recent decisions, the court has made clear that it will look to meeting minutes as a key source of evidence of compliance or noncompliance with Caremark duties; that when the minutes are silent with respect to a topic, the court is likely to infer that the topic was not discussed; and that, not only the substance of a discussion should be reflected in the minutes, but also the follow-up the company took with respect to the issue. Accordingly, although conventional advice to preparers of minutes often has been to include only short, non-substantive descriptions of discussions, it is clear that that advice generally is no longer apt. In the context of Caremark claims, the minutes should state: the topics that were discussed; the substance of the discussions; and what follow-up (if any) by management or others was contemplated. Further, future minutes, or supplements to the original minutes, should reflect the follow-up actions that actually were taken.

On April 26, 2023, the court rejected dismissal of the case on demand futility grounds and found that the plaintiffs pled valid Caremark claims. That decision will be discussed in a future article. The case now will be scheduled to proceed to trial.