Delaware Court of Chancery Allows Caremark Claim To Proceed Against Boeing Directors

In a significant decision, the Delaware Court of Chancery recently denied a motion to dismiss, thus allowing discovery to proceed, on a Caremark claim against the directors of The Boeing Company (Boeing), arising out of the fatal crashes of two 737 MAX airplanes. Accepting the allegations in the complaint as true for purposes of the motion, the court determined that the directors had (1) failed to “establish a reporting system for airplane safety” and (2) “turn[ed] a blind eye to a red flag representing airplane safety problems.”^[1] Most striking was the court’s observation that these allegations did not just support an inference of scienter but rather directly satisfied that element.

Though the court noted that this type of claim was still “‘possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment,’”^[2] the decision signals a continued willingness to hold directors liable for failure to exercise oversight over critical company risks following the Delaware Supreme Court 2019 ruling in Marchand v. Barnhill.^[3] The decision also offers further insight into how directors should specifically and actively monitor and respond to risks concerning “mission critical aspects of the company’s business,” while documenting such efforts.^[4]

Factual Background

Beginning in 2011, Boeing worked on reconfiguring the current model of its aircraft to develop the more fuel-efficient 737 MAX airplane. The board approved the plan, focused on the potential to “maintain[] market share and a competitive advantage,” without discussing the safety implications of increasing the size of the engines.^[5] Because of the positioning of these engines on the airplane’s wings, the 737 MAX tended to tilt upward in flight. Boeing sought to address this issue with software called the Maneuvering Characteristics Augmentation System (MCAS), which pushed the nose of the airplane back downward. The MCAS would activate if the plane tilted at a “high angle of attack” — though the external sensor was known to be “highly vulnerable to false readings or failure for numerous reasons, such as general weather, lightning, freezing temperatures, software malfunctions, or birds.”^[6] Boeing rejected a proposal to implement a safety feature that would detect false readings, due to the additional cost. Internal safety studies indicated that the MCAS could cause “catastrophic failures” if the pilot took more than a few seconds to respond to its activation.           

Boeing pressed ahead with its plan to certify, manufacture and market the 737 MAX. To enhance the competitiveness of the airplane, Boeing secured a less extensive level of required training for pilots, which involved the omission of the MCAS from the Federal Aviation Administration’s (FAA’s) training materials. Boeing also allegedly concealed from the FAA issues with the airplane’s external sensor that triggered the MCAS. Upon launching, the 737 MAX became the “fastest-selling airplane in Boeing’s history,” primarily targeting customers in emerging markets.^[7]

On Oct. 29, 2018, a 737 MAX airplane operated by Lion Air fatally crashed in Indonesia because of the repeated activation of the MCAS. Boeing’s management did not bring this crash to the board’s attention for more than a week—blaming the flight crew and asserting, contrary to the FAA and news reports, that the “737 MAX fleet [was] safe.”^[8] One month after the board decided not to conduct an internal investigation, another fatal crash of a 737 MAX airplane, operated by Ethiopian Airlines, occurred due to issues with the MCAS. The FAA eventually grounded the fleet over Boeing’s objection.

Nature of the Action

As a result of the ensuing corporate trauma, Boeing’s stockholders filed a derivative suit alleging that the directors consciously breached their fiduciary duties under Caremark. Having obtained company books and records pursuant to Section 220, the stockholders had access to more than 44,100 documents to support the allegations in their complaint. Boeing’s directors, in turn, filed a motion to dismiss, asserting that plaintiffs could not meet the “high hurdle” of pleading with particularity that the “board cannot be entrusted with the claim because a majority of the directors may be liable for oversight failures.”^[9] The directors submitted 88 exhibits in support of this motion.

Court’s Analysis 

A Caremark claim may survive when the allegations satisfy either of the following two prongs: (1) “‘the directors utterly failed to implement any reporting or information system or controls,’” or (2) “‘having implemented such a system or controls, [the directors] consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.’”^[10] The complaint must also support a reasonable inference that the directors acted with scienter, meaning with “‘conscious disregard for [their] responsibilities,’” such that they cannot be entitled to a presumption of good faith.^[11] Issuing a decision that largely follows the Marchand framework and accepting the complaint as true, as required on a motion to dismiss, the court concluded that the complaint succeeded under both prongs.

As to the first prong, the Boeing directors allegedly failed to make a “good faith effort—i.e., try—to put in place a reasonable board-level system of monitoring and reporting” for aspects of the company’s business that were “essential and mission critical.”^[12] Leaving this effort to management’s discretion did not suffice. The court observed that the list of deficiencies alleged in this action were “remarkably similar” to those in Marchand (which involved food safety).^[13]

• No dedicated committee: The Boeing board lacked a committee specifically responsible for monitoring airplane safety. While the audit committee was generally charged with risk oversight, the record indicated that it “did not regularly or meaningfully address airplane safety” at any time before or after the crashes.^[14] Rather, the audit committee focused on financial and regulatory risk. Moreover, Boeing lacked any internal reporting system for employees and whistleblowers to raise safety concerns.
• No regular board discussions: The Boeing board did not regularly discuss airplane safety before the crashes, according to the meeting minutes and agendas in the record. To the extent that the subject of these crashes came up, the discussions centered on the “restoration of profitability and efficiency, but not product safety, MCAS, or the [external] sensor.”^[15] That Boeing may have nominally complied with FAA regulations in seeking certification of the 737 MAX did not equate to a board-level system of monitoring airplane safety, consistent with Marchand.
• No board protocol for soliciting regular updates from management: The Boeing board did not have management submit airplane safety reports on a “consistent and mandatory basis,” but rather “passively accepted” whatever information management decided to send from time to time.^[16] Any mentions of safety were “in name” only.^[17] For example, in the weeks after the first crash, Boeing’s CEO sent to the board one-off communications “focused on discrediting media reports faulting MCAS, and on blaming Lion Air repair shops and crew,” in an attempt to restore the company’s public image.^[18] This pattern continued with the second crash. Further, the contents of management’s communications were “one-sided at best and false at worst, conveying only favorable and optimistic safety updates and assurances” — which the board did not question despite contradictory news reports.^[19]
• No efforts by management to report “red flags, or at least, yellow flags”: Boeing management knew that the 737 MAX had various safety defects, including through the internal study determining that it would be “catastrophic” if a pilot took more than a few seconds to respond to the MCAS activation.^[20] Management’s failure to alert the board to these “red flags” supported the reasonable inference that there was no board-level reporting system in place at the company.

Perhaps most noteworthy was the court’s “explicit finding of scienter,” which went beyond the inference of scienter in Marchand.^[21] In reaching this conclusion, the court found significant internal board emails among certain board members belatedly suggesting a meeting dedicated to “a review of quality within Boeing” — arguably corrective conduct that the court viewed as demonstrating the board’s prior deficiencies.^[22] The court also focused on public statements by board members “crowing about taking specific actions to monitor safety that it did not actually perform.”^[23]

As to the second Caremark prong, the Boeing directors “‘knew of evidence of corporate misconduct—the proverbial red flag—yet acted in bad faith by consciously disregarding its duty to address that misconduct.’”^[24] Even without a board-level monitoring system in place, the directors became aware of the first crash caused by the MCAS activation because it was widely reported in the media. However, the board chose to ignore this “red flag.” For example, it made the first board call devoted to the crash “optional,” did not request any information from management and decided to delay an internal investigation — “treat[ing] the crash as an ‘anomaly,’ a public relations problem, and a litigation risk.”^[25]

Key Takeaways

The Boeing decision underscores the need for corporate boards to take an active role in implementing reasonable information and reporting systems that monitor “mission critical” matters — rather than leave such tasks in the hands of management. These efforts should involve, among other things, (i) board meeting time allocated to meaningfully discussing and monitoring mission-critical matters on a regular basis, with input from executives operationally involved in these matters; (ii) if appropriate, a committee charged with direct responsibility for the matter; (iii) a protocol by which the board receives updates from management on a “consistent and mandatory basis” and engages with and challenges this information especially in times of crisis; and (iv) the documentation of these efforts in board and committee meeting minutes, agendas, and other books and records available to stockholders. Additionally, boards should periodically identify any new risks facing the company that might require systematic oversight.

^[1] _{In re The Boeing Company Deriv. Litig., 2021 WL 4059934, at *1 (Del. Ch. Sept. 7, 2021).}

^[2] _{Id. at *24 (citing In re Caremark Int’l Inc. Deriv. Litig., 698 A.3d 959, 967 (Del. Ch. 1996)).}

^[3] _{212 A.3d 805 (Del. 2019).}

^[4] _{2021 WL 4059934, at *26.}

^[5] _{Id. at *8.}

^[6] _Id.

^[7] _{Id. at *10.}

^[8] _{Id. at *13.}

^[9] _{Id. at *1.}

^[10] _{Id. at *24 (citing Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006)).}

^[11] _{Id. (citing In re Walt Disney Co. Deriv. Litig., 906 A.3d 27, 66 (Del. 2006)).}

^[12] _{Id. at *25-26 (citing Marchand, 212 A.d 3d. at 821).}

^[13] _{Id. at *26.}

^[14] _{Id. at *27.}

^[15] _{Id. at *28.}

^[16] _{Id. at *29.}

^[17] _Id.

^[18] _Id.

^[19] _{Id. at *31.}

^[20] _Id.

^[21] _{Id. at *32.}

^[22] _Id.

^[23] _Id.

^[24] _{Id. at *33 (citing Teamsters Local 443 Health Servs. *Ins. Plan v. Chou, 2020 WL 5028065, at *17 (Del. Ch. 2020)).}

^[25] Id.