The Management Friendly Nature of Delaware Courts: Of Boards, Ostriches, and the Absence of a Duty to Create a “Better” Reporting System (Part 2)
We are discussing In re General Motors Co. Derivative Litigation, a recent case in the Chancery Court holding that directors had no obligation to ensure that a reporting system was sufficiently robust to ensure that certain vehicle safety issues were reported to the board prior to 2014.
The case arose out of the faulty ignition switch installed in a number of GM cars. As a result of the switch, GM engaged in massive recalls that resulted in costs of approximately $1.5 billion. A fund set up to compensate victims of accidents arising out of the faulty switches, at the time of the litigation, received 1130 claims, with 23 death claims already approved. Moreover, “[t]he Fund has no cap on overall payments.” Private lawsuits and government fines increased the total cost.
Shareholders brought a derivative suit seeking "to recoup some of the loss on behalf of the corporation itself, alleging that the directors breached their duty of loyalty by failing to oversee the operations of GM." Involving what the court called an “iconic American company” and corporate activity viewed as "particularly distressing,” the court nonetheless found that it had no choice but to dismiss the derivative claims for failure to have made demand.
The court did so, even though the standard of review involved “a whiff of irony, even tautology, in a Court determining, at the pleading stage, whether it would be futile to ask a director to decide, on behalf of her principal, to sue herself.” Moreover, shareholders, in advance of filing suit, had adhered to the additional procedural hurdles imposed by the courts by seeking corporate records pursuant to Section 220.
Nonetheless, dismissal was the order of the day. There would be no discovery, no trial. There would be no holding that imposed on directors an obligation to be better informed about possible problems inside the company.
So what did shareholders allege?
According to the allegations in the complaint, knowledge about possible problems with the ignition switch percolated inside the GM bureaucracy. Specifically, by the end of 2013, notice of the problem had reached GM's Executive Field Action Decision Committee, but “once there, more questions were raised about root cause, and the decision-makers were hamstrung by a lack of accurate data about what vehicles were affected and how many people may have been impacted by the defect.”
Information about possible problems with the ignition switch also came from private lawsuits. Reports in 2010, 2012 and 2013 about possible problems from outside counsel, including the warning that a jury would “almost ‘certainly’ find that the ignition switch was unreasonably dangerous” and possible exposure to punitive damages were never escalated to the general counsel or the board. The possibility of a design defect that resulted in the non-deployment of airbags was raised by a number of experts in cased brought against the company.
Nonetheless, the information never made it to the board. Plaintiffs asserted that the “Board prevented [Board-level reporting] from happening by failing to put into place common procedures and policies for the escalation of issues involving serious defects, large investigations, and punitive damages.”’’ Moreover, the plaintiffs asserted that "the Board failed to create a policy or procedure for reporting outside counsel warnings of punitive damages to the Board or General Counsel.”
For primary materials in this case, go to the DU Corporate Governance web site.