In a recent memorandum opinion dismissing a suit brought by stockholders derivatively on behalf of Walgreens Boots Alliance, Inc. (Walgreens), Vice Chancellor Lori Will of the Delaware Court of Chancery issued a reminder of the “narrow confines” in which a successful Caremark claim lives. The suit, based on allegations that the pharmacy company’s board of directors (the board) ignored an alleged scheme involving overfilled insulin pen prescriptions and overbilled government health programs, failed to show the board acted with bad faith—a necessary condition to director oversight liability. The opinion serves as a practical reminder to Court of Chancery litigants that a successful Caremark claim is rare, and the case brought by the Walgreens stockholders was “an unexceptional member of this broader group” of failed oversight claims.
Background
In a Feb. 19, 2024, memorandum opinion, Vice Chancellor Will tossed a derivative suit alleging Walgreens’ board ignored “red flags” of an alleged scheme related to the overfilling and subsequent overbilling of insulin pens. The scheme alleged by the plaintiffs involved Walgreens’ billing practices specifically related to the prescription and refilling of insulin pens. The plaintiffs alleged that Walgreens used software that was programmed to dispense a minimum of five insulin pens, which is the amount of pens contained in the boxes from the insulin manufacturer. The software, as the plaintiffs alleged, dispensed the single five-pen box even if fewer pens were prescribed to a patient. According to the plaintiffs, government health care programs, like Medicare and Medicaid, would deny Walgreens’ claims for reimbursement when the quantity of pens prescribed was more than the “days of supply limits” calculated by pharmacies. The plaintiffs alleged that pharmacists would then resubmit claims for the same number of pens, but edit the days of supply data. Going forward, Walgreens’ software automatically applied the edited days of supply to later refills, which prompted premature fill reminders and unnecessary prescription refills for patients, the plaintiffs argued.
These allegations first arose in a 2015 qui tam action in the U.S. District Court for the Southern District of New York. The U.S. Department of Justice opened an investigation in October 2016. The Audit Committee of Walgreens’ Board (audit committee”)—a committee responsible for overseeing federal health care program compliance—was notified about the DOJ investigation before meetings in January 2017. “Key legal and regulatory matters” were discussed at the Jan. 25, 2017, audit committee meeting and the meeting of the full board the next day. Between April 2017 and October 2017, the audit committee convened on six occasions. In each meeting, updates were provided on the DOJ investigation and Walgreens’ response to it. Walgreens has a robust compliance apparatus to address compliance, legal, and regulatory matters, reports of which are sent to the audit committee. Updates were provided at the full board meeting the day after each audit committee meeting including “reports from the compliance, legal, and internal audit groups.”
The audit committee and the board also discussed the qui tam action at several meetings between October 2017 and January 2018, which included a review of a report prepared by Walgreens’ chief compliance officer. Shortly thereafter, in April 2018, Walgreens remediated the problem by reprogramming its system to allow individual insulin pens to be dispensed as opposed to the default minimum quantity setting of a five-pen box.
On Nov. 16, 2018, the qui tam was amended and the DOJ moved to intervene. In January 2019, the DOJ announced a $209.2 million settlement with Walgreens. One aspect of the settlement mandated that Walgreens enter in a corporate integrity agreement with the Office of the Inspector General for the U.S. Department of Health and Human Services (corporate integrity agreement) that mandated various compliance practices and confirmed that the audit committee’s continued responsibility for overseeing Walgreens’ compliance with government health care program requirements.
Court of Chancery Litigation
The Court of Chancery litigation began on March 19, 2021, when a derivative suit was filed following a books and records demand against 11 directors and officers for breach of fiduciary duty and unjust enrichment. The complaint was amended on Oct. 8, 2021. The defendant directors and officers moved to dismiss the complaint on Oct. 22, 2021, under Court of Chancery Rule 23.1 for failure to plead demand excusal and under Rule 12(b)(6) for failure to state a claim upon which relief can be granted.
Starting with the Rule 23.1 argument, the court engaged in the requisite demand futility analysis. The plaintiffs failed to make a pre-suit demand on the Walgreens’ board and instead argued that demand was futile because the majority of the board would not have been able to impartially consider a demand at the time the litigation commenced. Narrowing the analysis to the only contested prong of the three under the standard set forth in the Delaware Supreme Court’s 2021 decision in Zuckerberg, the court considered whether six of the 12 Walgreens’ directors face “a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.” See United Food & Commercial Workers Union & Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, 262 A.3d 1034, 1059 (Del. 2021). In order to carry this burden, the plaintiffs argued that the director defendants breached their duties of oversight under the Delaware Court of Chancery’s seminal decision in In re Caremark International Derivative Litigation. 698 A.2d 959, 967 (Del. Ch. 1996). Director oversight liability is predicated on two possible conditions: either “the directors utterly failed to implement any reporting or information system or controls; or having implemented such a system or controls, consciously failed to monitor or oversee its operations.” (Caremark Prongs) Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006). The plaintiffs invoked both Caremark Prongs to argue the defendants breached their duty of oversight under Caremark. However, their claim founders due to a failure to adequately plead bad faith, which is a “sustained or systemic failure” to exercise oversight and a prerequisite to either of the two prongs.
Although the plaintiffs effectively waived their arguments in support of the first Caremark Prong by failing to respond to the defendants’ arguments on the papers, the court addressed and disposed of prong one quickly. Citing to the plaintiffs’ own pleadings, the court showed that the board did, in fact, make a good faith effort to establish an oversight system and monitor it. The audit committee, among other things, oversaw Walgreens’ legal and regulatory compliance, discussed compliance risks at meetings and at meetings of the full board, regularly convened with the company’s chief compliance officer, and implemented compliance programs during and after Walgreens’ entry into the corporate integrity agreement.
The plaintiffs claimed, however, that the board’s oversight systems were ineffective and instead offered alternative measures, which, in the plaintiffs’ mind, were superior in hindsight. The court disagreed, leaving how to create oversight controls to the discretion of the board, and pointing out that Walgreens’ reporting system successfully remediated the reporting issue.
Turning to the second Caremark Prong, the court considered the plaintiffs’ argument that, while Walgreens may have instituted compliance monitoring systems, it still consciously ignored “red flags.” The court previewed its ultimate holding here by again pointing to the “fatal flaw” in the plaintiffs’ argument that Walgreens actually fixed the problem by reprogramming its software to modify the default amount of insulin dispensed. Nonetheless, the plaintiffs unsuccessfully argued that the Walgreens board’s awareness of certain shortcomings in the company’s internal compliance systems, other compliance issues unrelated to insulin, and the DOJ investigation in January 2017 were evidence of ignored red flags. The court was not persuaded. At any rate, even if any of these various allegations did rise to the level of a red flag, the court held, the plaintiffs still failed to plead the necessary element of bad faith. As a result, the court dismissed the complaint.
Takeaway
In Walgreens, Vice Chancellor Will diligently reinforces the longstanding identity of a Caremark claim as “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win judgment.” She shrewdly cautions litigants from “reflexively filing [a Caremark claim] whenever a government investigation is announced, a class action lawsuit succeeds, or a big-dollar settlement is reached.” She reminds the reader that such an expansion in the claim’s scope, “from a doctrinal perspective, … risks weakening the core protections of the business judgment rule.” And from a practical perspective, “it drains resources from the very corporations that derivative plaintiffs purport to represent.” This opinion marks the latest in rise of Caremark suits in recent years. It also falls into the majority category of suits of that ilk that are ultimately unsuccessful. Given the recent uptick in these types of cases, Walgreens serves as a useful reminder of the rarity that is a successful Caremark claim.
Reprinted with permission from Delaware Business Court Insider, © ALM Media Properties LLC. All rights reserved.
