On September 7, 2021, Delaware’s Court of Chancery rejected a motion by The Boeing Company (“Boeing”) to dismiss a shareholder derivative lawsuit against its directors for billions of dollars of damages suffered by the company as the result of the directors’ alleged failure to oversee the design, production, and remediation of the firm’s 737 MAX airplane.
That airplane model was announced by the company in 2011 and delivered to airlines beginning in 2017. In October 2018, one of those planes crashed in the Java Sea; in March 2019, another crashed in Ethiopia. All passengers and crew of both planes—a total of 346 people—were killed.
The 102-(double-spaced)-page opinion (download), whose especially clear and simple recitation of facts and exposition of law suggest that the Court anticipated a readership well beyond the business bar, connected cornerstones for corporate counsel: Rales v. Blasband, 634 A.2d 927 (Del. 1993), and In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), as applied in Marchand v. Barnhill, 212 A.3d 805 (Del. 2019).
Under Rales, a shareholder may institute a suit in the name of the corporation without first alerting the board to possible wrongdoing by directors and/or officers—and thus may deny the company the opportunity to investigate, and possibly to initiate its own lawsuit—if the directors would themselves face a “substantial likelihood of liability” for the alleged misconduct.
In Caremark, as numerous Delaware decisions subsequently observed, the Chancery Court imposed extremely low requirements for directors’ supervision of a company’s operations. To face personal liability, they must be shown either to have “utterly failed to implement any reporting or information system or controls”; or, after installing such a system, to have “consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.”
Yet in Marchand, which concerned an company that had allegedly manufactured and sold listeria-contaminated ice cream, the Delaware Supreme Court found just such a breach of the directors’ responsibility. The board had not adopted sufficient systems, schedules, and structures to address the products’ purity, which was “the most central safety and legal compliance issue facing the company,” and thus required the board’s oversight to be “more rigorously exercised.”
While clarifying that the governance failures addressed in Marchand did not constitute “any sort of prescriptive list” for all companies and industries, the Court of Chancery, in ruling on Boeing’s motion to dismiss, found that decision “dispositive in view of [the] remarkably similar factual allegations” of the board’s mismanagement.
The Court concluded that the shareholders had legimately established a claim alleging, and were therefore entitled to discovery about, violations by the majority of the Boeing directors of the board’s “rigorous oversight obligation where safety is mission critical, as the fallout from the Board’s utter falure to try to satisfy this ‘bottom-line requirement’ can cause ‘material suffering,’ even short of death, ‘among customers, or to the public at large,’ and attendant reputational and financial harm to the company.”
Although the full opinion’s substance (and style) repay careful study, its damning discussion of Boeing’s apparent mismanagement offers at least ten practical (if not surprising) lessons to other boards, especially those of companies whose products or services could, if defective, physically injure or even kill people:
● First, product safety should be among the priorities of the audit committee.
The Chancery Court found that although Boeing’s audit committee “was tasked with handling risk generally, it did not take on airplane safety specifically. Its yearly updates regarding the Company’s compliance risk management process did not address airplane safety.” In short, according to the pleadings, “the Audit Comttee did not regularly or meaningfully address or discuss airplane safety.”
● Second, product safety should be a focus of discussion at every board meeting.
At Boeing’s board meetings, “airplane safety was not a regular set agenda item or topic. . . . While the Board sometimes discussed production line safety, the Board often met without mentioning or discussing safety at all.”
The Court found that, “[t]he Board did not regularly allocate meeting time or devote discussion to airplane safety and quality control until after the second crash. Nor did the Board establish a schedule under which it would regularly assess airplane safety to determine whether legitimate safety risks existed.”
● Third, senior officers should promptly inform directors about product safety issues or concerns.
“Management’s periodic reports to the Board did not include safety information[, but instead] focused primarily on the business impact of airplace safety crises and risks.” Indeed, “[t]he nature and content of management’s ad hoc reports to the Board indicate that the Board had no regular process or protocols requiring management to apprise the Board of airplane safety.”
It was only six months after the first crash (and six weeks after the second) that the Board “critically assessed” the plane’s navigational software, “the FAA certification process, and pilot training requirements” for the 737 MAX, and adopted a practice of “Board-level safety reporting.”
● Fourth, unlike Boeing’s, a board should establish “a means of receiving internal complaints about product safety” by which concerns come specifically to, or are quickly elevated to, the directors’ attention, rather than remaining at or “below the level of the most senior officers.”
“While some. . . complaints made their way to senior management, none made it to the Board. The Board was unware of whistleblower complaints regarding airplane safety, compliance, workforce exhaustion, and production schedule pressure at the 737 MAX facility.”
Astonishingly, “[m]anagement did not bring the [first crash] to the Board’s attention for over a week.”
● Fifth, directors should personally request product safety information and discussions if they are not forthcoming from senior officers.
“According to three people present at the August [2011] Board meeting, no Board member asked about the safety implications of reconfiguring the 737 NG with larger engines” to create the 737 MAX.
In fact, the pleadings and their exhibits indicated that “the Board received intermittent, management-initiated communications that mentioned safety in name, but were not safety-centric and instead focused on the Company’s production and revenue strategy. And when safety was mentioned to the Board, it did not press for further information, but rather passively accepted management’s assurances and opinions.”
“The Board did not request any information about [the first crash] from management, and did not receive any until. . . over one week after it happened.” Despite being aware of a Wall Street Journal article suggesting that critical software was seriously defective, the directors “did not question management’s contrary position,” and apparently did not request, or receive, more written material about the software, the company’s interactions with the FAA, the necessary level of pilot training for 737 MAX airplanes, “or about airplane safety generally.”
Boeing’s then-Lead Director and a fellow director did, five days after the second crash, “recommend[ ] a Board meeting devoted to product safety.”
Several weeks later, the board heard, for the first time, presentations from the company’s Vice President of Engineering and from its Vice President of Safety, Security & Compliance.
● Sixth, directors should assess crically information provided by officers.
At Boeing, “Management’s ad hoc reports were. . . one-sided at best and false at worse, conveying only favorable and optimistic safety updates and assurances that the quality of Boeing’s aircraft would drive production and revenue.”
Even worse, “as in Marchand, Boeing management knew that the 737 MAX had numerous safety defects, but did not report those facts to the Board.”
● Seventh, directors should not be reluctant to initiate internal investigations, particularly of a situation that might recur, and/or might indicate larger concerns.
Four months after the first crash, the board, in an addendum to its meeting minutes, indicated that it had “decided to delay any investigation until the conclusion of the regulatory investigations or until such time as the Board determines that an internal investigation would be appropriate.”
● Eighth, board meetings should be held promptly upon reports of product failure, and directors should be advised that (except for situations of personal emergency) their attendance is mandatory.
More than three weeks after the first crash, the individual serving as both Boeing’s Chair and its CEO “e-mailed the Board to invite them to an ‘optional’ . . . Board call [two days later] for an update” on that situation from himself, the General Counsel, and the Chief Financial Officer. “This was the first time the Board convened after the crash.”
That e-mail instructed directors to: “Consider this phone call ‘optional’, understanding that many of you have family and friend activities planned for this coming weekend.”
● Ninth, minutes should be taken at such meetings, and should at a minimum reflect the general issues considered.
It would be particularly helpful for the directors’ defense if not only the minutes but the meetings’ agenda/schedule, and the documents distributed before and during the meeting, demonstrated that a significant amounts of time and discussion were devoted to product safety issues.
Because no minutes were created for Boeing’s board call, the court referred to a document indicating management’s “talking points,” which of course could not by itself indicate the board’s reception of, or engagement with, the presentation made to it.
Although minutes were taken at the board’s two regularly-scheduled meetings three weeks later, they “reflect[ed] that the Board’s primary focus relating to the 737 MAX and Lion Air [i.e., the first] Crash was on restoring profitability and efficiency in light of longstanding supply chain issues. . . The Board allocated . . . five minutes to reviewing a four-page legal memo ‘including matters related to the Lion Air incident.’ And it allocated ten minutes to Compliance Risk Management. The associated risk management report contained one page on the FAA Settlement, which said nothing about the 737 MAX or airplane safety generally.”
In addition, “The Board did not consider, deliberate, or decide on grounding the plane or other immediate remedial measures until after the second crash [about four and a half months after the first] and the FAA’s grounding over Boeing’s objection. No Board minutes or agendas between November 2018 and March 2019 reference a discussion about grounding the 737 MAX.”
● Finally, individual directors should not publicly misrepresent the responsiveness of the board—and the other directors should insist on public corrections to, or should themselves publicly correct, such misstatements.
After reviewing a number of statements made by the Lead Director at the time, including “that the Board met within twenty-four hours of the [second] crash to discuss potential grounding of the 737 MAX and recommended that the 737 MAX be grounded,” the Court observed that, “Each of [his] representations was false.”
As if that were not damaging enough, the Court also considered those statements “evidence that at least [he] knew what the Board should have been doing all along.”
The Chancery Court’s instructive opinion in In re The Boeing Company Derivative Litigation will certainly be included in corporate law classes and materials for years to come.
It should also be read by all directors.
