The Merck Directors and the Vioxx Debacle: A Good Chance to Revisit the Phrase “In Good Faith�

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Elizabeth Nowicki, The Merck Directors and the Vioxx Debacle: A Good Chance to Revisit the Phrase “In Good Faith�, Truth on the Market (May 19, 2006),

Have we already discussed the In re Merck & Co. opinion (2006 WL 1228595 (D.N.J. May 6, 2006)), wherein we find a curious demand futility discussion regarding the Vioxx debacle? Please tell me that someone out there in the blogosphere has already dissected the opinion at length. No?

On May 5, 2006, Federal District Court Judge Chesler (D.N.J.) dismissed the consolidated federal derivative lawsuits brought by shareholders of Merck & Co. against former and current Merck officers and directors for claims related to the Vioxx situation. (As we all know, Vioxx is a non-steroidal anti-inflammatory drug that was recalled by Merck on Sept. 30, 2004, due to concerns related to Vioxx’s potential link to cardiovascular problems. It is maintained by some that Merck executives/researchers knew about the potential causal relationship between Vioxx and an increased risk of heart attacks and sudden cardiac deaths, but nobody from Merck made timely disclosure of this relationship. In this period of intentional silence, many users of Vioxx suffered serious cardiovascular complications, including heart attacks and death.)

The Merck shareholders maintained in their lawsuit that the directors and officers of Merck breached their fiduciary duties to the corporation and its shareholders (among other claims) by doing numerous improper things – things such as threatening academics who publicly questioned the safety of Vioxx, concealing Vioxx’s potential link to increased cardiovascular risks, and touting in a misleading fashion Vioxx’s safety – after it became clear to the directors and officers that Vioxx might well be linked to cardiovascular problems. Judge Chesler granted the defendant’s motion to dismiss the complaint for failure to make a demand on the directors as required by Federal Rule of Civil Procedure 23.

The plaintiff shareholders had conceded that they did not make demand on the Merck Board, but the plaintiffs predictably maintained that such a demand should be excused as futile. I do not yet have the complaint, but, based on the District Court opinion, it seems that the plaintiffs made their demand futility argument in large part on the “disinterested� aspect of the demand futility analysis. Under Aronson v. Lewis (looked to by NJ courts when dealing with demand futility), demand is excused if a reasonable doubt is created that “(1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.� Judge Chesler concluded that the Merck shareholders did not establish that the Merck directors conceded demand futility or were interested under the first prong of Aronson, and the Judge noted that the second Aronson prong was technically unavailable to the plaintiffs because the shareholders were complaining about “alleged inaction.� Slip op. at 8.

Notwithstanding that last point, which strikes me as odd, Judge Chesler still seemed willing to consider that second prong of Aronson, as he offered that “the conclusory allegations before this Court are insufficient to demonstrate that Defendants’ participation in the alleged wrongdoing creates a risk of substantial personal liability that excuses demand.� Slip op. at 13. The Judge seemed to view the plaintiffs’ allegations that the defendant directors promoted Vioxx and authorized further efforts to promote Vioxx despite mounting evidence that Vioxx was seriously linked to cardiac problems as weak an/or boilerplate. The Judge said “Plaintiffs fail to allege facts establishing that any of the outside directors were involved in the research, development, manufacturing or sale of Vioxx.� Further, the Judge wanted a showing from the plaintiffs of “a substantial likelihood of liability� (for breaching the duty of care, it seems), as opposed to the plaintiffs merely showing that there was a threat of personal liability.

The Judge said many other interesting things in his opinion, but what I note above covers what was most interesting to me. In an unsurprising turn of events, I see this case as boiling down to yet another “good faith� case. Despite the Judge’s incomprehensible (forgive me) “inaction� position, it seems that the Judge would have accepted a showing of demand futility based on clear lack of independence or, more importantly, an almost proven case of a breach of the duty of care. Phrased differently, ignoring the independence point, our plaintiffs seemed to have needed to point to facts strong enough to create a substantial likelihood that the directors either (a) acted “not in good faith� or (b) were grossly negligent in becoming informed, such that they were outside the BJR presumption’s protection.

Setting aside my criticism of the Judge’s “inaction� position, and setting aside the whole “independence� discussion (after the Martha Stewart travesty from the SDNY, I cannot discuss “independence� without feeling. . . dirty), my biggest question about Judge Chesler’s opinion comes from his determination that the plaintiffs did not establish facts sufficient to show a substantial likelihood of liability. What was he looking for, given that we were not yet at discovery? I guess I cannot fault him for sending the plaintiffs back to at least make the demand, but I cannot help but feel that that is just a wasted effort. . . . That said, before I complain about Judge Chesler’s unwillingness to do a complete “good faith� analysis under that second Aronson prong, I suppose I need to see the plaintiffs’ complaint, to see what Judge Chesler was served up, in terms of facts and law.

As a warm-up to what might later follow as my monologue on good faith in the Vioxx context, consider reading read my prior opining on how the judiciary (among others) keeps going wrong on the “good faith� aspect of director liability:

For those of you who are too busy to click on the links, I offer the two-pronged nutshell version of “Nowicki on Good Faith:�

First, “good faith� in the context of director conduct is a “positive duty� (an active duty, an affirmative duty) that requires the director to act in a way that is in pursuit of the best interest of the shareholders/corporation. The definition of “good faith� in the fidcuairy context does not merely prohibit a director from acting in bad faith, in a way that is venal toward or fraudulent regarding the corporation/shareholders.

Second, acts that are “not in good faith� (such that they are beyond the protection of the BJR or DGCL § 102(b)(7)) do not need to reach the level of bad faith. The “not in good faith� universe is larger than the “bad faith� universe; the phrases “bad faith� and “not in good faith� are not interchangeable. A plaintiff/shareholder can show that a director acted “not in good faith� by showing something much more “Caremark-esque� than “Enron-esque.� A director does not need to affirmatively act in bad faith (fraud, lying, deceit) in order to violate his obligation to act “in good faith.� She just has to. . . fail to act in good faith.