Derivative Case Against Cardinal Health Partially Survives Dismissal

Judge Sarah Morrison of the Southern District of Ohio issued an opinion in a case captioned In re Cardinal Health, Inc. Derivative Litigation on Monday, partially dismissing a shareholder complaint that was originally filed in 2019. The defendant medical and pharmaceutical distributor, as well as numerous individual defendants, were accused of violating their fiduciary duties and corporate waste in connection with their response to decades of Controlled Substances Act (CSA) compliance issues.

The opinion explained that Cardinal, the “sixteenth largest company in the United States,” has faced scrutiny from government agencies, including the Drug Enforcement Administration (DEA), in relation to the company’s statutory obligations to “‘maintain effective controls against diversion of controlled substances.'” The opinion recounted years of investigations, settlements, and Congressional inquiry specifically concerning Cardinal’s alleged failure to report suspicious orders of pharmaceuticals from some of its constituent facilities.

Cardinal’s motion to dismiss argued that the plaintiffs failed to make a “pre-suit demand” of Cardinal’s board, as required by statute. Citing Ohio law, the judge explained that shareholders like the plaintiff do not have a right to sue a corporation on behalf of its board “unless the board refuses to do so and that refusal in wrongful, fraudulent, or arbitrary, or is the result of bad faith or bias on the part of the directors.”

To succeed, the judge explained, the plaintiffs must show that making a pre-suit demand of the Board would have been futile; the plaintiff argued that they did so by recounting the “‘Board’s passive receipt of information rather than the directors’ active engagement, questioning and monitoring of the effectiveness of the Company’s anti-diversion controls.”

The court agreed with the plaintiff as to the fiduciary duty breach allegations, finding that such a demand would have been futile and rejecting Cardinal’s other defenses, such as issue preclusion and timeliness.

The second count, alleging corporate waste, arose from allegations that company executives were paid excessively despite the compliance issues. The judge dismissed this claim, stating that the plaintiff must undertake a similar futility analysis to show that the Board acted “in reckless disregard for the best interests of the company, or with the deliberate intent to cause injury to it” in the specific context of executive compensation.

The plaintiffs are represented by Isaac Wiles Burkholder & Teetor, Kessler Topaz Meltzer & Check, Strauss Troy, and Gardy & Notis. Cardinal and the individual defendants are represented by Porter Wright Morris & Arthur and Wachtell, Lipton, Rosen & Katz.