For many years, Delaware’s courts emphasized that duty of oversight claims (often known as Caremark claims) are “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.”However, in a line of cases beginning with the Delaware Supreme Court’s 2019 decision in Marchand v. Barnhill, Delaware courts have sustained various plaintiffs’ assertion of breaches of the duty of oversight. This in turn encouraged more claimants to file duty of oversight claims, a development that clearly has alarmed the Delaware courts. The more recent result has been a series of cases in which the Delaware Chancery Court has emphatically shot down would-be duty of oversight claims.
The latest of these decisions is a ruling in a case involving the directors of Centene Corporation, in which Vice Chancellor Morgan Zurn granted the defendants’ motion to dismiss the plaintiff’s breach of the duty of oversight claims against the Centene board, in an opinion that emphasizes the high bar for Caremark liability. A copy of the July 12, 2024, opinion in Bricklayers Pension Fund of Western Pennsylvania v. Brinkley can be found here. A July 15, 2024, Memo from the Fried Frank law firm about the court’s ruling can be found here.
Background
Centene is a healthcare company that administers Medicaid plans. In the time period before the events that were involved in the subsequent D&O litigation, Centene faced regulatory scrutiny for its Medicaid pricing practices, as result of which Centene’s board was kept apprised of the company’s efforts in connection with its pricing practices.
In 2016, according to later allegations, certain executives at Centene allegedly entered into a scheme to increase their incentive-based compensation through inaccurate cost reports that resulted in increased cost reimbursem*nts to Centene. These efforts ultimately resulted in regulatory investigations of the company’s pharmacy benefit management operations. The board learned of the alleged scheme when the Ohio attorney general filed a complaint against Centene for legal violations. Several other states also filed regulatory enforcement actions against Centene. These various enforcement actions ultimately resulted in settlements totaling hundreds of millions of dollars.
A plaintiff shareholder filed a derivative action against Centene’s board seeking to hold the directors liable for the loss, based on the directors’ alleged failure to exercise adequate oversight. The directors filed a motion to dismiss, arguing that the plaintiff’s oversight duty claimed belonged to the board itself, and that the plaintiff had not made the requisite demand on the board to pursue the claim. While the plaintiff claimed that any such demand would be futile, the defendants argued that the plaintiff had filed to establish that a majority of Centene’s current directors faced a substantial likelihood of liability.
The July 12, 2024, Opinion
In a detailed July 12, 2024, opinion, Vice Chancellor Zurn granted the defendants’ motion to dismiss, holding that the plaintiff had “fallen short of demonstrating a majority of Centene’s current directors face a substantial likelihood of liability, either in the maintenance of the Board’s reporting systems, or in failing to respond to the alleged notice of the wrongdoing.”
In reaching these conclusions, VC Zurn specifically found that the Centene board did not breach its oversight duties even though it had deferred to management to deal with the company’s ongoing compliance problems. While reliance on management alone to address compliance risks is insufficient to address board-level oversight duties, the extent to which reliance on management may be sufficient depends on the context. Here, VC Zurn inferred that the Board knew what steps management was taking to address the compliance problems; the overall context was not so “extreme” that the Board was unreasonable in accepting management’s assurances that the problems “were being handled.”
In reaching this conclusion, VC Zurn observed that the company had information systems in place, including with respect to Medicaid compliance issues, and the company had several committees responsible for overseeing Medicaid compliance; the record, VC Zurn found, showed that the committees “did real work and reported to the full Board.”
VC Zurn also rejected the plaintiff’s assertion that the board ignored “red flags” of compliance problems. The plaintiff had argued that the board had disregarded “red flags” signifying “imminent corporate trauma,” contending that the board willfully ignored the information and consciously decided not to act. VC Zurn was willing to “assume that adding knowledge of a known faulty compliance system to knowledge of investigations, a subpoena and regulatory scrutiny would put the Board on notice that Centene was headed for a major corporate trauma,” but, the court emphasized, even so the plaintiff had not supported “the essential conclusion that the board ignored that information in bad faith.”
In discussing these issues, VC Zurn emphasized the high bar for finding the required element of bad faith. Here, the board accepted management’s statements that the compliance risks “were being handled,” and the board “did not make a conscious decision to violate the law.” VC Zurn found that no facts were alleged that supported an inference that the board failed to respond in bad faith. VC Zurn emphasized that the fact that illegal behavior took place at the company does not mean that a company’s internal controls must have been faulty, nor does it mean that a board must have known it. VC Zurn observed that “A bad outcome, without more, does not equate to bad faith.”
In addition, VC Zurn declined to infer from the absence of discussion in board minutes of compliance-related issues that there had been no such discussion. VC Zurn accepted that the alleged facts supported an inference that management had reported compliance problems to the board, notwithstanding the absence of the discussion of these issues in the minutes.
Discussion
As I noted at the outset, this ruling in the Centene case is the latest in a recent series of decisions in which the Delaware courts have granted defendants’ motions to dismiss in Caremark cases. For example, as discussed here, last December, Vice Chancellor Lori Will granted the defendants’ motion to dismiss in the Segway case. Similarly, in February, and as discussed here, VC Will granted the defendants’ motion to dismiss in the Walgreens Boots Alliance case. These two cases and the ruling in this case are similar in that in each case the court emphasized the high bar to establish liability in Caremark cases.
It is noteworthy, and relevant to the discussion of the outcome in the Centene case, that the court in both the Segway case and the Walgreens case communicated alarm at the seeming proliferation of Caremark cases since the Supreme Court’s decision in Marchand v. Barnhill. Both in those two earlier cases, and again in this case, the courts seemed committed to underscoring how difficult it is for claimants to sustain Caremark claims.
I was struck in reading VC Zurn’s opinion in the Centene case of the extent to which she seemed comfortable affirming that the company’s directors had not breached their duties of oversight notwithstanding the plaintiff’s allegations of the board’s reliance on the assurances of management. To be sure, VC Zurn did specifically find that the overall context was not so “extreme” that the board was unreasonable in relying on management’s assurances.
The law firm memo to which I linked above, in discussing this aspect of the court’s decision, emphasized that “the clearer and more extreme the noncompliance, and the more significant the potential harms, the more the board should be involved.” The memo also noted with respect to management reporting that “management should not only inform the board of significant compliance risks and problems but should specify any potential noncompliance by the company and should specify the steps management is taking to address the issues.”
I also think it should be emphasized that while VC Zurn did not find the absence of discussion of compliance issues in the board minutes to be preclusive of the issue, the better practice would be for companies and their boards to take active steps to ensure that board minutes reflect board consideration of all key identified risk issues.
One final thought about this significance of the Centene decision, especially in the context of the earlier decisions in the Segway and Walgreens cases. There has been a been a great deal of speculation amongst various commentators and observers that oversight duty breach cases could emerge from various kinds of current litigation risk exposures, such as, for example, with respect to cybersecurity, ESG, and AI. The courts opinions in these three cases seem to be intended to communicate to would-be oversight duty breach claimants “Not so fast.”
