Delaware Court Affirms High Threshold for Breach of Directors' Caremark Duties

July 30, 2024

Written By Preet Gill and Denise Bright

In a recent case, Bricklayers Pension Fund of Western Pennsylvania (derivatively on behalf of Centene Corporation) v Brinkley (Centene),¹ Delaware's Court of Chancery dismissed “Caremark duty claims”—named after the 1996 case establishing a duty of oversight required by a U.S. board of directors²—against members of Centene's board of directors.

Allegations against the directors focused on the failure to oversee, and deferral to, management. The decision confirms the high threshold applicable to find a breach of a director’s Caremark duty.

Caremark duties do not currently form part of Canadian law; however, as discussed in previous blogs on these cases,³ the fact that this duty continues to be affirmed and particularized under Delaware law may be instructive to Canadian courts, which often look to Delaware law in respect of corporate law.

Facts

The nominal defendant company Centene is a healthcare company that administers Medicaid plans in about 20-30 states. Centene had faced numerous regulatory investigations relating to compliance issues over the years, in particular relating to “spread pricing”. The root of the claim against Centene in this case focused on a scheme implemented by four officers which, if successful, would increase their incentive-based compensation and subsequently resulted in payments received by each between $890,000 to $3.915 million.

The Plaintiff—the Bricklayers Pension Fund of Western Pennsylvania—commenced a derivative action against members of the Board of Directors of Centene to hold them liable for the losses as a result of the officer's scheme. At a high level, the Plaintiff alleged that the directors: (1) failed “to make a good faith effort to implement and monitor compliance policies and systems to monitor compliance with applicable law”; and (2) ignored “red flags indicating that Centene and its subsidiaries were not complying with applicable law.”

The Plaintiff also claimed against several former officers of Centene for unjust enrichment and breach of fiduciary duty. While the Delaware Court of Chancery has previously held that “Caremark claims” also extend to officers,⁴ this decision focused on the allegations against the directors of Centene.

The Defendants moved to dismiss the claim; in order to defend against dismissal, the Plaintiff had to demonstrate that a majority of directors faced a substantial likelihood of liability for breach of their Caremark duties.

The Decision

In considering whether the two-pronged Caremark duty of oversight was breached, first, with respect to the information-systems claims, the Court considered whether the directors made a good faith effort to "put in place a board-level compliance system" and ensured that a "reasonable information and reporting system exists."

The Plaintiff did not attempt to argue that Centene lacked adequate oversight on paper but rather tried to rely on case law “concluding the existence of such systems does not foreclose an information systems claim where the board knows they are inadequate.” The Plaintiff’s argument relied on the Court making a number of inferences, which were not accepted, including asking the Court to infer bad faith from the mere absence of any Board or committee discussion of Medicaid compliance. While the absence of board discussions on a topic can be one factor supporting a Caremark claim, it was not sufficient in and of itself.

Second, for the red flag claims, directors can be liable if they consciously ignored "red flags", as a result of the reporting system, that indicate wrongdoing or matters requiring further investigation. In this case, the key “red flags” alleged by the Plaintiff included reports of increased regulatory scrutiny, state investigations and threatened litigation; admittedly, facts that could not, without more, satisfy the threshold. However, the Plaintiff argued that those reports, coupled with evidence of inadequate compliance measures, put the Board on notice. The Plaintiff was unable to meet the requisite threshold: that the directors knew from the “red flags” that corporate trauma was coming and nevertheless forged ahead contrary to the best interests of the corporation. Rather, “the Board accepted management’s statements that both the compliance issues and the regulatory risks were being handled. The Board did not make conscious decision to violate the law.”

The claims were therefore dismissed.

High Level Takeaways

• The Delaware Court affirmed that just because illegal behaviour occurred does not mean internal controls were deficient; hindsight cannot dictate the result of a Caremark action.
• An absence of discussions on a topic at the Board level is not sufficient, in and of itself, to support a Caremark claim.
• In this case, the Board was entitled to rely on senior management, and audit and compliance committees, that the litigation and compliance problems were actively being addressed.
• The issuance of a subpoena, where the Board does not know its contents, or even a regulatory investigation by a state agency, is not in and of itself evidence of wrongdoing or a red flag on its own.
• The Court is not likely to make a finding of "bad faith" for Caremark liability except in more extreme circumstances.

Takeaways For Canadian Corporate Law

As we have previously noted, while there is presently no duty of oversight in Canadian corporate law, directors and officers must act honestly and in good faith with a view to the best interests of the corporation. On this basis, we expressed that it is foreseeable that a Caremark-style claim may be brought in Canada against directors and officers of Canadian corporations, depending on the particular facts of a case. Although not bound by them, of course, Canadian courts often heed developments in Delaware corporate law, and therefore it is possible that these decisions may find influence. However, the high threshold set by these cases, including Centene, demonstrate that fairly egregious facts are likely necessary before such a duty may be successful north of the border.

For more information about directors' and officers' duties in the context of your organization, please do not hesitate to contact the authors or a member of the Bennett Jones Corporate Governance group.

The authors thank Salma Barakat, summer student, for her contributions to this blog.

Authors