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In mid-July, the Delaware Court of Chancery dismissed Caremark claims alleging board oversight failures related to compliance with Medicaid laws (core to the company’s business of administering Medicaid plans) in Bricklayers Pension Fund of Western Pennsylvania v. Brinkley (Del. Ch. 7/24). In the decision, Vice Chancellor Zurn clarified the circumstances in which a board reasonably relies on management to handle compliance issues and reinforced that there is a high bar to pleading Caremark claims. This Fried Frank alert identifies these key takeaways:

– The decision reaffirms that, generally, directors will not face Caremark liability unless the factual context is extreme. In this case, the Company had a compliance reporting system in place and the system appeared to be functioning at least to some extent. Also, we would note, while the regulatory noncompliance was ongoing over many years and resulted in significant financial losses (and reputational damage) to the Company, there was no loss of life or direct threat to human health. The court stated that the Plaintiff “ha[d] not painted the extreme picture present” in cases where it has found potential Caremark liability.

– The court indicated a high bar for a finding of the required element of bad faith for Caremark liability. The court found that, even if the Plaintiff’s alleged facts supported reasonable inferences that the Board had known about and failed to respond to the Company’s compliance problems, no facts were alleged that supported an inference that the Board failed to respond in bad faith. The Board accepted management’s statements that the compliance risks and issues “were being handled”—it “did not make a conscious decision to violate the law,” the court stated.

– The court found that the Board did not breach its Caremark duties although it had deferred to management to deal with the Company’s serious, longstanding compliance problems. In certain previous Caremark cases, the court has stressed that Caremark requires board-level oversight of compliance risks and that reliance on management alone to deal with critical compliance risks and problems is insufficient. Centene, however, indicates that the extent to which reliance on management may be sufficient for fulfillment of Caremark duties depends on the context. Here, the court found it reasonable to infer, from the facts the Plaintiff alleged, that the Board knew what steps management was taking to address the problems; and the court found the overall context was not so “extreme” that the Board was unreasonable in accepting management’s assurances that the problems “were being handled.”

In concluding, the alert notes that “Centene joins a list of recent cases— including NiSource; LendingClub; and MoneyGram—in which the court has dismissed Caremark claims at the pleading stage notwithstanding that the company had an extensive history of regulatory noncompliance. Successful defenses in these cases (that supported a lack of bad faith by directors) included that: the board was not aware of the regulatory noncompliance; the noncompliance was not sufficiently related to the corporate trauma that occurred; the noncompliance occurred at a different subsidiary of the company; the board had taken steps to remediate the noncompliance; and, now, in Centene, that the board reasonably relied on management’s assurances that it was handling the issues.”

It also makes recommendations to boards and management teams in light of these decisions, including that key risks are delegated to a board committee, that management regularly reports to the board on important developments, including “red flags” or “yellow flags,” and that a thorough record is created of the board’s risk monitoring and oversight efforts.

– Meredith Ervine