On April 7, 2022, the United States Court of Appeals for the Eighth Circuit affirmed the dismissal of derivative claims brought by shareholders of Centene Corporation (the “Corporation”) against directors and officers of the Corporation following its merger with Health Net, Inc. (the “Target”). Carpenters’ Pension Fund of Ill. v. Neidorff, No. 20-3216 (8th Cir. Apr. 7, 2022). In connection with the merger, the companies issued a joint proxy statement soliciting shareholder approval of the merger. Plaintiffs’ central allegation was that defendants purportedly concealed their knowledge of “significant financial problems” faced by the Target. Plaintiffs thus asserted derivative claims for violation of Section 14(a) of the Securities Exchange Act and breaches of fiduciary duty. The Court held that pre-suit demand was not excused, because the complaint failed to adequately plead that at least five of the nine board members at the time the suit was filed faced a substantial likelihood of liability.

The two health insurance companies agreed to the merger on July 1, 2015 and issued the joint proxy the next day. On October 23, 2015, the Corporation’s shareholders voted to approve the merger. The deal ultimately closed on March 24, 2016. On July 26, 2016, the Corporation released second-quarter financial results, which disclosed a $390 million increase in reserves for the Target’s increased liabilities. According to the complaint, the Corporation’s CEO admitted its directors knew of related problems prior to the merger. Moreover, several defendants sold shares—amounting to more than $28 million—prior to the second quarter disclosure.

Under Federal Rule of Civil Procedure Rule 23.1, shareholders asserting derivative claims must plead that they have made a pre-suit demand on the board to bring the desired action or the reasons for not doing so. The Court explained that Delaware law provides the “framework for assessing demand futility” with respect to a Delaware corporation. Further, under the “universal test” for assessing whether demand is excused recently announced by the Delaware Supreme Court, the court is to consider whether the directors (i) received a material personal benefit from the alleged misconduct; (ii) faced a substantial likelihood of liability on any of the claims; or (iii) lacked independence from someone who received a material personal benefit or faced a substantial likelihood of liability.

According to the Court, the complaint did not allege any material personal benefit received by at least half the board in connection with the challenged transaction. Moreover, the Court found that plaintiffs pleaded only “bare assertion[s]” of personal friendships and financial and other entanglements that were insufficient to demonstrate a lack of independence amongst the directors.

As to the Section 14(a) claim, plaintiffs alleged that the proxy was materially misleading for failing to adequately disclose existing problems at the Target regarding substance abuse facilities claims, poorly designed and unprofitable policies, tax liabilities, and involvement in a Medicare fraud. The Court, however, concluded that the contention that the alleged omissions rendered the “entire” proxy misleading lacked the requisite specificity under the Private Securities Litigation Reform Act (“PSLRA”) to demonstrate a substantial likelihood of liability. The Court also found that cautionary language in the proxy warning shareholders not to place undue reliance on unaudited financial projections precluded plaintiffs’ claims that the alleged omissions rendered pro forma analyses in the proxy materially misleading.

The Court also rejected plaintiffs’ contention that defendants faced a substantial likelihood of liability for failing to update the proxy statement. The Court explained that it had not found any authority for the proposition that Section 14(a) requires the updating of a proxy and the argument to the contrary is also inconsistent with the text of SEC Rule 14a-9(a), which provides a proxy may not contain statements that are materially misleading “at the time” they are made.

Regarding the breach of fiduciary duty claims, the Court first highlighted that the Corporation’s exculpatory provision under Section 102(b)(7) of the Delaware General Corporation Law precluded a substantial likelihood of liability for breaches of the duty of care. As to the duty of loyalty, the Court found that, even assuming defendants had knowledge of the purported problems in advance of the deal, the complaint did not plead particularized facts showing defendants failed to disclose them in “bad faith—that is, with intent to do harm or in conscious disregard of their responsibilities.”

With respect to the insider trading-based claim, the Court noted that it was asserted against only two of the nine demand board directors. Moreover, the Court explained that the insider trading claim was “not so intertwined” with the claims against the remaining directors such that proving it would expose them to a risk of liability.

Concluding that plaintiffs “failed to plead particularized facts demonstrating that at least half of the Board faces a substantial likelihood of liability as to any claim,” the Court affirmed the dismissal.