In a major decision released on Jan. 25, 2023, the Delaware Court of Chancery held that corporate officers have obligations comparable to the duty of oversight articulated in In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996) – so-called Caremark claims. Previously, Caremark claims were reserved only for directors.
Here are the top four things to know:
1. What triggered the lawsuit?
The case is In re McDonald’s Corporation Stockholder Derivative Litigation (Del. Ch. Jan. 25, 2023). McDonald’s shareholders allege that David Fairhurst, McDonald’s Executive Vice President and Chief People Officer from 2015-2019, breached his fiduciary duties and allowed a corporate culture to develop at McDonald’s condoning sexual harassment and misconduct.
Plaintiffs assert that Fairhurst had a “duty of oversight,” requiring him to make good faith efforts to establish the internal systems needed to manage McDonald’s human resources function. Plaintiffs, in turn, allege that Fairhurst had a duty to use the resulting information to perform his job responsibilities and report issues to McDonald’s CEO and its board of directors. The complaint claims Fairhurst had a duty to report upward any red flags regarding sexual harassment and misconduct and breached his duty of oversight by consciously ignoring those red flags.
The defense moved to dismiss the oversight claim against Fairhurst for failure to state a claim on which relief can be granted, contending that officers do not have obligations comparable to the duty of oversight articulated in In re Caremark.
2. What did the court hold?
Vice Chancellor Laster’s decision holds that corporate officers – like corporate directors – owe a duty of oversight. The CEO’s duty of oversight covers all corporate activities. The duty of oversight for other officers is “context-driven.”
For officers under the CEO, the duty of oversight applies to their “particular areas of responsibility.” For instance, a chief financial officer has a fiduciary duty to oversee the financial department. The general counsel has a fiduciary duty to oversee all legal operations.
So what’s the key takeaway?
Officers have (1) a duty to make a good faith effort to establish an information system within their department to identify red flags and significant corporate issues, and (2) to address and report upward any red flags they discover.
An officer’s duty to address and report upward about red flags generally applies only within his or her department. But the court emphasized that “a particularly egregious red flag” might require an officer to address and report the issue, even when falling outside of his or her department.
3. What do claimants need to allege to state a claim for an oversight duty breach?
To allege a breach of an officer’s duty of oversight, plaintiffs must plead that the officer’s disloyal conduct took the form of “bad faith.” As a general rule, Delaware law presumes that directors and officers act in good faith. A complaint must plead facts sufficient to support an inference of an officer’s “bad faith intent.”
The court held that “it is reasonable to infer” that corporate officers who engage in misconduct “consciously ignored red flags about similar behavior by others.”
The plaintiffs in the McDonald’s case had an easy time making those allegations against Fairhurst. The complaint alleged that Fairhurst engaged in acts of sexual harassment in 2016 and 2018. McDonald’s warned Fairhurst about his use of alcohol at corporate events. McDonald’s disciplined Fairhurst for the 2018 sexual harassment incident. And then it terminated him in November 2019 after Fairhurst committed another act of sexual harassment.
4. Can an officer’s own acts of misconduct state a claim?
Yes. The court held that Fairhurst’s acts of sexual harassment “constituted a breach of duty in themselves.” The duty of good faith requires that an officer “subjectively act in the best interests of” the corporation.
When engaging in misconduct like sexual harassment, the court held an officer engages in “reprehensible conduct for selfish reasons.” By doing so, the fiduciary acts in bad faith and breaches the duty of loyalty. A plaintiff’s claim against an officer for his or her own acts of misconduct, like sexual harassment, states a claim upon which relief can be granted.
Reminder: Taft’s 2022 year-end M&A Litigation webinar
Taft’s M&A Litigation team hosted a CLE on Dec. 14, 2022, to discuss some of 2022’s most significant M&A developments. A recording of the webinar plus the program materials can be accessed here.