I have pasted below select wording from the Opinion in In Re McDonald’s Corporation Stockholder Derivative Litigation in which the Court held that a corporate officer has an oversight duty (the entire Opinion is 65 pages). In Re McDonald’s Corporation Stockholder Derivative Litigation, Court of Chancery of the State of Delaware, C.A. No. 2021-0324-JTL (January 25, 2023). The Opinion has already resulted in an amount of discussion, and will continue to do so; however, it is my view that the Opinion expresses a view that has been coming step-by-step for a considerable time. This is a developing area of law – the holding in In Re McDonald’s Corporation Stockholder Derivative Litigation will be variously followed, disagreed with, differentiated, or expanded upon in future cases, and in other jurisdictions.
The following is select wording from the Opinion in In Re McDonald’s Corporation Stockholder Derivative Litigation – I have provided you with specific wording so that you can read for yourself – and officers of corporations, whether incorporated in Delaware, or in California, or in some other jurisdiction, should kept this Opinion in mind in addition to the business judgment rule, risk management, compliance and compliance programs, entity controls, Dept. of Justice compliance program guidance, specific areas of liability for which officers have already been held personally liable (e.g., environmental contamination, and food safety), and the like. Below the following quoted language I have also provided a complete pdf of the Opinion in In Re McDonald’s Corporation Stockholder Derivative Litigation.
Generally, following the approach in In Re McDonald’s Corporation Stockholder Derivative Litigation, (1) evaluate whether you have the requisite corporate officer status or standing; and if you do, (2) have you evaluated and considered your area(s) of responsibility and control; (3) have you made an effort or has an effort been made to consider, design, implement and monitor risk management and entity controls and compliance programs in those areas as believed relevant and necessary; and/or (4) are there relevant red flags of which you are aware (or perhaps about which someone in hindsight might argue that you should have been aware)? Obviously such an approach also raises other important issues and questions at law.
The following is quoted from In Re McDonald’s Corporation Stockholder Derivative Litigation * * * * *
6. The Scope Of An Officer’s Oversight Duty
For the reasons previously discussed, officers owe duties of oversight comparable to those of directors. But that does not mean that the situational application of those duties will be the same. “Although the fiduciary duty of a Delaware director is unremitting, the exact course of conduct that must be charted to properly discharge that responsibility will change in the specific context of the action the director is taking with regard to either the corporation or its shareholders.” Malone v. Brincat, 722 A.2d 5, 10 (Del. 1998). The same is true for officers, who regularly operate in different contexts than directors.
Most notably, directors are charged with plenary authority over the business and affairs of the corporation. See 8 Del. C. § 141(a). That means that “the buck stops with the Board.” In re Del Monte Foods Co. S’holders Litig., 25 A.3d 813, 835 (Del. Ch. 2011). It also means that the board has oversight duties regarding the corporation as a whole.
Although the CEO and Chief Compliance Officer likely will have company-wide oversight portfolios, other officers generally have a more constrained area of authority. With a constrained area of responsibility comes a constrained version of the duty that supports an Information-Systems Claim.12 For example, the Chief Financial Officer is responsible for financial oversight and for making a good faith effort to establish reasonable information systems to cover that area. The Chief Legal Officer is responsible for legal oversight and for making a good faith effort to establish reasonable information systems to cover that area. The executive officer in charge of sales and marketing is not responsible for the financial or legal reporting systems. And of course, the board can tailor the officers’ obligations and responsibilities.
For similar reasons, officers generally only will be responsible for addressing or reporting red flags within their areas of responsibility, although one can imagine possible exceptions. If a red flag is sufficiently prominent, for example, then any officer might have a duty to report upward about it. An officer who receives credible information indicating that the corporation is violating the law cannot turn a blind eye and dismiss the issue as “not in my area.”
Another important question is the standard of liability for officers. As with directors, officers only will be liable for violations of the duty of oversight if a plaintiff can prove that they acted in bad faith and hence disloyally.
As scholars have chronicled, Delaware’s oversight jurisprudence has evolved from the original Caremark decision, where the oversight duty could sound in both loyalty or care, to a strictly loyalty-based regime. 13 The corporation in Caremark had an exculpatory provision that eliminated director liability for breaches of the duty of care. After noting that the failure to ensure that a corporation information and reporting system existed could, “under some circumstances . . . render a director liable for losses caused by non-compliance with applicable legal standards,” Chancellor Allen observed in a footnote that “questions of waiver of liability under certificate provisions authorized by 8 Del. C. § 102(b)(7) may also be faced.” Caremark, 698 A.2d at 970 & n.27. That comment only makes sense if, in the absence of an exculpatory provision, a breach of the duty of care could support an otherwise actionable claim. Other references in the decision also acknowledged that a breach of the duty of care could lead to a failure of oversight.14
In another portion of the opinion, however, Chancellor Allen expressed his view that a pure breach of the duty of care, absent conduct that rose to the level of bad faith, should not support a monetary damages award:
Indeed, one wonders on what moral basis might shareholders attack a good faith business decision of a director as “unreasonable” or “irrational”. Where a director in fact exercises a good faith effort to be informed and to exercise appropriate judgment, he or she should be deemed to satisfy fully the duty of attention. If the shareholders thought themselves entitled to some other quality of judgment than such a director produces in the good faith exercise of the powers of office, then the shareholders should have elected other directors. 15
It is possible to read this passage as indicating that a breach of the duty of care should never support liability, whether as an oversight claim or otherwise.
Writing as a member of this court, Chief Justice Strine took up this aspect of Caremark and held that director liability for oversight claims always requires a showing of bad faith. See Guttman v. Huang, 823 A.2d 492, 506 (Del. Ch. 2003). In Stone, the Delaware Supreme Court adopted the Guttman formulation and stated that a breach of the duty of loyalty, such as acting in bad faith, was a “necessary condition to liability.” Stone, 911 A.2d at 364; see Banbridge, supra, at 595. After Stone, then-Vice Chancellor Strine acknowledged that Caremark duties carried overtones of care, but explained that “to hold directors liable for a failure in monitoring, the directors have to have acted with a state of mind consistent with a conscious decision to breach their duty of care.” Desimone v. Barrows, 924 A.2d 908, 935 (Del. Ch. 2007). After becoming the Chief Justice, he authored a Delaware Supreme Court decision that made a similar statement: “If Caremark means anything, it is that a corporate board must make a good faith effort to exercise its duty of care. A failure to make that effort constitutes a breach of the duty of loyalty.” Marchand v. Barnhill, 212 A.3d 805, 824 (Del. 2019).
There is room to debate whether the same loyalty-based framework that governs directors should apply to officers, or whether officers could be held liable for a failure of oversight caused by a breach of the duty of care.16 To state a care-based claim, a plaintiff would have to plead and later prove that the oversight failure resulted from gross negligence. For purposes of Delaware entity law, a showing of gross negligence requires conduct akin to recklessness.17
The arguments about the oversight regime that should apply to officers parallel the arguments about whether an officer’s duty of care should resemble the director regime and require a showing of gross negligence, or whether it should track the agency regime and require only simple negligence. Scholars engaged in extensive debate on that topic.18
The arguments in favor of a less protective standard for officers generally start from the observation that, while directors are part-time monitors who may meet a handful of times per year, officers are full-time employees who are deeply involved in corporate decision-making on a daily basis. Compared to directors, officers have greater knowledge about and responsibility for the areas under their control. They also receive significantly higher levels of compensation for doing their jobs. The arguments in favor of a more protective standard for officers generally rely on the same justifications that support the business judgment rule, including the risk of hindsight bias in judicial decision-making, the relative incompetence of judges in assessing business decisions, the disproportionate level of liability that an individual could face from harm to a large enterprise, the bluntness of liability as a tool for shaping behavior, and a concern that the threat of liability will cause good people to decline to serve. See, e.g., Petrin, supra, at 460–73. Chancellor Allen highlighted some of those arguments in Caremark, when he observed that “a demanding test of liability in the oversight context is probably beneficial to corporate shareholders as a class, as it is in the board decision context, since it makes board service by qualified persons more likely, while continuing to act as a stimulus to good faith performance of duty by such directors.” 698 A.2d at 971.
When faced with this type of policy decision, Delaware courts generally view the latter set of considerations as more persuasive and opt for a more protective standard. For example, a comparatively recent series of decisions have adopted the director model for analyzing officers’ duty of care.19 Similar policy rationales about protecting directors and officers against unjustified lawsuits, and the importance of encouraging capable people to serve, drive Delaware’s broad construction of advancement and indemnification rights.20
A recent event with potential implications for officers’ oversight duties is the statutory amendment authorizing limited exculpation for officers. Historically, officers have not been entitled to exculpation, rendering them subject to liability for the duty of care. See Gantler, 965 A.2d at 709 n.37. Effective August 1, 2022, the General Assembly amended Section 102(b)(7) of the DGCL to authorize corporations to exculpate officers for care-based liability for direct claims by stockholders. Del. S.B. 273, 151st Gen. Assem., 83 Del. Laws ch. 377 (2022). The amendment did not authorize exculpation for “any action by or in the right of the corporation.” Id.
The bifurcated approach taken by the amendment might imply a legislative intent to preserve care-based liability for officers for derivative claims, including for breaches of the duty of oversight. But that is not the only inference. Claims for breaches of fiduciary duty generally focus on actions or decisions that a fiduciary has taken affirmatively. Although Delaware authorities regularly equate action and conscious inaction,21 humans intuitively distinguish between the two and associate greater culpability with an affirmative act rather than a conscious decision not to act.22 The amendment to Section 102(b)(7) can be read as preserving care-based liability for officers when they act in a grossly negligent (i.e., reckless) manner. It need not be read to suggest an intent to override the loyalty-based premise of oversight liability for officers and preserve care-based liability in that area.
This decision concludes that oversight liability for officers requires a showing of bad faith. The officer must consciously fail to make a good faith effort to establish information systems, or the officer must consciously ignore red flags.
End of quoted wording from the Opinion in In Re McDonald’s Corporation Stockholder Derivative Litigation * * * * *
The following is a pdf of the complete Opinion in In Re McDonald’s Corporation Stockholder Derivative Litigation.
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Regards, and best to you,
David Tate, Esq.
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