A recent Delaware Court of Chancery decision (In re McDonalds Corporation Stockholder Derivative Litigation, C.A. No. 2021-0324-JTL) increases potential exposure for officers and may appropriately prompt reevaluation of insurance limits (especially Side A DIC limits).
In the last few months, the Delaware legislature and courts have continued an ongoing process of treating non-director corporate officers more similarly to corporate directors. Just a few months after the Delaware legislature amended Delaware General Corporations Law section 102(b)(7) to allow a company’s certificates of incorporation to exculpate officers from liability from the same types of breaches of duty of care as directors, the Delaware Court of Chancery has held that the Caremark duty of oversight extends to corporate officers as well as directors. Unfortunately for officers and directors, neither category of defendant can be exculpated from derivative liability.
On January 25, 2023, the Delaware Court of Chancery issued a decision denying the motion to dismiss of a non-director corporate officer in a derivative lawsuit (In re McDonald’s Corporation Stockholder Derivative Litigation, C.A. No. 2021-0324-JTL). In this suit alleging a Caremark failure of the duty of oversight relating to allegedly pervasive sexual harassment and discrimination issues, the defendant officer had moved to dismiss on the basis that Delaware did not recognize such a duty in non-director officers.
Writing for the Court, Vice Chancellor Laster was clear in the core holding: “This decision clarifies that corporate officers owe a duty of oversight. The same policies that motivated Vice Chancellor Allen to recognize the duty of oversight for directors [in the landmark Caremark decision] apply equally, if not to a greater degree, to officers.”
Vice Chancellor Laster offered as background the relative histories of officer liability risks and defenses versus director liability risks and defenses:
“The absence of an earlier decision holding that officers owe oversight duties likely has a more practical explanation. Before January 1, 2004, Delaware’s jurisdiction-by-consent statute did not extend to officers. See Del. S.B. 126, 149th Gen. Assem., 81 Del. Laws ch. 83 (2003). After that date, stockholder plaintiffs moved slowly to name officers as defendants. Only recently has naming officers as defendants become more frequent1, prompting the General Assembly to authorize exculpation for officers for stockholder claims, albeit not for claims by or in the name of the corporation, effective August 1, 2022. Del. S.B. 273, 151st Gen. Assem., 83 Del. Laws ch. 377 (2022)”2
Vice Chancellor Laster elaborated that the scope of an officer’s duty of oversight should be appropriate to the scope of that officer’s responsibilities: “Although the duty of oversight applies equally to officers, its context-driven application will differ. Some officers, like the CEO, have a company-wide remit. Other officers have particular areas of responsibility, and the officer’s duty to make a good faith effort to establish an information system only applies within that area.” In the McDonalds case, the defendant’s title of “Executive Vice President and Global Chief People Officer” was considered to demonstrate a relevant “company-wide remit”.
Vice Chancellor Laster explained that the duty of oversight has two distinct prongs: putting monitoring systems in place, and spotting and reacting appropriately to “red flags”. In this case, the Vice Chancellor read the allegations as focusing on a case concerning the disregarding of red flags. Vce Chancellor Laster attached significance to the fact that the defendant evidently admitted to committing sexual harassment as evidence that he was aware of red flags in order to sustain a potential claim for a breach of the duty of oversight.3
One potential distinction between the categories of defendants which the Vice Chancellor discussed was that the board’s duties of oversight may include a duty to oversee the corporation’s officers in their oversight duties. Vice Chancellor addressed the possibility of different liability outcomes for officers than for directors, particularly if directors can successfully demonstrate that there were failures of oversight on the part of officers of which they were reasonably unaware:
“The role of the board in providing oversight for officers also illustrates how a case could result in different outcomes as to different actors. While it seems likely that if a court found a board liable for breach of an oversight obligation, then the officers with responsibility for that area also would be liable, the converse is not true. A board could direct an officer to establish an information system to cover their area, or a board could reasonably believe that an officer had established one. If the officer failed to fulfill those responsibilities, and the board did not consciously act in bad faith by not following up, then the directors would be in a position to hold the officer accountable without facing oversight liability themselves. The ability of directors to rely on reports from an officer is also pertinent. See 8 Del. C. § 141(e). If an officer was not providing adequate oversight, but the directors did not have reason to know that, then the board could have relied on the officer in good faith. Again, the directors would be in a position to hold the officer accountable without facing oversight liability themselves.”
In other words, according to Vice Chancellor Laster, theoretically directors could criticize officers as part of a successful defense, perhaps even acting preemptively by bringing claims against officers themselves.
This decision is another not unexpected step towards reconciling the duties and defenses of officers with those of directors. On the positive side, officers are now capable of received the basic exculpatory protections afforded by Delaware General Corporations Law section 102(b)(7), but on the flip side it is now clear that officers (like directors) can be subject to duties of corporate oversight which cannot be exculpated. As a result, it will likely become more common for officers to be sued alongside directors in corporate derivative suits. D&O policies will continue to provide excellent protection (defense and indemnity) for both categories of defendants from such suits.
There is a chance that the decision could inspire some directors to point fingers at or even bring claims against officers, in which case it will become more important than ever to have sufficient Side A DIC coverage in order to avoid the operation of Entity v. Insured exclusions (ideally including endorsements which import such broad Side A DIC coverage into the ABC tower). Even in situations where open warfare doesn’t break out between director and officer camps, the increased risk of such dynamics may lead more individual defendants to feel a need for separate counsel; as a result, it may be appropriate for companies to evaluate the adequacy of their total limits.
Postscript: Since this article was written, the Court issued another decision on March 1, 2023 which dismissed the derivative claims against the defendant directors. Having previously discussed the possibility that it might be possible for directors to successfully defend against a Caremark duty of oversight derivative claim by establishing that the breach was committed by officers who didn't sufficiently inform the directors, the Court has now stated that such a scenario in fact occurred in this case. As discussed above, this may incentivize directors to defend themselves by pointing fingers at officers (and sometimes even suing them). As a result, companies and their directors and officers may see a need for higher limits, particularly in their Side A DIC towers which don’t have insured v. insured exclusions.
1 The anomalies caused by the apparently different liability standards had been highlighted by the Delaware Supreme Court’s holding in Gantler v. Stephens, 2009 WL 188828 (Del. 2009) that officers and directors each owe fiduciary duties of care and loyalty to a corporation and its stockholders but that personal liability for breaches of the fiduciary duty of care differ for officers and directors given the statutory language contained in Section 102(b)(7)
2 The effect of the August 2022 amendment was to add references to “officers” wherever section 102(b)(7) previously mentioned only “directors”.
Section 102(b)(7) allows companies to add to their certificates of incorporation “provisions eliminating or limiting the personal liability of a director or officer to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director or officer”, but there remain several things which cannot be exculpated:
3 The Vice Chancellor went further, however, to find that the active participation in sexual harassment could constitute a separate breach of the duty of loyalty. VIce Chancellor Laster wrote, in simple and conclusory terms: “Sexual harassment is bad faith conduct. Bad faith conduct is disloyal conduct. Disloyal conduct is actionable.” The application of this aspect of the decision could be limited, or could be widespread, depending on the current and future state of executive behavior in relation to sexual harassment.
Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).
