Delaware Court Of Chancery Declines To Dismiss Breach Of Fiduciary Duty Claims Against Nondirector Officer, Holding That Officers Owe A Caremark Duty Of Oversight
On January 25, 2023, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery denied a motion to dismiss a derivative suit brought by stockholders asserting breach of fiduciary duty claims against a former officer of McDonald’s Corporation (the “Company”). In Re McDonald’s Corp. Stockholder Derivative Litig., Case No. 2021-0324-JTL (Del. Ch. Jan. 25, 2023). Plaintiffs alleged that defendant, who served as the Chief People Officer responsible for human resources at the Company, breached oversight duties by “consciously ignoring red flags” regarding sexual harassment at the Company. The Court acknowledged that Delaware courts had not previously “expressly held that officers . . . owe oversight duties” comparable to the duty of oversight owed by directors under In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996). But the Court sustained the claim, noting that “[t]his decision clarifies that corporate officers owe a duty of oversight.” The Court also found that plaintiffs adequately pled a claim against defendant for breach of the duty of loyalty based on specific purported acts of sexual harassment in which he allegedly engaged.
The Court found support for the application of oversight duties to officers from several sources. For example, the Court highlighted that the reasoning of Caremark, focusing on the “seriousness” of the role of directors under Delaware corporate law “applies equally to officers,” as they “may have a greater capacity to make oversight and strategic decisions on a day-to-day basis.” The Court also noted that, in Gantler v. Stephens, 965 A.2d 695, 709 (Del. 2009), the Delaware Supreme Court held that “the fiduciary duties of officers are the same as those of directors.” The Court added that officers are agents and therefore have an “obligation to provide information to the principal,” which provides further support for recognizing that officers have an oversight duty. The Court also opined that a determination that officers do not have such a duty would “create a gap in the ability of directors to hold officers accountable.”
The Court, however, clarified that in its view the “context-driven application” of the duty of oversight for officers “will differ” from that of directors. For instance, while officers like the CEO have “company-wide remit,” other officers have “particular areas of responsibility” and an officer’s oversight duty “applies within that area.” Nevertheless, “a particularly egregious red flag might require an officer to say something even if it fell outside the officer’s domain.” The Court added that, “of course, the board can tailor the officers’ obligations and responsibilities.”
The Court also clarified that in its view “[a]s with the director’s duty of oversight, establishing a breach of the officer’s duty of oversight requires pleading and later proving disloyal conduct that takes the form of bad faith.” Thus, to be held liable, the officer “must consciously fail to make a good faith effort to establish information systems, or the officer must consciously ignore red flags.”
In this case, the Court found that plaintiffs adequately pled red flags indicating that sexual harassment occurred at the Company and that defendant knew about those red flags. For example, the Court pointed to allegations that, in October 2016, more than a dozen workers filed complaints with the Equal Employment Opportunity Commission (“EEOC”) that contained allegations about sexual harassment and retaliation, which were followed by an organized walkout by employees in over thirty cities to draw attention to the complaints. The Court referred to these as “massive red flags.” The Court also highlighted that there was a second round of similar EEOC complaints in 2018, followed by a ten-city strike.
As to allegations of bad faith, the Court concluded that, “[w]hen a corporate officer himself engages in acts of sexual harassment, it is reasonable to infer that the officer consciously ignored red flags about similar behavior by others.” The Court explained that several factors supported an inference of scienter, including that there were allegations that defendant participated in multiple acts of sexual harassment. For example, there were allegations that defendant was found to have violated company policy in a particular incident with an employee (which the Court noted, as alleged, “technically constituted an assault”), had been warned repeatedly about excessive drinking and conduct that made employees feel uncomfortable, and was ultimately terminated. The Court also noted allegations that, under defendant’s watch, “the human resources department ignored complaints” about misconduct and that employees “feared retaliation for reporting complaints to the human resources department.”
The Court also held that plaintiffs had adequately pleaded that defendant’s alleged acts of sexual harassment “constituted a breach of duty in themselves.” The Court explained that “[w]hen engaging in sexual harassment, the harasser engages in reprehensible conduct for selfish reasons,” rather than in the best interests of the corporation, and thereby breaches the duty of loyalty. The Court summarized: “Sexual harassment is bad faith conduct. Bad faith conduct is disloyal conduct. Disloyal conduct is actionable.”
This decision to extend Caremark oversight duties to officers has already garnered significant attention. While on one level, it might be viewed as unremarkable to impute oversight duties to senior corporate officers, it does leave significant unanswered questions about how the scope of those duties would be interpreted in practice. It may be that this issue has not been explicitly addressed previously because it seems very unlikely that a plaintiff could successfully plead demand excusal with respect to a single officer’s fiduciary duty breach where a disinterested majority of directors is available to pursue that claim. Notably, the Court here reached the officer defendant’s motion to dismiss for failure to state a claim without first addressing the more typically threshold question of demand excusal. Relatedly, it will also be interesting to see whether this decision prompts more shareholders to make demands on boards that they pursue claims against individual officers, citing an individual officer oversight duty, and generally whether boards feel greater pressure to independently pursue such claims.