The Delaware Court of Chancery has recently held in In re McDonald’s Corporation Stockholder Derivative Litigation that shareholders can pursue a derivative claim for breach of the fiduciary duty of oversight against corporate officers. Prior to this ruling, no Delaware court had expressly held that the duty of oversight for corporate directors set forth in In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996) (“Caremark”), applies equally to corporate officers.
In or about January 2022, shareholders of McDonald’s filed a consolidated stockholder derivative complaint on behalf of the company naming the company’s former executive vice president and global chief people officer (“Former Officer”), among others, as a defendant. The shareholders alleged that the Former Officer breached his fiduciary duties while he served as the company’s head of human resources because he permitted a culture to develop within the organization that tolerated sexual harassment and related misconduct. According to the shareholders, the Former Officer owed a fiduciary duty of oversight, which required, among other things, that he address or elevate red flags concerning sexual harassment and misconduct at McDonald’s. The shareholders further alleged that the Former Officer breached that duty of oversight by “consciously ignoring red flags.”
In Caremark, the Delaware Court of Chancery described the duty of oversight as “a director’s obligation…to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists, and that failure to do so under some circumstances may, in theory at least, render a director liable for losses caused by non-compliance with applicable legal standards.” Per the court, liability would result where there is a “lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight.”
The Former Officer moved to dismiss the shareholders’ claim for breach of the fiduciary duty of oversight, arguing that, under Delaware law, there is no Caremark duty of oversight imposed on corporate officers. The court rejected this argument and, instead, agreed with the shareholders that corporate officers and directors owe the same fiduciary duties, including the duty of oversight.
Importantly, the court clarified that the oversight duty applicable to corporate officers may differ based on context, given the scope of a particular officer’s responsibilities. While some officers, for example the CEO, have the entire company within their purview, other officers have responsibility over only narrow portions of the company. As to the latter officers, per the court, “the officer’s duty to make a good faith effort to establish an information system only applies within” the particular area for which that officer is responsible, whereas the officer’s duty to address and report upward concerning red flags would not only generally apply within the officer’s area of responsibility but also “might require an officer to say something even if it fell outside the officer’s domain” in the instance of a “particularly egregious red flag.”
Why it matters: In re McDonald’s Corporation Stockholder Derivative Litigation represents the first time a Delaware court has explicitly applied Caremark oversight duties to corporate officers. Companies will need to address this potential for individual exposure to liability for their officers, including, among other things, through indemnification, exculpation (which raises the issue of whether the duty of oversight is an aspect of the duty of care or the duty of loyalty) and D&O insurance. Moreover, companies will need to strengthen their information and reporting protocols to protect officers against shareholder lawsuits.