Court of Chancery Declines to Dismiss Plaintiffs’ Derivative Claims and Confirms that Corporate Officers Owe a Fiduciary Duty of Oversight Under Delaware Law
In re McDonald’s Corporation Stockholder Derivative Litigation, C.A. No. 2021-0324-JTL (Del. Ch. Jan. 26, 2023) (Laster, V.C.)
By Pamela L. Millard, Alyssa Gerace Frank, Charles R. Hallinan, and Charles P. Wood, Potter Anderson & Corroon LLP
In this memorandum opinion, the Delaware Court of Chancery denied defendant’s motion to dismiss plaintiffs’ derivative claims after confirming that corporate officers of a Delaware corporation owe a fiduciary duty of oversight. The Court held that plaintiffs sufficiently pled that officer-defendant David Fairhurst consciously ignored red flags concerning endemic sexual harassment within McDonald’s Corporation (the “Company”), and allegations of Fairhurst’s own pattern of sexual harassment independently supported a claim for breach of the duty of loyalty.
Fairhurst became the Company’s chief human resources officer in 2015 shortly after the Company promoted Stephen J. Easterbrook to Chief Executive Officer. Easterbrook, in turn, promoted Fairhurst to Global Chief People Officer, charged with ensuring a safe and respectful workplace. As longtime employees of the Company, Easterbrook and Fairhurst had an existing relationship and used their new positions to promote a “party atmosphere” at the Company’s headquarters. Employees complained of inappropriate behavior by male employees—including Easterbrook and Fairhurst—at these events, but the complaints were ignored.
Beginning in 2016, the Company faced increased public scrutiny regarding sexual harassment throughout the Company. Dozens of employees filed complaints with the Equal Employment Opportunity Commission (“EEOC”) alleging sexual harassment in the Company’s restaurants. In 2018, the EEOC received more complaints that further detailed systemic issues related to reporting harassment within the Company, and the Company’s alleged environment of sexual harassment prompted a December 2018 Senate inquiry. After the Company received additional reports that Fairhurst had engaged in sexual harassment, the Company entered into a letter agreement with Fairhurst (the “Last Chance Letter”) pursuant to which any further instances of misconduct would be cause for termination.
In 2019, as the Company developed its response to the Senate inquiry, the board received a report outlining the Company’s sexual harassment and misconduct issues and its remedial efforts, which Fairhurst participated in developing and implementing. The board fired Easterbrook in October 2019 due to a prohibited relationship with an employee. One month later, the board fired Fairhurst for cause. Given the terms of the Last Chance Letter, the Court found it reasonable to infer that Fairhurst’s termination was due to further instances of sexual harassment.
Various plaintiffs filed class action lawsuits beginning in 2019 in connection with sexual harassment issues at the Company, and in 2021, plaintiffs filed the present lawsuit alleging that Fairhurst’s conduct constituted a breach of his fiduciary duties. Fairhurst moved to dismiss on the grounds that officers do not owe a duty of oversight under Delaware law.
With respect to the duty of oversight claim, the Court confirmed that corporate officers owe a fiduciary duty of oversight flowing from multiple sources of authority, including (i) the Caremark decision’s reasoning, which it found logically extended to officers, (ii) the fact that officers share the same duties as directors, as recognized by the Delaware Supreme Court in Gantler v. Stephens, (iii) agency principles requiring officers to disclose material information to directors or superior officers, and (iv) the role officers play in corporate oversight structures and the need for officers to be accountable to the board. The Court also noted the absence of express authority holding that officers do not owe oversight duties. Other than officers with company-wide roles, the Court noted that the scope of officers’ oversight duties would generally be limited to such officers’ areas of authority (i.e., financial oversight by a chief financial officer). However, the Court clarified that officers still have a duty to report egregious red flags of which they are aware, even if beyond their area of management expertise.
The Court also determined that plaintiffs’ oversight allegations against Fairhurst set forth a “red flags claim” under Caremark that Fairhurst was aware of sexual harassment issues within the Company, but consciously ignored them. First, the Court explained that plaintiffs pled facts supporting a reasonable inference that Fairhurst was aware of misconduct at the Company based on, among other things, the number of EEOC complaints filed by employees, the ensuing publicity, the fact that Fairhurst himself had engaged in problematic behavior, and the Senate inquiry. The Court then found that Fairhurst’s own acts of sexual misconduct, which allegedly occurred following each round of EEOC complaints and internal efforts to address the Company’s sexual harassment issues, supported an inference that Fairhurst consciously ignored these red flags.
Relatedly, the Court explained that Fairhurst’s misconduct, along with his efforts to promote an alcohol-fueled “party atmosphere,” bolstered allegations that the Company ignored complaints and made employees fear retaliation. The Court also noted the lack of any evidence from a prior Section 220 demand indicating that Fairhurst took any action to report sexual harassment issues to the board before June 2019, by which time the Company was already working on a response to the Senate inquiry. Fairhurst’s presumed sexual misconduct in 2019 further suggested that Fairhurst continued to turn a blind eye, notwithstanding his participation in the Company’s remedial efforts. Ultimately, given the pleadings stage posture of the case, the Court held that plaintiffs had sufficiently pled a claim against Fairhurst for breach of his duty of oversight.
Finally, the Court determined that plaintiffs pled facts sufficient to state a claim for breach of the duty of loyalty. The Court explained that sexual harassment is bad faith conduct, and bad faith conduct is disloyal conduct, which is actionable under Delaware law.
Interpreting the Contractual Duty of Good Faith: Latest Clarifications from the English Court of Appeal
By Louise Nash, Partner, Covington & Burling LLP; Luciana Griebel, Associate, Covington & Burling LLP
English law does not recognise an implied duty on contracting parties to deal with one another in good faith, so parties frequently include an express contractual obligation. The English Court of Appeal’s judgment in Re Compound Photonics Group Ltd; Faulkner v. Vollin Holdings Ltd  EWCA Civ 1371 provides clarity on the interpretation of such clauses; at a minimum parties must act honestly. Any further obligations must be capable of being derived as a matter of interpretation or implication from the other terms of the contract.
Compound Photonics Group Limited (“CPGL”) was in the business of developing and commercializing a very small projector. CPGL’s shareholders documented their relationship in an agreement (the “SHA”), which included the following obligation:
Each Shareholder undertakes to the other Shareholders and the Company that it will at all times act in good faith in all dealings with the other Shareholders and with the Company in relation to the matters contained in this Agreement.
After disappointing results, CPGL’s majority investors demanded that Dr. Sachs step down as CEO and removed M. Faulkner as a director. Dr. Sachs and M. Faulkner (who were also shareholders in CPGL) claimed that their removal was in breach of the good faith provision contained in the SHA.
The English High Court found in favour of the claimants, who had been “entrenched” as directors by CPGL’s constitutional documents. Mr. Justice Adam Johnson held that the SHA obligation imported the minimum standards of good faith from Unwin v. Bond  EWHC 1768 (Comm).
Court of Appeal Judgment
The English Court of Appeal overturned the judgment, finding that the interpretation of the contractual duty of good faith was too broad and stepping away from the “formulaic” approach established in Unwin. The English Court of Appeal found that:
- the duty of good faith imposes a core requirement that the parties act honestly towards each other;
- the duty of good faith may, in certain circumstances, include a duty not to act in bad faith or in a way “that reasonable and honest people would regard as commercially unacceptable, but not necessarily dishonest”; and
- a duty of fidelity to the bargain in the context of changes to the constitution of a company or the composition of its board is not inherent in a good faith clause, as articles and directors “are not cast in stone when the company is incorporated.”
Lord Justice Snowden noted that the concepts of fidelity to the bargain and a requirement to have regard to the interests of the other contracting party were first introduced in a commentary on US contract law. The concepts were then developed in New South Wales; however, this was outside the context of individually negotiated contracts. Therefore, parties to an English law governed contract should not automatically be presumed to have intended to incorporate such terms into their agreement.
The Court of Appeal endorsed existing case law, noting that cases from other areas of law and commerce may be of “limited value” in interpreting good-faith provisions and “must be treated with considerable caution.”