Court of Chancery Dismisses Caremark “Red-Flags Claim” Against the Directors of McDonald’s Corporation Relating to Pervasive Sexual Harassment; Holds Directors’ Termination of McDonald’s CEO Without Cause Was Governed by the Business Judgment Rule
In re McDonald’s Corporation Stockholder Derivative Litigation, C.A. No. 2021-0324-JTL (Del. Ch. March 1, 2023) (Laster, V.C.)
By Pamela Millard, Potter Anderson & Corroon LLP
On the heels of a January 2023 opinion denying defendant officer’s motion to dismiss plaintiffs’ derivative claims after determining that corporate officers of a Delaware corporation owe a fiduciary duty of oversight under In re Caremark Int’l Inc. Derivative Litig. (“Caremark”), the Court dismissed similar claims brought against the director defendants (the “Directors”) of McDonald’s Corporation (the “Company”), citing plaintiffs’ failure to plead a bad faith “Red-Flags Claim.” In addition, the Court dismissed claims alleging that the Directors erred in terminating the Company’s CEO in 2019 without cause after learning that the CEO had engaged in an inappropriate relationship with a Company employee, finding that the Directors’ determination was entitled to deferential business judgment review.
To reprise the facts leading to the Court’s January 2023 opinion (“McDonald’s I”), the derivative lawsuit stemmed from ongoing claims of pervasive sexual harassment at the Company, beginning in 2015 when Stephen Easterbrook was hired as CEO and David Fairhurst became Global Chief People Officer. Beginning in 2016, the Company faced increased public scrutiny regarding sexual harassment and misconduct, and dozens of employees filed complaints with the Equal Employment Opportunity Commission (“EEOC”) alleging sexual harassment in the Company’s restaurants. In 2018, after receiving additional EEOC complaints, the Company’s alleged “party atmosphere” and environment of sexual misconduct prompted a December 2018 Senate inquiry.
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. The board also terminated Easterbrook in October 2019 without cause and fired Fairhurst for cause one month later. In 2021, plaintiffs filed the present lawsuit alleging claims against Fairhurst, who was the subject of McDonald’s I, as well as Caremark claims against the Directors.
In dismissing plaintiffs’ claims, the Court first reviewed the history of Caremark duty of oversight claims under Delaware law, distinguishing between a claim that directors (1) utterly failed to implement any reporting or information system or controls (an “Information-Systems Claim”); or (2) having implemented such a system or controls, consciously failed to monitor or oversee its operations, negating the board’s ability to be informed of risks or problems requiring board oversight (a “Red-Flags Claim”).
The Court then noted that plaintiffs’ claims involved the Directors’ awareness of sexual harassment and misconduct at the Company and allegations that the Directors acted in bad faith by failing to address them: “In other words, the plaintiffs have asserted a Red-Flags Claim. They have not asserted an Information-Systems Claim.” To state a Red-Flags Claim, plaintiffs must plead facts supporting an inference that the directors were aware of pervasive sexual harassment at the Company— “a proverbial red flag”—but consciously ignored it. Plaintiffs were also required to prove a “serious failure of oversight” sufficient to support an inference that the Directors acted in bad faith.
Characterizing Fairhurst’s behavior as the head of the Company’s human resources division as “the most vibrant of red flags regarding a potential problem with sexual harassment and misconduct,” the Court nonetheless determined that plaintiffs failed to allege facts supporting an inference that the Directors failed to act. Rather, in 2019, the board worked with management to craft a comprehensive Company-wide response, including (1) hiring outside consultants, (2) revising Company policies, (3) implementing new training programs, (4) providing additional support to the Company’s franchise owners, and (5) taking other steps to improve the Company’s work environment.
Based on the remedial actions taken by the Company, the Court concluded that it could not draw a pleading-stage inference that the Directors acted in bad faith in responding to pervasive sexual harassment and misconduct at the Company, and dismissed plaintiffs’ Red-Flags Caremark claim.
Turning to allegations that the Directors breached their fiduciary duties by terminating Easterbrook without cause versus with cause, the Court reaffirmed prior case law holding that the business judgment rule protects a board’s decision to terminate an executive without cause, even if a with-cause termination was supportable. The Court also held that it was not reasonably conceivable that the Directors’ decision was based on self-interest, or that the board acted hastily in evaluating the terms of the CEO’s departure. Finally, the Court determined that the terms of Easterbrook’s separation agreement with the Company, including a severance package payable to the former CEO, did not support a separate claim for waste.