The Delaware Court of Chancery Ruled That Caremark Applies to Officers
Vice Chancellor Laster rejected both arguments. He first held that, while no Delaware case has found that officers owe oversight duties, three different considerations supported a holding that officers owe those duties.
He first looked at the reality that officers manage the business affairs of a corporation and only report to the board on a periodic basis. In re McDonald’s Corp. S’holder Deriv. Litig., 289 A.3d 343, 360 (Del. Ch. 2023). Applying the logic of Caremark, Laster observed that this obligation of reporting to the board implicates oversight duties because officers are “optimally positioned to identify red flags and either address them or report upward to more senior officers or to the board.” Id. at 362.
Second, Vice Chancellor Laster observed that the Delaware Supreme Court’s ruling in Gantler v. Stephens that officers owe “the same” fiduciary duties as directors “establish[es] that officers owe oversight duties.” Id. at 362–63 (citing Gantler v. Stephens, 965 A.2d 695, 709 (Del. 2009)).
Third, Laster discussed aspects of agency law that underlie an officer’s duty to provide information to the board as supporting a finding that officers owe oversight duties. Id. at 366. Separately, the vice chancellor held that engaging in sexual harassment is a clear example of bad-faith conduct where a “fiduciary ‘intentionally acts with a purpose other than that of advancing the best interests of the corporation’” and thus implicates fiduciary duties. Id. at 381 (quoting Stone v. Ritter, 911 A.2d 362, 369 (Del. 2006)).
Some Say McDonald’s Ruling Will Lead to a Flood of Litigation
Some in the legal bar reacted negatively to the ruling, with one noting that the ruling’s “attempt to extend Caremark from directors to officers, judicially rather than legislatively, will create even greater opportunity for abusive lawsuits.” Alison Frankel, “McDonald’s case is wake-up call for corporate execs—botch oversight, risk liability,” Reuters, Jan. 26, 2023. Professor Bainbridge remarked that the decision involved an “arguably unprecedented jump” from the original Caremark decision. He further characterized the holding that sexual harassment is an act of bad faith, which is a breach of fiduciary duty, as “explosive” and “a slippery slope” whereby employment and civil rights law are transformed into corporate law claims. Stephen Bainbridge, “In re McDonald’s Corp. Stockholder Litig.: Caremark is the Chicken Heart,” ProfessorBainbridge.com (Jan. 25, 2023).
A National Law Review article noted that the McDonald’s case did not involve any allegations that the alleged oversight violations involved any “mission critical aspects of the company’s business” and questioned whether Laster’s not focusing on that question suggests “a somewhat more expansive modern version of Caremark.” Jason M. Halper et al., “The Ramifications of The Delaware Court of Chancery’s McDonald’s Decision—Beyond Holding That Caremark Oversight Obligations Apply to Corporate Officers,” Nat’l L. Rev., Feb. 9, 2023.
The McDonald’s Decision Does Not Materially Change the Playing Field
However, it appears that certain of these concerns may be overblown. At the outset, while the court identifies practical justifications for holding that officers owe oversight duties, the Delaware Supreme Court’s holding in Gantler that “the fiduciary duties of officers are the same as those of directors” supports the proposition that officers owe oversight duties. See Gantler, 965 A.2d at 709. Further, that sexual harassment is an act of bad faith, and thus a fiduciary breach, appears difficult to dispute given the Stone court’s articulation of bad faith as conduct taken for a purpose other than advancing the corporation’s best interest.
It is not surprising that the commentators who have expressed disagreement or unease with the court’s holding rely less on doctrinal disagreements than on practical considerations. The central theme of these criticisms is that the ruling will result in an upsurge of frivolous claims targeting officers, as well as an undesirable extension of corporate fiduciary principles to address conduct already covered by state and federal civil rights laws. These concerns regarding the implications of the holding in McDonald’s may be misplaced.
First, the court was careful in explaining that the Caremark duties that officers owe are more circumscribed than they are for directors. While directors are charged with overseeing all of a corporation’s operations, an officer’s domain is usually far more limited. For example, a chief accounting officer may be required to maintain oversight over a company’s financial disclosures but is unlikely to have any oversight responsibilities regarding human resources issues. Indeed, with the exception of chief executive officers (who are often board members in any event), there are likely very few executives who would be required to participate in corporate oversight in a manner similar to a director. This protects officers from oversight claims regarding corporate matters over which they have little control of information.
Second, it is unlikely that this ruling will result in a significant increase in the filing of non-meritorious lawsuits. To start, despite recent notable decisions rejecting dismissal motions of oversight claims, Caremark claims remain extremely difficult to plead and rarely result in liability for officers and directors. See generally Marchand v. Barnhill, 212 A.3d 805, 809 (Del. 2019). But, more fundamentally, extending oversight liabilities to officers will generally not create new claims, only new defendants. For example, if a company fails to comply with applicable regulations and thus suffers a “corporate trauma” as a result of this regulatory noncompliance, a Caremark claim against directors was already an option for stockholder plaintiffs. Marchand, 212 A.3d at 809. That these plaintiffs may now name officers as defendants does not mean oversight claims that would not otherwise have been brought will be filed.
Third, Rule 23.1, which requires plaintiffs bringing derivative claims to plead particularized facts leading to a reasonable inference that the company’s board of directors would not impartially consider a litigation demand, remains a powerful force protecting officers from oversight liability. To survive a Rule 23.1 motion in an officer oversight liability case, the plaintiff would need to show that directors (1) are personally interested in the case (an unlikely claim in a Caremark case), (2) lack independence from an interested party, or (3) face a substantial likelihood of liability. United Food & Commercial Workers Union & Participating Food Indus. Emps. Tri-State Pension Fund v. Zuckerberg, 262 A.3d 1024, 1059 (Del. 2021). The first two circumstances seem unlikely—indeed, the concept of “personal interest” in an oversight claim makes little sense—and thus will not lead to any significant increase in the number of Caremark claims surviving a Rule 23.1 motion. Regarding the third, there does not seem to be any appreciable number of potential cases in which an inference of a substantial likelihood of liability for directors at the pleading stage occurs because of an officer’s oversight failures where there are also not directorial oversight failures that would implicate a traditional Caremark claim. This, too, means that extending oversight liability to officers will not result in new claims surviving a pleading motion; instead, it should result only in already meritorious claims being potentially asserted against additional defendants.
Regarding sexual harassment claims, it will be the rare case that a derivative claim challenging sexual harassment at a company will survive a Rule 23.1 motion. Boards of directors are ideally situated to determine whether they should pursue a derivative claim against officers (or directors) who have engaged in acts of sexual harassment. Demand is unlikely to be futile except in cases in which the board itself ignored red flags surrounding sexual harassment or the board is being asked to bring a suit against a controlling stockholder. And, in the former case, a board would still be protected from liability unless they engaged in some non-exculpated conduct, such as an oversight failure. See In re Cornerstone Therapeutics Inc. S’holder Litig., 115 A.3d 1173, 1175 (Del. 2015).
Thus, the practical impacts of the McDonald’s ruling are likely to be limited. Rule 23.1 remains a barrier against frivolous lawsuits and fully vests a board with authority in determining whether to pursue potentially meritorious derivative claims against officers who fail to comply with their oversight duties or engage in acts of sexual harassment.