A novel Delaware Chancery Court ruling that corporate officers can be held accountable by shareholders sheds some new light on oversight liability while raising questions over how far the line of duty extends.
The court for the first time explicitly held—in a toxic workplace case against McDonald’s Corp.'s former chief people officer—that CEOs and other executives owe investors a duty of oversight comparable to that owed by a board of directors. Typically a company’s board will face shareholder claims that it failed to engage in adequate oversight or ignored red flags over time.
To see the court write it out so plainly caught practitioners’ attention, even if most already operated under a similar understanding of Delaware law, said Larry Hamermesh, an emeritus professor at the Widener University Delaware Law School.
Vice Chancellor J. Travis Laster’s opinion last week serves as a warning that corporate officers may not be able to dodge liability to shareholders under Delaware law, even though the state’s Supreme Court has yet to address the issue.
It also opens the door to uncertainty over what Laster meant by “corporate officer,” said Richard Renck of Duane Morris LLP, potentially putting executives lower than the C Suite in the crosshairs.
Laster ruled Jan. 25 that a group of pension funds can move forward with sections of their shareholder derivative lawsuit against David Fairhurst, who was fired over sexual harassment allegations. The ongoing case includes other claims against nine current and former board members.
“This decision clarifies that corporate officers owe a duty of oversight,” Laster said in his opinion.
Fairhurst had argued he couldn’t be sued by shareholders—who claimed he ignored red flags about McDonald’s toxic culture—because Delaware courts have found that oversight obligations fall to a board of directors, who monitor corporate officers.
Laster disagreed, saying day-to-day company operations are managed by corporate officers, and therefore they have a duty to identify red flags and address them or report the information to the board.
“The officers are far more able to spot problems than part-time directors who meet a handful of times a year,” he wrote. He added that if officers didn’t owe a duty of oversight to a company’s stockholders, such a ruling would also undermine the board of directors’ statutory authority to hold the officers accountable.
Laster noted that shareholder claims against corporate officers have been gradually increasing since 2004, when lawmakers amended state law and made it somewhat easier to establish Delaware jurisdiction over corporate officers.
The decision comes after the Delaware legislature in July 2022 passed amendments to state statutes that now allow shareholders to add provisions to their corporate charters limiting the personal liability that certain officers have for fiduciary duties.
“There is an overriding dispute between the Chancery and the legislature at where the line should be for officers and directors in terms of bad behavior,” said Paul Weitzel, a professor at the University of Nebraska College of Law.
“This is an expansion in the liability for officers while at the same time the legislature is reducing the amount of liability for officers, and that’s why this is such a weird and poorly timed decision,” he said.
Those amendments don’t extend to derivative lawsuits, however.
Legal scholars say the Jan. 25 decision likely won’t spark a rush of new lawsuits. But it is poised to spark new debate in ongoing cases over how far the liability extends.
For example, Renck asked whether a global plant manager based in Europe for a company incorporated in Delaware could be subject to personal jurisdiction in a derivative lawsuit, even though he’s several levels removed from the company’s CEO or chief operating officer.
It’s clear Laster was talking about C Suite officers, but he doesn’t mention the people below them, Renck said.
“That is, I think, going to be the next thing you’re going to see coming out of this opinion—alright, well, what is an officer? I think people are going to fight about, what is their area of responsibility?” Renck said. “Officers are going read this or they’re going hear about it and say, ‘Well, gosh, what do I have to keep my eyes on going forward?’”
Shareholders alleging that a board or officer failed to engage in adequate oversight or ignored red flags over many years, commonly referred to as Caremark claims, still have a high legal bar to clear, Hamermesh said.
To survive a motion to dismiss, shareholder plaintiffs suing a corporate officer would have to show a company’s board is incapable of objectively resolving their claim against the officer, he said. “And that’s a hard motion to defeat.”
In the McDonald’s case, the board fired Fairhurst and the CEO. Former CEO Stephen Easterbrook, also ousted over personal sexual misconduct allegations, was dismissed from the case last month.
“The board has not been supine in dealing with this, and that’s where the responsibility for discipline and accountability is supposed to come from,” Hamermesh said.
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