More than 25 years ago, the Delaware Court of Chancery held that corporate directors owe a "duty of oversight," which requires that directors in good faith both (a) implement a reasonable reporting or information system or controls, and (b) monitor or oversee that system or controls' operation. Stockholders suing derivatively have asserted such so-called "Caremark" claims with increasing frequency in recent years, perhaps most notoriously in the claims successfully asserted against Blue Bell Creameries USA, Inc.'s directors in connection with that ice cream manufacturer's listeria outbreak. In this week's In re McDonald's Corporation Stockholder Derivative Litigation decision, the Delaware Court of Chancery held for the first time that corporate officers also owe a fiduciary duty of oversight.
In In re McDonald's, stockholders suing derivatively on behalf of the company asserted breach of fiduciary duty claims against several former and current officers and directors, including David Fairhurst. Fairhurst had served as Executive Vice President and Global Chief People Officer of McDonald's Corporation from 2015 until 2019, during which time the company faced increasing public scrutiny and litigation concerning problems with sexual harassment and misconduct throughout the organization. Fairhurst, who in his role oversaw the company's human resources function, was himself disciplined and ultimately terminated for sexual harassment. The stockholders alleged that Fairhurst (1) breached his duty of oversight by exercising inadequate oversight in response to risks of sexual harassment and misconduct at the company and its franchises, and (2) breached his duty of loyalty by personally engaging in acts of sexual harassment.
Fairhurst moved to dismiss, arguing in part that Delaware law did not impose on officers any obligation comparable to the duty of oversight imposed on directors. Vice Chancellor Laster disagreed. While acknowledging that "to date, Delaware cases have only applied the duty of oversight to directors," the Court held that the reasons for that duty's application to directors applied equally to officers and noted the Delaware Supreme Court's prior pronouncement that "the fiduciary duties of officers are the same as those of directors."
Importantly, while the Court held that officers and directors both owe duties of oversight, it also held that the particular oversight required for any officer would depend on that officer's particular role and may be narrower than for a director. "Although the duty of oversight applies equally to officers, its context-driven application will differ." Some officers, like the CEO or the Chief Compliance Officer, "likely will have company-wide oversight portfolios." Other officers have particular areas of responsibility, and the officer's duty only applies within that area. "For example, the . . . Chief Legal Officer is responsible for legal oversight and for making a good faith effort to establish reasonable information systems to cover that area." An officer's duty to address and report serious misconduct (i.e., red flags) generally only exists within the officer's area, although a "sufficiently prominent" red flag—for example, credible information that the corporation is violating the law—might require an officer to act even if it fell outside the officer's domain.
As with the director's duty of oversight, establishing a breach of an officer's duty of oversight requires pleading, and later proving, disloyal conduct that takes the form of bad faith. That is, the officer must consciously fail to make a good faith effort to establish information systems, or the officer must consciously ignore red flags. Turning to the facts of the case before it, the Court concluded that plaintiffs had sufficiently pleaded the existence of red flags indicating that sexual harassment occurred at the company, facts supporting a reasonable inference that Fairhurst knew about the red flags, and sufficient facts that Fairhurst acted in bad faith by engaging in several acts of sexual harassment himself and overseeing a human resources department that, according to statements from several employees, turned a blind eye to complaints about sexual harassment. The court noted that "[w]hen a corporate officer himself engages in acts of sexual harassment, it is reasonable to infer that the officer consciously ignored red flags about similar behavior by others."
In addition to its holding expanding the duty of oversight to include officers, the Court also held that plaintiffs sufficiently pleaded a claim that Fairhurst's alleged personal engagement in acts of sexual harassment constituted a breach of the duty of loyalty. In so holding, the Court rejected potential concerns about whether, as a matter of policy, a claim for breach of fiduciary duty should extend to acts of sexual harassment, including concerns that the ruling would "open the floodgates to employment-style litigation" in the Court of Chancery. "When engaging in sexual harassment, the harasser engages in reprehensible conduct for selfish reasons. By doing so, the fiduciary acts in bad faith and breaches the duty of loyalty. . . If an officer or director personally engages in acts of sexual harassment, and if the entity suffers harm, then either the governing body of the entity (or, if necessary, a plaintiff acting properly on its behalf) should be able to assert a claim for breach of fiduciary duty in an effort to shift the loss that the entity suffered to the human actor who caused it."
In re McDonald's Corporation Stockholder Derivative Litigation breaks new ground by expanding the duty of oversight to include corporate officers and by holding that an officer's own acts of sexual harassment constitute a breach of the duty of loyalty. This case underscores the importance for directors, and now corporate officers, to make a good faith effort to implement information reporting systems or controls and to address and report upward about serious misconduct. As the Court explained in discussing Fairhurst's alleged disregard of his oversight duties: "He was supposed to have his ear to the ground and be knowledgeable" about his area of responsibility, and upon learning of red flags he "should have been figuring out whether something was seriously wrong and either addressing it or reporting it upward."
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