By: William Wilson
History of the Caremark Duty within Delaware
The duties owed by the board of directors of corporations within the State of Delaware have changed substantially within the last fifty years, moreover, the law in Delaware half a century ago did not place any duty on the board of directors of a corporation to implement a kind of system to help monitor the corporation’s regulatory compliance; without a reason to believe that fraud or wrongdoing has occurred. [1] This absence of duty for the board of directors began to change within the 1990’s in the landmark In Re Caremark case, where Chanceller William Allen’s stated within his opinion that directors “might be held liable if they knew or should have known that violations of law were occurring in the corporation, and if they then failed to take steps in good faith to prevent or remedy the situation.” [2] Even with this, Chancellor William Allen believed that it would remain extremely difficult for a plaintiff to win a judgment against the board of directors of a corporation. [3]
Throughout the late 1990’s and early 2000’s, Chancellor Allen’s sentiment was correct and the doctrine regulating board of directors based on their regulatory systems was slow moving and there were very minimal changes by way of case law or through laws and regulations passed by the Delaware State legislature. [4] This began to change in 2006 with the Stone v. Ritter case, when the Delaware Supreme Court added to a growing body of case law focused on good faith. [5] Furthermore, the Delaware Supreme Court held that for director oversight liability to be applicable, then there must be a showing that the board of directors completely failed to implement any type of information or reporting system to the board of directors, or after implementing such a system, the conscious failure to monitor or oversee the operations of the board. [6]Which would in turn disable the board from being informed of the risk or problems that may require their action. [7] For a plaintiff to be able recover under this standard, the plaintiff must show that the board of directors knew that they were not discharging their applicable fiduciary obligations to the corporation. [8] This showing of a ‘“conscious disregard’ for discharging fiduciary obligations in good faith is a breach if the duty of loyalty.”[9]
In Re McDonald’s Shareholder Derivative Litigation
In 2023, the Delaware Court of Chancery dealt with In Re McDonald’s Shareholder Derivative Litigation, which is important case for the future of the Caremark duty within the state of Delaware. [10] Within this case, the McDonald’s Corporation had Stephen Easterbrook, as CEO, and David Fairhurst as Global Chief People Officer, subsequently, these two created an atmosphere within the corporate structure that resembled more of a gentlemen’s club than a major world corporation. [11] Furthermore, with the changing demeanor of the corporation, Human Resources leaders frequently ignored complaints of misconduct between employees and executives as the Human Resources team reported directly to Mr. Easterbrook.[12] When Mr. Fairhurst was found sexually assaulting an employee, Mr. Easterbrook changed the zero tolerance rule within the corporation and just decided to punish Fairhurst by taking 50% of his target incentive. [13] Once the board fully learned of the extend of inappropriate relationships that Mr. Easterbrook and Mr. Fairhurst were engaging in, they terminated them from their positions.[14] This litigation is brought by the shareholders, which they assert that the board of directors breached their fiduciary duties by “opting to terminate Easterbrook without cause” as well as not addressing the known misconduct from Easterbrook and Fairhurst earlier. [15]
This court held that the board of directors can be liable under Caremark for sexual harassment and misconduct, it is an issue of liability due to a failure to oversee the corporate directors, therefore, conceptually it is the same issue. [16] The plaintiff’s here set their central claim on the red flags prong of the analysis, which under this analysis the court looks to see whatever actions taken by the officers or directors was done in good faith and on an informed basis, which is already presumed based on the business judgment rule; but this presumption can be rebutted by a showing of an inference of bad faith.[17] The court held here, that there was a substantial amount of red flags that the directors and officers should have been made aware of based on the party atmosphere created in corporate buildings as well as the multiple reported sexual misconduct instances from Fairhurst. [18]
The second part of the red flags prong is that whether the directors or officers took affirmative steps to remediate the red flags once they had actual knowledge of the issues. The court held here that the board of directors did take the necessary actions to remedy the issues when they were fully made aware, as can be seen that once the board learned of Easterbrook’s involvement in an inappropriate relationship with and employee the board terminate him without cause. [19]Subsequently, the board also terminated Fairhurst after learning that he violated the terms of his Lance Chance Letter, however, unlike Easterbrook he was terminated with cause. [20] Therefore, the court dismissed the shareholders suit pursuit to Rule 12 (b) (6), which is that the shareholder plaintiffs failed to state a claim on which relief can be granted. [21]
Caremark duty within Delaware after In Re McDonald’s
After the In Re McDonald’s case, within the state of Delaware officers of a corporation now have the same duty of oversight that the board of directors have. [22]Officers within corporation now will be liable for violating a fiduciary duty if, within their role or responsibility, they have made a conscious failure to “make a good faith effort to establish information reporting systems, or they consciously ignore red flags that arise from those reporting systems or otherwise come to their attention. [23]Even with the liability of officers being expanded to the same level as the board of directors, it is unlikely that it will result in more suits or judgments for plaintiffs as the state recently added an amendment to the Delaware General Corporation law for the personal liability of officers who violate their fiduciary duties that allow corporations to amend their certificate of incorporation to then equalize the protections that are currently afforded to the board of directors to now extent to the corporate Officers. [24] Therefore, even though the same liability for violating fiduciary duties that applies to directors now also extents to corporate officers, it is unlikely to overall change the corporate landscape because corporate officers now enjoy the same protections that directors have previously held; which is that to be liable a plaintiff must show that there was a conscious disregard of a known fiduciary duty.
About the Author
William is a third-year law student at Widener University Law School and serves as a Staff Editor for Volume 51 of the Delaware Journal of Corporate Law. William Graduated from Salisbury University in 2023, earning his bachelor’s degree, cum laude, with a major in political science and a minor in psychology. While in law school, William works at Balaguer, Milewski, & Imbrogno LLP, in Delaware as a law clerk. After law school, William plans to take the bar exam in Maryland.
[1] Elizabeth Pollman, The Evolution of Delaware’s Corporate Oversight Doctrine., The Regul. Rev. (October 5, 2020), https://www.theregreview.org/2020/10/05/pollman-evolution-delaware-corporate-oversight-doctrine/.
[2] Id.
[3] Id.
[4] Id.
[5] Pollman, supra note 1.
[6] Pollman, supra note 1.
[7] Id.
[8] Id.
[9] Id.
[10] In re McDonald’s Corp. Stockholder Derivate Litig., 291 A.3d 652 (Del. Ch. 2023).
[11] Id. at 665.
[12] Id. at 665–666.
[13] Id. at 666–667.
[14] In re McDonald’s Corp., 291 A.3d at 669.
[15] Id. at 672–673.
[16] In re McDonald’s Corp., 291 A.3d at 667–677.
[17] Id. at 680.
[18] Id. at 682.
[19] Id. at 684.
[20] In re McDonald’s Corp., 291 A.3d at 684.
[21] Id. at 701.
[22] For the First Time, a Delaware Court Holds That Corporate Officers Have a Duty of Oversight, Covington & Burling LLP (March 6, 2023), https://www.cov.com/en/news-and-insights/insights/2023/04/for-the-first-time-a-delaware-court-holds-that-corporate-officers-have-a-duty-of-oversight.
[23] Id.
[24] Id.
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