Delaware recently delivered two important legal changes that officers, directors and shareholders should be thinking about. First, a Delaware court last month held that officers, like directors, owe their companies a duty of oversight. Second, the Delaware legislature last year authorized companies to amend their charters to immunize officers, as well as directors, for violations of their duty of care.

Taken at face value, the two changes may not interact: it’s possible that violations of the case law duty of oversight, often seen as culpable breaches of the duty of loyalty, cannot be immunized under the statute’s duty of care exculpation, which tends to encompass innocent haplessness.

But other shoes are still to drop in this area that will force interaction between the case law and the statute. Courts could interpret the duty of oversight to encompass duty of care breaches that the statute would immunize and/or the legislature could amend the statute to encompass some duty of oversight activities.

Dynamics in this area are therefore relevant to officers, directors and shareholders as they consider officer liability risks and how to mitigate them, including as they consider charter amendments this proxy season to opt into statutory exculpation.

The recent case involved a complaint by shareholders of McDonald’s alleging that an executive vice president breached the duty of oversight by consciously ignoring red flags, turning a blind eye to repeated sexual harassment (as well as committing such harassment). The executive moved to dismiss the complaint by arguing that the duty of oversight applies to directors, but not officers.

In a scholarly opinion, Vice Chancellor J. Travis Laster rejected this argument. The Vice Chancellor relied on the Caremark line of cases which articulate the duty of oversight for directors. Vice Chancellor Laster held that the rationales behind the duty of oversight apply to officers too, so the duty also applies, narrowed to an officer’s specific scope of responsibility. While the case can thus move forward, it’s too soon to say whether the executive will be liable in money damages for breach.

But this is where the new statutory immunization option comes in for future cases. The statute, section 102(b)(7) of the Delaware General Corporation Law, permits excusing officers’ liability for money damages for violations of the duty of care, but not for the duty of loyalty or certain other violations (and not in derivative suits, those brought by shareholders on the corporation’s behalf, such as McDonald’s). If Caremark and McDonald’s oversight violations breach the duty of loyalty, the statutory immunity is irrelevant, but if they breach the duty of care, it is pivotal.

The case law is not entirely clear on this critical question and it’s likely to continue to evolve on the case-by-case basis favored by the Delaware courts. Caremark itself suggested that the duty of oversight was a species of either the duty of loyalty or the duty of care. Over the years, as Vice Chancellor Laster noted in McDonald’s, the courts increasingly treated it as strictly based on the duty of loyalty. But, as the Vice Chancellor also noted, there is “a hint that care continues to play a role.”

As Delaware courts continue to draw and redraw lines in this area, officers may perceive a degree of liability risk they want to mitigate. In order to attract and retain talented officers, boards and shareholders may find it prudent to support charter amendments under the new 102(b)(7) to immunize officers for ordinary haplessness as well as any potentially exculpable violations of the McDonald’s oversight duties.

Moreover, if Delaware corporate citizens—companies and their officers, directors and shareholders—discern too much uncertainty and risk from the evolving case law, they may turn their attention to the Delaware legislature. After all, the original 102(b)(7) for directors was a legislative response to a court ruling: the Delaware Supreme Court in Smith v. Van Gorkom held directors personally liable for money damages for breach of the duty of care. The legislature, addressing concerns from corporate America that such exposure would prevent talented people from serving as directors, neutralized the fallout.

Meanwhile, expect increased frequency of lawsuits alleging officer violations of the duty of oversight, whether rooted in care or loyalty or both. Cases will begin to fall into some clear categories of loyalty or care violations and exculpable or not. But many cases will fall in between. The uncertainty is probably an argument favoring the charter exculpation. It is certainly a factor to consider.

Officers and directors should also appreciate the fuller context in which these issues will play out. For instance, they might focus, in employment agreements and otherwise, on the scope of each officer’s corporate responsibilities, and ways to demonstrate meeting them for fiduciary purposes. They will also want to consider potential liability and limitations, not only under a 102(b)(7) charter provision but under such employment agreements, D&O insurance policies and indemnification protections. Shareholders should appreciate the nuances and company-specific judgments necessary in this area, and give due deference to related board recommendations.


Authors

Lawrence Cunningham
Special Counsel, New York
lcunningham@mayerbrown.com
+1 212 506 2203

Dr. Ziv Schwartz
Associate, New York
zschwartz@mayerbrown.com
+1 212 506 2290