In a significant and far-reaching development in Delaware corporate law, the Delaware Court of Chancery recently held in In re McDonald’s Corporation Stockholder Derivative Litigation, C.A. No. 2021-0324-JTL (Del. Ch. Jan. 25, 2023), that corporate officers owe a duty of oversight to the corporation. Prior to this ruling, it was unclear if claims for breach of the fiduciary duty of loyalty based on a lack of oversight applied to corporate officers of Delaware corporations. This decision is an extension of the line of Delaware decisions first appearing in In re Caremark Intern. Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), which established liability to directors for failing to properly discharge their duty of oversight and has broad implications for Delaware corporations and their fiduciaries across many legal areas.

Under the Caremark test, liability to directors for failing to properly discharge their duty of oversight arises where directors either:

(a) failed to implement any reporting or information system or controls; or

(b) having implemented such a system or controls, directors consciously failed to monitor or oversee its operations and therefore were not informed of risks or other problems requiring their attention.

In its decision, the McDonald’s court held that corporate officers owe a duty of oversight to the corporation. This ruling expands the original Caremark holding that directors have a duty of oversight to the corporation. The decision clarifies an important but previously ambiguous area of Delaware corporate law related to fiduciary duties.

The McDonald’s case involved a suit related to the Executive Vice President and Global Chief People Officer at McDonald’s Corporation who oversaw the company’s global human resources department. His area of responsibility for the company was to make sure its employees were provided with a safe and respectable workplace. In a derivative action on behalf of McDonald’s, stockholders of the company sued alleging that, as a corporate officer responsible for labor and human resources, this executive officer breached his fiduciary duty of oversight by allowing a corporate culture to develop that fostered sexual harassment, misconduct and a toxic workplace, and by engaging in sexual harassment and misconduct himself which led to his eventual termination in 2019.

The McDonald’s Court indicated that the duty of oversight applicable to officers will apply in a different manner than the blanket duty of oversight that applies to directors. Officers with broad areas of responsibility, such as a Chief Executive Officer or Chief Compliance Officer, will have company-wide oversight responsibilities while officers with more limited areas of authority will have a correspondingly limited duty of oversight. As with directors of Delaware corporations, officers will continue to receive the deferential presumption that their actions (or omissions) were made in good faith unless intentional or bad faith conduct is well plead. In McDonald’s, the Plaintiff survived a Motion to Dismiss, because the Chancery Court could infer intentional conduct when the officer himself was alleged to have engaged in it. Thus, as with a director’s duty, liability for an officer’s breach of its duty of oversight will require a showing of bad faith by such officer. For a claim involving a breach of an officer’s duty of oversight to proceed, a plaintiff will need to establish that the officer consciously failed to make a good faith effort to establish information reporting systems or consciously ignored red flags.

This decision, delivered in connection with a motion to dismiss, is subject to appeal and may be modified by future rulings. In the interim, boards of directors and officers of Delaware corporations and alternative entities should consider the implications of this decision within their organizations as this decision has numerous implications related to matters of corporate governance, fiduciary duties, employment law and corporate litigation.

Key takeaways:

Duty of Oversight. The duty of oversight is extended to corporate officers.

Who is an “Officer”? One open question from this decision is who is considered an officer under Delaware law? Applying the ruling broadly means that many employees could be designated as officers with corresponding fiduciary duties to the corporation. Corporate boards may wish to implement policies that require documentation of who is an officer of the corporation and the responsibilities of such officer.

Information Monitoring Systems. Corporate officers should identify areas of mission-critical legal compliance within the scope of the officer’s responsibilities and establish information monitoring systems that bring this information to the officer’s attention.

“Red Flag” Issues. Corporate officers should pay attention to any red flag issues that may evidence non-compliance with applicable legal requirements and take prompt action to report those issues to their designated superiors.

More Derivative Litigation? Although the McDonald’s court indicated that it does not believe this decision will lead to an increase in stockholder litigation, corporate counsel should be mindful of this additional avenue for legal action against a corporation.

Books and Records Demands. Boards of directors and corporate officers may want to review policies related to documenting officer performance of their responsibilities. To the extent a Delaware General Corporation Law Section 220 books and records claim is made against the corporation, records should be available demonstrating an officer’s good faith efforts in such officer’s area of responsibility including that the officer had a functioning oversight system and that the officer addressed any red flag issues. Detailed documentation can help show that officers discharged their obligations in good faith.