Delaware Chancery Court extends Caremark oversight duties to corporate officers
On January 25, the Delaware Court of Chancery extended the duty of oversight beyond corporate directors to corporate officers. In re McDonald’s Corporation Stockholder Derivative Litigation, No. 2021-0324, 2023 WL 407668 (Del. Ch. Jan. 25, 2023). This decision applies important obligations to officers, including compliance officers, and underscores the importance of implementing strong compliance programs.
Background on Caremark claims
In the seminal Caremark decision, the Delaware Court of Chancery set forth conditions for a corporate director’s breach of their fiduciary duty of loyalty for oversight failures. Known as the Caremark test, a director’s lack of oversight may breach their fiduciary duty of loyalty under two factual prongs: “(a) directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.” The Caremark court also made clear that part of a director’s fiduciary duty requires implementing and overseeing compliance programs.
To state a Caremark claim, plaintiffs must plead with particularity that “a majority of the directors may be liable for oversight failures,” which the Court of Chancery has noted is “extremely difficult” to plead. In re Boeing Company Deriv. Litig., No. 2019-907, 2021 WL 4059934, at *1 (Del. Ch. Sept. 7, 2021). However, since 2019, the court increasingly has permitted Caremark claims to survive a motion to dismiss, exposing corporate directors to a higher likelihood of liability.
The court’s extension of Caremark oversight duties to corporate officers
In McDonald’s, the Delaware Court of Chancery declined to dismiss claims that a corporate officer – the head of the corporation’s human resources functions – breached his fiduciary duties by “allowing a corporate culture to develop” that condoned misconduct.
Plaintiffs allege, in part, that the officer owed and breached a Caremark duty by ignoring misconduct signals. The officer moved to dismiss the claim, arguing Delaware law did not impose oversight duties on corporate officers.
The Court of Chancery disagreed, “clarif[ying] that corporate officers owe a duty of oversight.” The court first looked to Caremark’s reasoning for extending oversight duties to directors, looking to factors such as: (1) the seriousness corporate law views a corporate board’s role, (2) a board’s need for relevant and timely information to meet its supervisory and monitoring role; and (3) the importance of implementing compliance systems to receive credit under the federal Organizational Sentencing Guidelines. The court reasoned that these factors similarly apply to officers – “the day-to-day managers of [an] entity” – meaning “it also makes sense for the Red-Flags Obligation to extend to [them].”
The court also addressed officers’ “additional duties . . . as agents who report to the board” as “provid[ing] the foundation for” an oversight duty. This obligation dovetails with “[a]nother critical part of an officer’s job,” being “to identify red flags, report upward, and address them if they fall within the officer’s area of responsibility.”
The court recognized, however, that “the situational application” of a director’s or officer’s duties “will [not] be the same.” Rather, an oversight duty is “context-driven.” “Directors,” the court explained, “are charged with plenary authority over the business and affairs of the corporation.” Officers, however, may have “a more constrained area of authority.” Therefore, the scope of responsibility will differ between a CEO or CCO – who have “a company-wide remit” – and other officers with “particular areas of responsibility.” However, the court did not foreclose the possibility that “a particularly egregious red flag might require an officer to say something even if it fell outside the officer’s domain.” At bottom, as with corporate director oversight duty inquiries, establishing an officer’s breach “requires pleading and later proving disloyal conduct that takes the form of bad faith.”
Forecasting McDonald’s impact and liability for officers
The McDonald’s bottom line – that directors and officers both owe a duty of oversight – may not surprise some. As the Court of Chancery explained, “officers are far more able to spot problems than part-time directors who meet a handful of times a year.” However, the decision raises important questions about the scope of an officer’s personal responsibility, particularly in implementing compliance programs.
The McDonald’s decision further entrenches a chief compliance and ethics officer’s duty to implement and enforce a compliance and ethics program. Now, failure to do so may result in a breach of an officer’s fiduciary duty of loyalty – which may extend beyond compliance officers, particularly for companies that do not have a chief compliance officer. But as the Delaware Supreme Court noted in addressing director liability, the relevant inquiry is whether a reasonable compliance system is in place, not whether the system alerted directors to compliance violations. So too, a compliance officer’s primary concern should be implementing strong and appropriate controls.
Furthermore, the court’s sweeping statement that CCOs “likely will have company-wide oversight portfolios” underscores the importance of implementing strong controls, which will cut against a finding of bad faith. Compliance officers should be empowered to perform and independently exercise control over company-wide compliance functions, such as performing risk assessments, implementing policies, conducting trainings, and monitoring, auditing, and disciplining employees.
Finally, as a practical matter, an officer’s larger day-to-day activity – compared with a director’s limited actions and responsibilities – may ease plaintiffs’ difficulties in pleading facts sufficient to infer a Caremark claim. Although McDonald’s addressed claims only at a motion to dismiss stage, meaning it has not concluded whether misconduct or oversight failures occurred, its general principles nonetheless may impact corporate compliance frameworks. Regardless of whether any pleading sea changes come to fruition, at a minimum, Plaintiffs likely will include officer-concerned Caremark claims wherever director Caremark claims typically were pled. Of course, nothing in the decision obviates the need for plaintiffs to fulfill all of the procedural prerequisites to filing a derivative claim.
Learn more about the implications of the DE Chancery Court’s decision on your business and other compliance concerns and controls by contacting the authors or your usual DLA Piper attorney.
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