McDonald’s: Corporate Officers Served a Combo of Duties

February 7, 2023 - On January 26, 2023, the Delaware Court of Chancery issued a decision in In re McDonald’s Corp. Stockholder Derivative Litigation,¹ clarifying the scope of corporate officers’ fiduciary duties of oversight and loyalty.  The plaintiffs, who are McDonald’s shareholders, have asserted derivative breach of fiduciary duty claims against the McDonald’s board of directors and certain of the Company’s officers, claiming that the directors and officers breached their fiduciary duties by allowing the proliferation of widespread sexual harassment at the Company and, in certain instances, actively trying to conceal the extent of the misconduct and engaging in misconduct themselves. 

Although all the defendants have moved to dismiss the claims against them on various grounds, the recent decision only addresses one ground for dismissal argued by one defendant, David Fairhurst, McDonald’s former Chief People Officer.  Plaintiffs allege that Fairhurst breached his fiduciary duties by “engag[ing] in inappropriate conduct with female employees and exercise[ing] inadequate oversight in response to risks of sexual harassment and misconduct at the Company and its franchises.”² Fairhurst moved to dismiss the claims against him for failure to state a claim, primarily on the grounds that Delaware law does not recognize oversight claims—often referred to as “Caremark” claims based on the seminal case in this area³ —against corporate officers, as distinguished from members of the board of directors.  The Court denied the motion, and found that corporate officers are, in fact, subject to claims for breach of fiduciary duty based on a failure of oversight. 

Corporate Officers’ Oversight Duties 

Under Caremark and its progeny, directors must ensure that the corporation they oversee has effective compliance and reporting systems to flag misconduct, and directors must respond to any “red flags” indicating wrongdoing.⁴  Notably, it has long remained unclear whether officers who are not directors of the corporation also owe such a duty, given that oversight has traditionally been considered to be the province of a company’s board of directors.⁵ McDonald’s resolves this question, by making clear that officers of Delaware corporations “owe a fiduciary duty of oversight as to matters within their areas of responsibility.”⁶

However, the Court in McDonald’s recognized that even though directors and officers both owe oversight duties, “the situational application of [oversight duties]” will not be the same for directors and officers, because officers “regularly operate in different contexts than directors.”⁷ Specifically, the Court noted that the scope of an officer’s duty of oversight could be narrower than a director’s duty of oversight, because “the board has oversight duties regarding the corporation as a whole.”⁸  But officers (with the exception of the CEO and COO) typically have a more limited remit and are only responsible for a specific area of corporate operations.  Therefore, officers need only make a good faith effort to establish compliance systems within the area of the company under their authority.⁹  Likewise, officers’ primary duty to monitor “red flags” and report upward is within their area of responsibility—although they may also have a responsibility to report red flags outside of their area of responsibility if the underlying misconduct is “particularly egregious” or “sufficiently prominent,” such as where an officer “receives credible information indicating that the corporation is violating the law[.]”¹⁰

Delaware law presumes that directors and officers act in good faith. “As with directors, officers only will be liable for violations of the duty of oversight if a plaintiff can prove that they acted in bad faith and hence disloyally." ¹¹  As other Delaware decisions have stated, such a showing of bad faith is “rare” and requires an “extreme set of facts,” whereby the fiduciary “intentionally fails to act [] demonstrating a conscious disregard for his [or her] duties.”¹²

Employee Misconduct As Breaches Of Loyalty

Also of note is the Court’s holding that employee misconduct by an officer—in this instance, alleged sexual harassment—can constitute a breach of the officer’s fiduciary duty of loyalty.¹³  As the Court pithily put it, “Sexual harassment is bad faith conduct. Bad faith conduct is disloyal conduct. Disloyal conduct is actionable.”¹⁴  Traditionally, the duty of loyalty has been triggered in cases of corporate malfeasance (e.g., active disregard of corporate responsibilities, fraud, diversion of corporate assets).  The McDonald’s decision expands the duty to encompass workplace misconduct typically addressed under the rubric of employment law, and raises the question of whether employment law claims against officers will routinely be repackaged as breach of fiduciary duty claims brought by shareholders and subject to jurisdiction in the Court of Chancery.¹⁵ 

Takeaways

Given that the McDonald’s decision suggests potential new areas of liability for corporate officers, a natural reaction may be to give additional focus to the recent amendments to Delaware’s corporate code to allow corporations to exculpate officers from monetary liability for certain breaches of fiduciary duty.  It should be noted, however, that exculpation is not available for claims involving intentional misconduct or breaches of loyalty, nor does it apply to derivative claims—i.e., it would not protect against the type of claims at issue in McDonald’s.  

Strengthening controls and reporting systems may offer better protection against such claims. This could include (i) ensuring that officers with supervisory responsibility over specific corporate areas take steps to monitor compliance in those areas; (ii) properly responding to red flags and ensuring any indicia of misconduct are elevated to the appropriate levels; and (iii) understanding that officers have a duty to report any serious misconduct even if outside their direct purview (it’s not “somebody else’s problem”).