January 27, 2023

Caremark: Claim Against Corporate Officer Survives Motion to Dismiss

On Wednesday, the Delaware Chancery Court declined to dismiss fiduciary duty claims against a corporate officer arising out alleged oversight failures that allowed “a corporate culture to develop that condoned sexual harassment and misconduct.” The decision marks the first time that a Delaware Court has applied Caremark’s oversight duties to a corporate officer. This Debevoise memo summarizes the basis for the court’s decision:

In a January 25, 2023 decision (In Re McDonald’s Corp. S’Holder Litig., C.A. No. 2021- 0324-JTL (Del. Ch. Jan. 25, 2023)), the Delaware Court of Chancery declined to dismiss claims that a corporate officer, who led the company’s human resources function, breached his fiduciary duties by “allowing a corporate culture to develop that condoned sexual harassment and misconduct.” The plaintiffs claimed that the officer breached a “Caremark” duty by consciously ignoring “red flags” signaling misconduct. Despite the fact that no prior Delaware case had applied Caremark duties to an officer, the court declined to dismiss the claims, finding as a general matter that corporate officers owe a duty of oversight to an equal, if not greater, extent than corporate directors.

In this case, the court held that the bad faith necessary to support a Caremark claim was supported by particularized factual allegations that the officer had himself engaged in acts of sexual harassment, making it reasonable to infer, in the context of a corporate culture that allegedly condoned sexual harassment, that he consciously ignored red flags about similar behavior by others at the company. Moreover, the court declined to dismiss the claim that the officer’s misconduct itself constituted a breach of the duty of loyalty.

While Delaware recently amended the DGCL to permit corporations to ask stockholders to approve amendments to their charter documents eliminating in some cases officers’ liability in damages for breaches of the duty of care, because Caremark claims involve alleged breaches of the duty of loyalty, those charter amendments aren’t much use when it comes to them.

Kevin LaCroix posted a detailed analysis of this case on the D&O Diary this morning in which he raises some concerns about its potential implications:

My concern here is that in light of this decision, it may be easier for plaintiffs to sustain claims that both officers and directors have breached their duty of oversight. In that regard, I note that academic commentators had already raised the alarm that oversight duty breach claims are not in fact the most difficult kind of claim to sustain, and in fact they increasingly are being sustained with alarming frequency.

But that is not my biggest concern about Vice Chancellor Laster’s opinion. My biggest concern is his brief but nonetheless explosive conclusion that allegations of sexual harassment against a corporate officer can state a claim for breach of fiduciary duty. The possibilities for this conclusion to do mischief are incalculable – they raise the possibility that every sexual misconduct claim will become a Delaware Chancery Court D&O claim brought by shareholders in addition to an employment practices liability claim brought by the victim of the alleged misconduct.

John Jenkins