Delaware Court of Chancery Allows Caremark Claim

26 January 2023
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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.

In one sense the decision, although one of first impression in Delaware, is not surprising: the Delaware Supreme Court has squarely held that corporate officers owe the same fiduciary duties as corporate directors. However, applying to officers a fiduciary duty of oversight—itself a judicially derived attribute of the duty of loyalty—is complex because, while the oversight role of directors is plenary, and therefore relatively homogeneous, the comparable roles of officers are not. The court in McDonald’s recognized the situational aspects of officers’ oversight duties: “Some officers, like the CEO, have a company-wide remit. Other officers have particular areas of responsibility, and the officer’s [Caremark] duty only applies within that area,” although a “particularly egregious red flag might require an officer to say something even if it fell outside the officer’s domain.”

In addition to relying on the general proposition that officers owe the same fiduciary duties as directors, the court noted the additional duties officers owe as agents who report to the board of directors. According to the court, these duties include an obligation to provide information to a superior officer or the board, where that information is material to the scope of the agent’s duties. The court called this “an indispensable part of an officer’s job” and “an essential link in the corporate oversight structure.”

Will the McDonald’s decision, if upheld, represent a sea change in the liability landscape? Caremark has not led to an avalanche of claims against directors, and such claims remain, in the words of the court in Marchand, “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” That difficulty stems in large part from the challenge of pleading facts sufficient to support a reasonable inference that the directors acted in bad faith. The day-to-day responsibility of officers, as compared to the significantly more limited role of the board, may provide greater opportunity to plead facts from which an officer’s bad faith may be inferred, especially when supported by materials obtained through books and records demands (which can be expected in this context to seek emails and other management-level materials).

Given the likelihood that a Caremark claim against an officer will be accompanied by fiduciary duty claims against directors, it may be the unusual case in which adding a Caremark claim against an officer materially changes the overall liability picture. Nonetheless, the factual nature of these claims as applied to officers seems likely to make them inviting targets for plaintiffs’ lawyers.