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Chancery Dismisses Oversight Claim Based on Board’s Response to Red Flags

In re McDonald's Corp. Stockholder Derivative Litig., CA No. 2021-0324-JTL (Del. Ch. March 1, 2023)
A plaintiff can plead an oversight claim against a board by alleging particularized facts to support an inference that the directors either: (1) utterly failed to implement a reporting or information system or controls or (2) consciously failed to monitor or oversee the business and, as a result, disabled themselves from being informed of problems or risks that required their attention. A "prong-two" failure to monitor Caremark claim, or "red flags" claim, requires that the plaintiff plead that the board's information system generated red flags and that the board subsequently failed to respond and address the red flags.

Here, the plaintiffs alleged that the director defendants, in breach of their duty of oversight, knew about evidence of a toxic corporate culture that condoned sexual harassment and misconduct and acted in bad faith by failing to address it. The Court of Chancery found that the plaintiffs had pled facts sufficient to support an inference that the director defendants were on notice of sexual harassment and misconduct that could harm the company and, therefore, satisfied the first element of a “red flags” claim for breach of the duty of oversight. The Court held, however, that the plaintiffs had not plead facts sufficient to support an inference that the directors failed to respond to the red flags. Rather, the director defendants had taken steps to address the misconduct, including “ (i) hiring outside consultants, (ii) revising the Company’s policies, (iii) implementing new training programs, (iv) providing new levels of support to franchisees, and (v) taking other steps to establish a renewed commitment to a safe and respectful workplace.” The Court explained that while these steps may not have solved the problem, the directors’ steps to attempt to remedy the situation was sufficient to negate an inference of bad faith. Accordingly, the Court concluded that the plaintiffs had failed to state a claim against the directors for breach of the duty of oversight and dismissed the claim.

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