Main Menu

Court of Chancery Rules That Corporate Officers Have a Duty of Oversight Within Their Corporate Area of Responsibility

Articles & Publications

February 8, 2023
By: Albert Manwaring IV
Delaware Business Court Insider

Delaware courts have firmly established that directors have oversight duties under the good-faith component of the fiduciary duty of loyalty. In the seminal Caremark decision, the Delaware Court of Chancery held that directors have an oversight duty to ensure that “information and reporting systems exist in the organization that are reasonably designed to provide to senior management and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to reach informed judgments concerning the corporation’s compliance with the law and business performance.” See In re Caremark International Derivative Litigation, 698 A.2d 959, 970 (Del. Ch. 1996). The court explained that a breach of a director’s oversight duty necessary to demonstrate a lack of good faith requires a “sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists … .” Ten years later, in Stone v. Ritter, the Delaware Supreme Court recognized two types of Caremark oversight claims against directors: “(a) the 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.” 911 A.2d 362, 370 (Del. 2006). While the Stone v. Ritter decision only recognized the oversight duties of directors, three years later, the Delaware Supreme Court ruled that “the fiduciary duties of officers are the same as those of directors.” See Gantler v. Stephens, 965 A.2d 695, 709 (Del. 2009).

The Gantler decision did not address oversight duties specifically. But by equating officer duties with director duties, Gantler paved the way for the Court of Chancery’s recent decision in In re McDonald’s Corp. Shareholder Derivative Litigation, No. 2021-0324-JTL (Del. Ch. Jan. 25, 2023), which concluded that like directors, corporate officers also have a duty of oversight premised on the duty of loyalty within their corporate area of responsibility. To establish a breach of an officer’s duty of oversight, the officer “must consciously fail to make a good faith effort to establish information systems, or the officer must consciously ignore” and fail to address and report “red flags” upward through the corporate chain of command. The court emphasized that while the duty of oversight applies equally to officers, the duty is context-driven, such that the application of the oversight duty to officers may differ from that of directors, who have responsibility to oversee the company as a whole, and among officers, depending on the officer’s area of responsibility. The court explained, for example, that some officers, “like the CEO, have a companywide remit.” Other officers “have particular areas of responsibility, and the officer’s duty to make a good faith effort to establish an information system,” and “to address and report upward about red flags,” only applies within that officer’s corporate area of responsibility. The court noted, however, that “a particularly egregious red flag might require an officer to” report upward even if the red flag “fell outside the officer’s domain.”

In holding that officers also have an oversight duty, the court reasoned that a contrary holding would create a gap in the ability of directors to hold officers accountable to collect information and provide a board with timely reports within their area of responsibility, which reports are essential for the board to in turn, exercise its oversight duties over the corporation as a whole. In short, for directors to perform their oversight duty, the board must be able to hold officers accountable for a failure to perform the officers’ oversight duties within the officers’ area of responsibility, and if this failure caused the corporation harm, the board should be able to bring a claim for breach of fiduciary duties against officers to hold them accountable. Moreover, the court reasoned that while Section 141(a) of the DGCL provides that the “business and affairs of every corporation … shall be managed by or under the direction of a board of directors, officers, who manage the operations of the company directly day-to-day, may be in a better position than directors “to identify red flags and either address them or report upward to more senior officers or to the board.”

Turning to the oversight claims against McDonald’s former executive vice president and global chief people officer, defendant David Fairhurst, the court held that plaintiffs had adequately pleaded a claim for breach of Fairhurst’s duty of oversight. In his executive position, Fairhurst had “day-to-day responsibility for ensuring that one of the largest employers in the world provided its employees with a safe and respectful workplace.” With responsibility for the department charged with promoting a safe and respectful workplace, Fairhurst had an obligation “to know what was going on with the company’s employees.” Viewed through the plaintiff-friendly standard of review on a motion to dismiss under Court of Chancery Rule 12(b)(6), the court found that the complaint contained sufficient allegations that Fairhurst had himself engaged and been disciplined for sexual harassment, and that his department had turned a blind eye to sexual harassment that permeated the management culture of the iconic company, culminating in a 10-city strike and resulting in a multitude of lawsuits. Accordingly, the court found that these allegations supported a reasonable inference that Fairhurst knew about and played a role in the sexual harassment and misconduct, and consciously ignored and failed to address red flags in bad-faith and disloyally in breach of his oversight duties. In sum, assuming the Delaware Supreme Court does not weigh in to overturn or limit the decision, McDonald’s will serve as a landmark decision under Delaware corporate law, complementing the court’s director-oversight decision in Caremark, and establishing that officers also have oversight duties.

Delaware Business Court Insider | February 8, 2023

Back to Page