In a first-of-its-kind ruling from earlier this year, the Delaware Court of Chancery (i) clarified that corporate officers of Delaware corporations (like corporate directors) are subject to the fiduciary duty of oversight, and (ii) held that sexual harassment by an officer constitutes bad-faith conduct breaching the duty of loyalty.1
In In Re McDonald's Corp. Stockholder Derivative Litigation, the plaintiff stockholders alleged that the corporation's former Global Chief People Officer, David Fairhurst, breached fiduciary duties by permitting a "party atmosphere" and "toxic culture" to develop at McDonald's in which sexual harassment and misconduct were condoned, HR was repeatedly nonresponsive to complaints, and employees feared retaliation.
Plaintiffs asserted that Fairhurst's duties included a duty of oversight, which he had allegedly breached by consciously ignoring red flags indicating pervasive sexual harassment and misconduct, and by failing to report alleged misconduct to superiors or to otherwise address it. Plaintiffs also asserted that Fairhurst himself had committed sexual harassment on multiple occasions.
Fairhurst moved to dismiss the duty of oversight claim based on the argument that Delaware law does not recognize such a cause of action against officers, as opposed to directors. Under well-established Delaware law, directors' fiduciary duties include a duty of oversight, which requires them to make good-faith efforts to ensure that effective information and reporting systems exist, and that they not turn a blind eye to red flags signaling misconduct.
Fairhurst's argument failed. In a first for the Court of Chancery, In re McDonald's explicitly held that officers, too, have duties of oversight. The court reasoned that officers are often better positioned than directors to implement reporting systems and to respond to red flags within their areas of responsibility, and that officers play a key role in informing directors of pertinent information. Addressing the scope of oversight duties, the court clarified that a specific officer's duty will be context specific, varying depending on their individual role and area of responsibility.
As applied to Fairhurst, the court sustained plaintiffs' claim for breach of duty of oversight, given their ample and specific allegations supporting inferences that he knew of potential problems (including based on numerous EEOC complaints and related public scrutiny, and on his own alleged participation in the misconduct), and that he acted in bad faith by consciously ignoring red flags at the company.
The court also issued the novel holding that if an officer (or director) personally engages in acts of sexual harassment, and if the corporation is thereby harmed, then the individual will be subject to claims for violation of fiduciary duty. Further, the court ruled that harassment is definitionally not in a company's best interests: "Sexual harassment is bad faith conduct. Bad faith conduct is disloyal conduct. Disloyal conduct is actionable."
The Court of Chancery's decision has important employment- and liability-related implications for corporations and their officers, including especially HR and Compliance executives. In light of this decision, and to minimize risks and help strengthen best practices, companies should consider taking the following steps:
- audit compliance policies to ensure they have been updated;
- monitor and document reporting on compliance issues;
- ensure effectiveness of information/reporting protocol and systems;
- set forth oversight responsibilities in written agreements or policies;
- ensure that executives are sufficiently trained based on areas of responsibility;
- promptly and adequately investigate, elevate, and respond to claims of officer misconduct or noncompliance; and
- review D&O liability insurance coverage and indemnification provisions.
Footnote
1. 289 A.3d 343 (Del. Ch. 2023).
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