Delaware recently amended its General Corporation Law to permit corporations to adopt provisions in their articles of incorporation allowing exculpation of their officers (in addition to the longstanding permission to have exculpation clauses applicable to directors):
The officer liability exculpation provision is not self-effectuating; instead, the amendment to Delaware law allows companies to take action to adopt exculpation provisions that protect covered officers from personal liability on the same basis as directors—that is, for all fiduciary duty claims other than breaches of the duty of loyalty, intentional misconduct or knowing violations of law—with an additional exception that claims against officers will not be barred “in any action by or in the right of the corporation.”
Under the newly amended provision of Delaware law, covered officers eligible for such exculpation from liability, if implemented by the corporation, will include the president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, controller, treasurer or chief accounting officer, the company’s most highly compensated executive officers as identified in SEC filings and certain other officers who have consented (or deemed to have consented) to be identified as an officer and to service of process. Companies and boards themselves will retain the right to bring appropriate actions against officers, and this additional exception will permit stockholder derivative claims against officers for breach of the duty of care to continue to be brought if demand requirements are met.
Bloomberg reported today that:
A Nov. 4 lawsuit against Fox Corp. over its adoption of the protection highlights the question of how some shareholders might respond. ...
“Due care claims targeting officers are the latest result of the shareholder plaintiffs’ bar’s efforts to develop litigation tactics that offer potentially lucrative fee awards” in mergers and acquisitions lawsuits, according to a research paper, written last year by two former Delaware Supreme Court justices and a University of Pennsylvania law professor. ...
Fox was sued by the Electrical Workers Pension Fund, Local 103, I.B.E.W. in what may be the first lawsuit related to the new liability shield. The pension fund’s legal challenge stems from Fox’s dual-class voting structure, which generally gives no voting rights to holders of Class A common stock.
The pension fund argues that, as a Class A shareholder, it has the right under Delaware law to vote on the change.There’s early momentum behind adoption of the provision.
Keith Paul Bishop explains in more detail:
The complaint does not challenge the statutory amendment. Rather, it challenges the procedure by which Fox Corporation adopted the amendment. According to the complaint, Fox Corporation has a dual class share structure and the amendment was approved by the voting shares but not the non-voting shares. The plaintiff hinges its case on Section 242(b)(2) of the Delaware General Corporation Law which provides that holders of a class of stock are “entitled to vote as a class upon a proposed amendment, whether or not entitled to vote thereon by the certificate of incorporation, if the amendment would . . . alter or change the powers, preferences, or special rights of the shares of such class so as to affect them adversely.” According to the plaintiff, the right to seek judicial relief to hold officers accountable for reckless or grossly negligent behavior is a component of the “bundle of rights” appurtenant to the non-voting stock. Therefore, the amendment required the affirmative vote of the non-voting stock. It remains to be seen how the Court of Chancery will deal with this novel theory.
California does not presently permit the articles of incorporation to include a provision exculpating officers. If it did, I don't think that the plaintiff's argument would succeed in the case of a California corporation.
In an earlier post, Bishop questioned the legal basis under which Delaware purports to authorize the exculpation of officers. He pointed out that the relationship between the officers and the corporation is subject to the law of agency and the choice of laws principals pertaining thereto. For example, an officer might have an employment agreement governed by the law of a state other than Delaware. Even without an express choice of law provision, the employment arrangement may be governed by the substantive law of another state.
Yet, if Bishop is correct, doesn't that suggest that the longstanding rules on indemnifying officers set out in DGCL section 145 would be invalid? After all, agency law also governs indemnification of employees. Likewise, Bishop's argument seems to call into question the validity of DGCL section 144's regulation of interested director and officer transactions. Again, agency law governs employee duty of loyalty issues.
Larry Hammermesh commented in an email exchange:
First, there are lots of ways in which Delaware law defines the corporate/officer relationship: it prescribes a great deal about indemnification (including mandatory indemnification), and if Delaware law didn't govern the relationship at least to some extent, stockholder claims against officers would have to be dismissed outright because officers owe no duty, fiduciary or otherwise, to stockholders directly under agency or contract law.
Second, even if the charter as "contract" isn't one to which officers are a party, there's no question that the Delaware statute can define and limit the rights of stockholders, including all aspects of their right to sue. ... As long as Delaware statute can define and limit the rights of stockholders of a Delaware corporation, it can define and limit their right to sue for a breach of some duty (of an officer, director, or controlling stockholder) that arises under Delaware corporate law.
