Apropos my post yesterday, Kevin LaCroix of the invaluable D&O Diary blog has weighed in on VC Travis Laster's opinion n In re McDonald's Corp. Stockholder Deriv. Litig., in which the VC held that Caremark's over sight duty applies to officers as well as directors.
As is his wont, Kevin provides extensive factual background. In delving into the opinion's analysis of the legal issues, he points out that:
While recognizing that corporate officers have a duty of oversight, “its context-driven application will differ.” Some company officers – for example, the CEO – will have company-wide oversight responsibilities, while other officers oversight responsibilities will generally pertain to their “particular areas of responsibility.” However, officers can be liable for violations of the duty of oversight only “if a plaintiff can prove that they acted in bad faith and hence disloyally.”
As developed by the Delaware Courts, a breach of the duty of oversight claim can be either an “Information-Systems Claim” (that is, failing to have systems in place to facilitate necessary oversight) and a “Red-Flags Claim.” Vice Chancellor Laster determined that the plaintiffs’ claims against Fairhurst were of the red flags variety. In order for a red flags claim to survive a dismissal motion, Vice Chancellor Laster said, a plaintiff must plead facts sufficient to support an inference that the fiduciary knew of evidence of corporate misconduct; that the fiduciary consciously failed to take action; and that the failure was sufficiently sustained, systematic, or striking to constitute action in bad faith.
Kevin shares my concern that "the Delaware courts are going too far in sustaining breach of the duty of oversight claims," noting the telling point that:
Vice Chancellor Laster’s opinion omits this ritualistic restatement of how difficult it is for plaintiffs to sustain a breach of the duty of oversight claim.
And he shares my concern that Fairhurst's misconduct, while doubtless egregious, did not go to the sort of existential, "mission critical" failures that drove the recent Marchand and Boeing decisions:
My concern here is that in light of this decision, it may be easier for plaintiffs to sustain claims that both officers and directors have breached their duty of oversight. In that regard, I note that academic commentators had already raised the alarm that oversight duty breach claims are not in fact the most difficult kind of claim to sustain, and in fact they increasingly are being sustained with alarming frequency.
(By the way, he kindly links to me in that passage.)
Critically, however, Kevin also points out that:
In a short but nonetheless important final section of his opinion that could be overlooked given his other holdings on the duty of oversight issue, Vice Chancellor Laster addressed the plaintiffs’ further and analytically distinct allegation that Fairhurst had also violated his fiduciary duties by engaging personally in acts of sexual harassment.
In concluding that the plaintiffs had sufficiently stated a claim on this basis, Vice Chancellor Laster noted that “When Fairhurst engaged in sexual harassment, he was not acting subjectively to further the best interests of the Company. He was therefore acting in bad faith.” Laster added further that “It is not reasonable to infer that Fairhurst acted in good faith and remained loyal to the Company while committing acts of sexual harassment, violating company policy, violating positive law, and subjecting the Company to liability. It is reasonable to infer that Fairhurst acted disloyally and for an improper purpose, unrelated to the best interests of the Company.”
This may in fact be a more important aspect of the opinion than that dealing with the Caremark issue on which I focused. Kevin aptly calls it "explosive."
Vice Chancellor Laster’s conclusion about breach of fiduciary duty claims based on alleged sexual misconduct is most unfortunate. I could be proven wrong – and I hope I am – but there is a very real risk that the court’s recognition of the validity of this type of claim could indeed open the floodgates to these kinds of shareholder claims.
As regular readers know, I am a great admirer of Kevin's work in this area. He is one of the most well informed and erudite commentators on the broad set of corporate law and governance issues loosely group as D&O questions. His post is one that everyone in the corporate law area needs to read and study.
