McDonald's Ruling Sheds Light on Scope of Caremark Claims Against Officers and Directors
On March 1, 2023, the Delaware Court of Chancery dismissed Caremark claims against David Fairhurst, the former Executive Vice President and Global Chief People Officer of McDonald’s Corp. These claims were asserted against Fairhurst in In re: McDonald’s Corp. Stockholder Derivative Litigation by a group of stockholders accusing Fairhurst of breaching his oversight duties amidst allegations of rampant sexual harassment at McDonald’s. The decision and the decisions preceding it shed light on the scope of stockholder Caremark claims against corporate officers.
Background
In Caremark, a 1996 decision, the Court of Chancery first recognized that corporate directors can be held liable for the failure provide sufficient corporate oversight. The court held that “a director’s obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system . . . exists, and that failure to do so under some circumstances may . . . render a director liable for losses caused by non-compliance.” In re Caremark Intern. Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996). Caremark claims have since become notoriously hard to maintain, with courts often dismissing claims at the pleading stage.
In the McDonald’s Derivative Litigation case, stockholders alleged that Fairhurst and other McDonald’s executives and directors, including the McDonald’s CEO, breached their duty of oversight by failing to address sexual harassment complaints. The plaintiffs argued that Fairhurst and the CEO not only fostered a culture of sexual misconduct at McDonald’s, but that Fairhurst himself sexually harassed employees, and the CEO had engaged in sexual relationships with employees. The plaintiffs asserted that neither Fairhurst nor the McDonald’s board responded to indications that the problem existed, including several EEOC claims, employee resignations and lawsuits, and inquiries by a U.S. senator.
The Delaware Court of Chancery has issued three decisions on the plaintiffs’ claims since the suit was filed. In the first decision in January 2023, the court denied Fairhurst’s motion to dismiss the claims, holding, for the first time, that Caremark duties apply not only to corporate directors but also to corporate officers. A link to the decision is here.
In the second decision, the court granted the directors’ motion to dismiss the claims, finding that the McDonald’s directors took some action to address the harassment problem, however deficient that action was. The court emphasized that Caremark liability requires a showing of bad faith on the part of the wrongdoer, and there was no such evidence of bad faith by the corporate directors. A copy of the March 2023 decision is attached here.
In the third decision issued on March 1, 2023 (the same day as the second decision), the court granted Fairhurst’s decision to dismiss the remaining claims under the theory of “demand futility.” Because Caremark claims represent a significant encroachment on the managerial authority of a company’s board, stockholder plaintiffs bringing Caremark claims must either demand that the board itself bring the claims or convince the court that such a demand would have been futile because the directors could not have exercised disinterested judgment in responding to the demand.
The court recognized plaintiffs may show futility by showing that the directors themselves would be subject to a substantial likelihood of liability on the plaintiff’s Caremark claims. Alternatively, plaintiffs may show that the director received a material personal benefit from the alleged misconduct, or that the director lacks independence from someone receiving such a benefit or someone who is subject to a substantial likelihood of liability.
The plaintiffs in McDonald’s did not make a demand on the board, arguing that such a demand would have been futile because most of the company’s directors faced a substantial risk of liability for the claims brought against them, they could not have exercised independent judgment in investigating them. The court rejected that justification, explaining that because the court dismissed the claims against the directors in its second decision, they no longer faced any substantial likelihood of liability. As such, “[f]or purposes of this case, the road to establishing demand futility that plaintiffs sought to travel is closed.”
Effect of the McDonald’s Decisions on Subsequent Caremark Claims
The McDonald’s decisions clarify the scope of Caremark claims, potentially expanding them to corporate officers. The court additionally found that Caremark duties are not exclusively confined to “mission critical risks” (i.e., risks that fundamentally impair a company’s ability to operate effectively). Instead, Caremark liability can extend to misconduct like sexual harassment and discrimination.
These decisions have reaffirmed the high bar plaintiffs must meet to prevail in Caremark suits. As the court emphasized in McDonald’s, a Caremark plaintiff must show that a corporate officer or director acted with bad faith when he or she breached the duty of oversight. This heightened scienter requirement makes it more likely that Caremark claims will be dismissed at the pleading stage. Additionally, the McDonald’s decisions recognize that plaintiffs may be unable to show futility if claims against directors have been dismissed.