Delaware Court of Chancery Addresses Officer Oversight Obligations
In a January 25, 2023 opinion (In re McDonald’s Corp. Stockholder Derivative Litig., C.A. No. 2021-0324-JTL), the Delaware Court of Chancery clarified that corporate officers’ fiduciary duties encompass a duty of oversight. As with directors, the duty of oversight requires that officers: (1) make a good faith effort to put in place reasonable information systems to generate the information necessary to address risks and report upward to higher level officers or the board; and (2) not consciously ignore red flags indicating that the company may suffer harm. The Court of Chancery also clarified that officers will not be held liable for violations of the duty of oversight unless they are shown to have acted in bad faith, as opposed to mere gross negligence.
The Court of Chancery further held that the scope of an officer’s duty of oversight may be constrained to the context in which the officer operates. For example, although a CEO or Chief Compliance Officer has a “company-wide oversight portfolio,” a Chief Legal Officer may be responsible only for oversight of risks within the legal function. The Court of Chancery noted, however, that where red flags are “sufficiently prominent,” any officer has a duty to report upward to the CEO or the board.
Given the already recognized duties of care and loyalty owed by officers, the opinion best represents a clarification of existing law rather than a sea change. Moreover, because the opinion denied a motion to dismiss under Rule 12(b)(6), but the Court of Chancery has not yet ruled upon pending motions to dismiss the action in full under Rule 23.1 based on the plaintiff’s failure to make a pre-suit demand, the impact of the opinion is unclear. However, corporate officers are well-advised to continue to ensure they are receiving periodic information and conducting regular reviews of risks in their areas of responsibility, and that CEOs and Chief Compliance Officers in particular are receiving such reporting on an enterprise-wide basis. Memorialization of such risk reviews may also help in establishing that officers have endeavored to fulfill their oversight duties in good faith.