McDonald’s Litigation Expands Caremark and Loyalty Claims to Officers

Note: This article addresses the claims brought against an officer of McDonald’s Corporation. While the concerns surfaced by the Delaware Chancery Court are still important, the actual case against the officer was dismissed on a technicality (failure to adequately plead demand futility). In addition, on March 1, 2023, the Caremark claim against the McDonald’s Corporation board of directors was dismissed because the court was able to cite instances in which the board, having learned of the problem, took steps to attempt to address it. 

Since the “Blue Bell Creameries” case in 2019, directors have been justifiably concerned about the rise in popularity of Caremark claims (breaching the duty of oversight in a way that implicates the duty of loyalty). 

These claims are typically brought as derivative suits, which means that Delaware corporations cannot indemnify the directors to settle the claims.

But wait—there’s more. A recent ruling in a Delaware Chancery Court, In re McDonald’s Corporation Stockholder Derivative Litigation, held that corporate officers can also be sued for oversight and breach of loyalty claims. However, the court limited oversight liability to areas that fall within an officer’s scope of control.

The Delaware Chancery Court’s arguments for allowing an oversight red-flag claim and a more personal breach of loyalty claim to proceed are compelling—due in large part to the underlying facts of the case.

A real concern, however, is whether the case opens the floodgates for claims against officers who may have made mistakes that fall short of an oversight or loyalty case.

McDonald's Case Overview

David Fairhurst served as executive vice president and global chief people officer at McDonald’s Corporation.

Plaintiffs allege that during Fairhurst’s tenure as head of human resources, he enabled a corporate culture of sexual harassment by ignoring red flags about misconduct at the company. Not only that, but Fairhurst himself was ultimately terminated for engaging in sexual misconduct.

Fairhurst filed a motion to dismiss the case, arguing that Delaware does not impose the same obligations on officers as it does directors regarding Caremark claims.

The court disagreed:

This decision clarifies that corporate officers owe a duty of oversight. The same policies that motivated Chancellor Allen to recognize the duty of oversight for directors apply equally, if not to a greater degree, to officers. The Delaware Supreme Court has held that under Delaware law, corporate officers owe the same fiduciary duties as corporate directors, which logically include a duty of oversight.

Officers’ Fiduciary Duties May Be More Limited in Scope

The court explained that while officers owe duties of oversight comparable to those of directors, it doesn’t mean that the “situational application of those duties will be the same."

The court went on to say that unlike directors who are charged with authority over the business and the affairs of the entire corporation, some officers may have a more constrained area of authority. Because of that, an officer’s fiduciary duty applies only to their area of work.

In the McDonald’s case, Fairhurst’s domain was human resources—a function that handles sexual harassment and misconduct. Therefore, his fiduciary duties would apply to his domain.

By contrast, someone like a CEO or the chief legal officer/general counsel of the firm may be found to have a range of duties where the scope includes the entire organization.

Red Flags

As I have written in the past:

To establish an oversight claim, plaintiffs must prove that either:

• Directors had utterly failed to implement any reporting or information system or controls, or
• Having implemented a system or controls, consciously failed to monitor or oversee operations, thus disabling themselves from being informed of risks or problems requiring their attention

In the case of Fairhurst, the plaintiffs focused on the second prong. The plaintiffs asserted a “red-flags” claim (having knowledge of red flags and ignoring them). The conscious disregard of red flags is critical to the establishment of this type of bad faith claim.

In the words of the court:

The pled facts must support an inference that the failure to take action was sufficiently sustained, systematic, or striking to constitute action in bad faith. A claim that a fiduciary had notice of serious misconduct and simply brushed it off or otherwise failed to investigate states a claim for breach of duty.

The plaintiffs cited a series of events over several years as evidence that Fairhurst turned a blind eye to sexual harassment and misconduct.

The plaintiffs painted a picture of Fairhurst as an executive who promoted a party culture of drinking at the company, where complaints about misconduct were ignored, and employees feared retaliation for reporting complaints to the HR department.

Worse, on three recorded occasions, Fairhurst was accused of sexual misconduct himself while serving in his role as head of human resources.

The court found that the allegations were sufficient to support the contention that Fairhurst knew there were potential sexual harassment problems at the corporation, which satisfies the first element of a red-flags claim. Next, plaintiffs would need to show that Fairhurst acted in bad faith by consciously ignoring red flags.

On that point, the court basically concludes that since Fairhurst was himself engaged in acts of sexual harassment, it’s reasonable to infer that he “could consciously turn a blind eye to red flags about similar conduct by others.”

The court particularly noted that in 2018, workers across 10 US cities held a strike to protest the company’s culture of sexual harassment. Beginning in 2019, the company began to address the issue, and Fairhurst was part of the effort.

He co-authored a memorandum on the topic and gave presentations to the strategy committee on sexual harassment. However, in November 2019, Fairhurst engaged in his third act of reported sexual misconduct and was fired

The court did, however, ponder that it was possible that Fairhurst “participated in good faith in the Company’s response [to sexual misconduct at the company] and therefore will not face liability for conduct that occurred during 2019.”

The court concluded that such a question could not be answered at the pleading stage, as it was not possible to determine.

Duty of Loyalty, Straight Up

In addition to the oversight claim, plaintiffs also brought a straight duty of loyalty claim against Fairhurst for engaging in sexual harassment. Fairhurst attempted to argue that plaintiffs failed to show that he subjectively intended to harm the company.

The court was not having it, addressing the issue bluntly:

When Fairhurst engaged in sexual harassment, he was not acting subjectively to further the best interests of the Company. He therefore was acting in bad faith. The allegations against Fairhurst accordingly support a claim for breach of the duty of loyalty.

The court further rejected Fairhurst’s efforts to narrow the definition of bad faith/breach of loyalty to an intention to harm the company, noting that bad faith also includes:

• “Intentional dereliction of duty;
• A “conscious disregard for one’s responsibilities;” and
• The possession of a “dishonest purpose or moral obliquity.”

For the avoidance of any doubt, the court stated:

Sexual harassment is bad faith conduct. Bad faith conduct is disloyal conduct. Disloyal conduct is actionable. The claim against Fairhurst for his own acts of sexual harassment survives [his efforts to dismiss the count for failure to state a cognizable claim].

Court Decision

The court’s opinion was a response to Fairhurst’s efforts to have the claims brought against him dismissed.

The court rejected Fairhurst’s efforts, finding instead that the plaintiffs had pled sufficient facts to survive the motion to dismiss their claims that Fairhurst breached his duty of oversight and also acted in bad faith.

Takeaways

In the case of McDonald’s, the old adage “bad facts make bad law” rings particularly loudly.

The inexcusable and pervasive culture of sexual harassment at McDonald’s Corporation has been well-documented. These include an employee walk-out to protest the sexual harassment, a large settlement with the EEOC by a franchisee for harassment taking place from 2017 to 2023, as well as a settlement with the Securities and Exchange Commission by the company’s former CEO relating to his dismissal for violating company policy.

This case raises the stakes for officers. While it might be surprising to some that a Caremark claim can be brought against an officer, we should absolutely expect that plaintiffs will feel encouraged to bring these types of cases (just as they did against directors after the Marchand v. Barnhill decision (Blue Bell Creameries).

It is unlikely that plaintiffs will limit themselves to situations involving sexual harassment. Consider, for example, a chief information security officer who is already concerned about personal liability should their company be hit with a major cyberattack. Now CISOs will surely also be concerned about facing fiduciary duty suits.

(Note, however, that in a similar situation, the SolarWinds’ directors had their Caremark claim dismissed. In other words, all is not lost.)

Nevertheless, diligent officers (and their directors) will want to understand how the McDonald’s derivative suit has changed expectations when it comes to duty of loyalty and oversight claims.

As a reminder, directors have broad exculpation for (are absolved from) monetary liability claims available to them through the company’s certification of incorporation, other than for breaches of the duty of loyalty or acts that are not in good faith.

Officers have something similar available to them in terms of exculpation from monetary claims, but it is far more limited. The exculpation available to officers under Delaware law also does not extend to Caremark oversight claims or bad faith claims. In addition, exculpation for officers only applies to direct suits and not derivative suits.

Most officers will never find themselves in Fairhurst’s position, which is to say, the object of oversight and loyalty claims in which they are fired for personally engaging in the very act they were supposed to be preventing.

Indeed, by emphasizing the “conscious disregard” elements of the claims brought against Fairhurst, the court was emphasizing that mere negligence—while surely not a desirable trait in an executive—will not lead to personal liability.

Take These Steps to Prepare for Litigation

Should the day come in which a well-meaning officer lands in the crosshairs of fiduciary duty litigation, it will be helpful if the officer has already taken these steps:

1. Avoid even the appearance of violating company policies, particularly ones you implement;
2. Have a personal indemnification agreement in place to ensure that legal defense fees are advanced quickly and easily should they be needed;
3. Be sure that the company purchases a comfortable amount of Side A insurance.

This last recommendation is particularly important.

Remember that while a solvent Delaware corporation can always advance defense costs to its directors and officers, the settlement of a derivative suit claim is something the corporation cannot pay on behalf of an individual director or officer (nor can the company pay a judgment against a director or officer for a loyalty or oversight claim). Side A refers to D&O insurance that can pay derivative suit settlements.

To learn more about Side A insurance, check out this Woodruff Sawyer Whiteboard video: Standalone Side A, Difference in Conditions Policies