Written By Preet Gill, Denise Bright and Phoebe Goldig
In the United States, corporate directors owe, as a subset of their duty of loyalty, a duty to monitor and oversee the operations of the company, referred to as the "duty of oversight" in this blog. This duty is known as the "Caremark" duty, named after the 1996 case establishing its parameters.1 The Caremark duty requires directors to carry out two functions, or otherwise risk facing personal liability under Delaware law: (1) attempt, in good faith, to assure that adequate information and reporting systems exist in the organization; and (2) properly respond to red flags indicative of wrongdoing that come to the attention of the board.
Recently, in In re McDonald’s Corp. Stockholder Derivative Litigation,2 the Delaware Court of Chancery issued an important decision (on a preliminary motion to dismiss), extending this duty of oversight to corporate officers of Delaware corporations.
Though neither directors nor officers of Canadian corporations currently owe a specific duty of oversight under Canadian law, the fact that this duty continues to be affirmed (and extended) under Delaware law may be instructive to Canadian courts, which often look to Delaware law in respect of corporate law. In an environment where director and officer liability is increasingly scrutinized, such decisions may find some influence in the right Canadian decision.
Shareholders of McDonald's Corporation brought derivative claims against the board of directors and certain officers of McDonald's. The claims centered around the actions of David Fairhurst, McDonald's Executive Vice President and Global Chief People Officer from 2015 until his termination with cause in 2019. The principal allegation was that Fairhurst breached his fiduciary duties by "allowing a corporate culture to develop that condoned sexual harassment and misconduct." The shareholders alleged that Fairhurst's fiduciary duties included a duty of oversight, and that he breached this duty by (1) consciously ignoring red flags indicating that sexual harassment and misconduct were prevalent at McDonald's, and (2) failing to report to his superiors, or otherwise address, the purported misconduct. The shareholders also alleged Fairhurst breached his duty of loyalty by personally engaging in acts of sexual harassment during his tenure at McDonald's, thereby creating red flags himself.
Fairhurst moved to dismiss the claim on the basis that the plaintiffs failed to state a claim on which relief could be granted, since Delaware law does not recognize a duty of oversight claim against corporate officers.
The Court denied Fairhurst's motion and held that officers have the same fiduciary duties as directors, including the duty of oversight.
Although the Court confirmed that officers, like directors, are required to perform both obligations under the Caremark duty (establish information systems and report red flags), importantly the scope of an officer's oversight duty differs from that of a director's. While the director's version of the duty is company-wide, an officer's duty of oversight is context-driven and may be confined to the area of the corporation under their control. This distinction is due to the nature of directors' and officers' respective roles in the company—directors are charged with "plenary authority over the business and affairs of the corporation," while officers, with the exception of the chief executive officer and chief compliance officer, generally have a more limited area of authority. Despite this distinction, the Court observed that a red flag may be so serious or prominent that an officer cannot ignore it without incurring liability, even if it falls outside of their domain.
The Court further instructed that officers, as with directors, will only be liable for violations of the duty of oversight if a plaintiff can prove that they acted in bad faith, and thus breached their duty of loyalty. Though the duty of oversight can encompass both the duty of loyalty and the duty of care, an officer will not be found liable (and a claim will not survive a motion to dismiss) where the plaintiff pleads only actions that constitute gross negligence (i.e., a breach of the duty of care) rather than bad faith (i.e., a breach of the duty of loyalty).
The Court concluded that the plaintiffs had effectively pled that Fairhurst had breached his duty of oversight by permitting a toxic corporate culture to develop at McDonald's, and by turning a blind eye to sexual harassment and misconduct. In addition, their claim for his own acts of sexual harassment could stand. Therefore, the motion by Fairhurst to dismiss was denied.
While this was determined on a preliminary motion to dismiss, the confirmation that officers owe a duty of oversight is more broadly applicable.
Takeaways for Canadian Corporate Law
Under Canadian law, every director and officer of a corporation has a duty to act honestly and in good faith, with a view to the best interests of the corporation (i.e., the duty of loyalty), and to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances (i.e., the duty of care).3 A general duty of compliance with corporate legislation, articles, by-laws, and any unanimous shareholder agreement is also imposed on both directors and officers.4
While Canadian law has not yet articulated a Caremark duty of oversight, a director's general duty to manage or supervise the management of the business and affairs of the corporation5 could potentially lead, with the right facts, to Caremark-style claims being brought in Canada as a subset of directors' general duties, and might include claims against officers as a result of the McDonald's decision. Although not bound by them, of course, Canadian courts often heed developments in U.S. law, and therefore it is possible that these decisions may find influence in the right case. As a result, Canadian directors and officers may wish to take note of these decisions and their potential application as a consequence of the increased focus in Canada on operational risks. In addition, in light of the heightened awareness on environmental, social and corporate governance (ESG), it is arguably more likely that these duties may start to be considered north of the border.
For more information about directors' and officers' duties in the context of your organization, please do not hesitate to contact the authors or a member of the Bennett Jones Corporate Governance group.
1 In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996) [Caremark].
2 C.A. No. 2021-0324-JTL (Del. Ch. Jan. 25, 2023) [McDonald's].
3 Canada Business Corporations Act, R.S.C. 1985, c. C-44, s. 122(1); Across Canada, see: (ON) Business Corporations Act, R.S.O. 1990, c. B.16, s. 134(1); (AB) Business Corporations Act, R.S.A. 2000, s. 122(1); (BC) Business Corporations Act, S.B.C. 2002, c. 57, s. 142(1); (MB) Corporations Act, C.C.S.M. c. C225, s. 117(1); (NL) Corporations Act, R.S.N.L. 1990, c. C-36, s. 203(1); (NT) Business Corporations Act, S.N.W.T. 1996, c. 19, s. 123(1); (NU) Business Corporations Act, S.N.W.T. (Nu.) 1996, c. 19, s. 123(1); (YT) Business Corporations Act, R.S.Y. 2002, c. 20, s. 124(1). See also People's Department Stores Ltd. (1992) Inc., Re, 2004 SCC 68 at para 32.
4 Canada Business Corporations Act, R.S.C. 1985, c. C-44, s. 122(2).
5 Canada Business Corporations Act, R.S.C. 1985, c. C-44, s. 102(1).