A judge’s decision to allow a shareholder lawsuit against a former McDonald’s Corp. human resources chief has put corporate executives on alert that they can be held personally liable for failing to oversee the biggest risks confronted by their companies.
The ruling follows a series of Delaware Court of Chancery decisions that have set off alarm bells in corporate boardrooms by making clear that directors can be sued for serious compliance failures. The latest decision by Vice Chancellor J. Travis Laster clarifies that the legal scrutiny doesn’t stop with the board. Corporate officers can also be held to account for failing to do their part, the judge ruled.
The lawsuit centers on a period of tumult at the fast-food company that led to the firing of former McDonald’s CEO Steve Easterbrook after a board investigation found he violated longstanding company policy by having a consensual relationship with an employee. Shareholders sued McDonald’s board of directors, as well as Mr. Easterbrook and the company’s former chief human resources officer, David Fairhurst, for allegedly violating their fiduciary duties to the company.
The ruling by Vice Chancellor Laster focuses on the claims against Mr. Fairhurst specifically. In their complaint, the shareholders alleged that Mr. Fairhurst failed to appropriately respond to systemic issues of sexual misconduct at the company, a problem in which he was implicated. At the time of his termination, Mr. Fairhurst had been the subject of multiple reports of sexual harassment during his tenure, according to the Delaware ruling.
A lawyer for Mr. Fairhurst didn’t respond to a request for comment.
Vice Chancellor Laster’s ruling is a first-of-its-kind and has raised a number of issues around oversight liability that are likely to be the subject of future rulings. While it remains unclear how the McDonald’s case will play out, the judge’s ruling highlights how recent Delaware court decisions have played an increasingly important role in pushing corporate leaders to pay attention to so-called mission-critical risks.
Emerging oversight liability
The legal doctrine driving the McDonald’s shareholder lawsuit extends back to a 1996 Delaware Court of Chancery decision.
The court’s decision in that case, which involved healthcare provider Caremark International Inc., held that directors have basic oversight duties for which they can be held personally accountable. Those duties center on the compliance systems that boards put in place to ensure their companies are operating within the bounds of the law and not harming their consumers.
At the same time, the court made clear that the bar for bringing such a claim against the board was particularly high. Shareholders must show that directors essentially failed to make almost any effort to put a system in place to address what it described as a mission-critical risk, according to the landmark ruling.
“Caremark claims,” as they became known, were rarely brought over the years and regularly thrown out when they were, according to legal experts. That changed in 2019, when a Delaware judge ruled that shareholders of ice-cream maker Blue Bell Creameries could proceed in a derivative lawsuit accusing the company’s directors of failing in their oversight duties.
The Blue Bell lawsuit followed a listeria outbreak that killed three people and caused the company to recall its products, shut down production at its plants and lay off a third of its workforce. The company in 2020 pleaded guilty to distributing adulterated ice-cream products and agreed to pay a fine over the outbreak.
Shareholders in the derivative suit accused Blue Bell’s directors of failing to ensure that there were sufficient compliance processes in place around what appeared to be a mission-critical risk for the company: the issue of food safety. After losing their motion to dismiss, the Blue Bell directors eventually reached a $60 million settlement to end shareholders’ claims.
Since then, a handful of other Caremark claims have also survived initial attempts by directors to have them dismissed, putting pressure on corporate leaders to show they are sufficiently addressing big compliance risks.
In one recent example, a Delaware judge in 2021 ruled that a derivative lawsuit involving Boeing Co. could proceed, saying the company’s directors had turned “a blind eye” to safety concerns following the crash of two of its 737 MAX jets. Two months later, a group of current and former Boeing directors struck a $237.5 million settlement with shareholders to end the litigation, under which they didn’t admit to any wrongdoing.
Although directors are typically covered by insurance that precludes them from paying out of pocket—and while such cases are inevitably settled after surviving a motion to dismiss—the rulings have had an impact, said Dorothy Lund, an associate professor at USC’s Gould School of Law who has studied the recent trend in Caremark litigation.
“Directors and officers really do fear litigation because there are reputational risks,” Ms. Lund said. “Despite the fact that nobody’s paying money, it does make people sit up and take notice.”
The role of top executives
Vice Chancellor Laster’s ruling is the first Caremark-related decision to directly address the role the executive team plays in the process of ensuring a company’s risk-management processes don’t go off the rails.
Gail Weinstein, a lawyer who advises on corporate governance, says the ruling doesn’t come as a big surprise: Delaware courts have long made clear that officers have many of the same fiduciary duties as directors. But the ruling is notable in the way it lays out some initial expectations for how executives should exercise their oversight duties.
Oversight duties will vary depending on an executive’s position, Judge Laster wrote. Although a CEO may have companywide remit, others only need to make a good-faith effort to monitor and respond to issues that fall within their area of responsibility.
In the case of Mr. Fairhurst, McDonald’s handling of sexual-harassment claims fell within his purview as the top human resources executive, Judge Laster found, while noting that Mr. Fairhurst himself faced allegations of sexual harassment.
While some legal experts are skeptical about whether the sexual-harassment problems at McDonald’s fit easily into the definition of a mission-critical risk, Mr. Fairhurst’s own alleged behavior and its relationship to the larger compliance problems clearly contributed to the judge’s finding, they said. Judge Laster also found that the executive had violated his duty of loyalty to the company.
“You didn’t just have an officer who was engaged, allegedly, in sexual harassment. He was the very guy in charge of making sure that didn’t happen at the company,” said Ms. Weinstein, senior counsel at Fried, Frank, Harris, Shriver & Jacobson LLP.
The ultimate impact of Judge Laster’s ruling vis-à-vis McDonald’s shareholders is as of yet unclear. Even though Vice Chancellor Laster allowed the lawsuit to go forward against Mr. Fairhurst, the judge has yet to decide whether shareholders have standing to bring the derivative lawsuit in the first place. To do so, shareholders must show that the directors weren’t sufficiently independent to bring the claims themselves. If the judge approves the McDonald’s directors’ motion to dismiss, the claims against Mr. Fairhurst would be moot.
Separately, the judge earlier in January dismissed shareholders’ claims against Mr. Easterbrook, citing legal action the board took after his termination that led to the former CEO returning $105 million worth of cash and stock compensation.
Nevertheless, by issuing his ruling before deciding whether shareholders have standing, Vice Chancellor Laster appears to be sending a message about the importance of top management in the oversight process, experts said.
“Here the court said management always plays a critical role in the oversight process,” Ms. Weinstein said. “They are the people on the ground who really know what’s going on.” Failing in their oversight duties could prevent directors from fulfilling their own, she added.
Source: Wall Street Journal
