January 26, 2023
|In Far-Reaching Decision, Delaware Chancery Court Rules that Officers Who Engage in Sexual Harassment Act in Bad Faith and may be Liable for Acts of Disloyalty
In a decision with important implications for businesses and stockholders nationwide, a Delaware Chancery Court judge ruled yesterday that corporate officers may be held liable for failing to oversee misconduct that harms a company and for acting in bad faith – the first time a Delaware court has extended duties of oversight beyond the boardroom and into the C-suite. Significantly, the decision by Vice Chancellor Travis Laster involved the former Global Chief People Officer of McDonald’s, who is not only accused of intentionally ignoring a corporate culture of sexual misconduct and harassment, but of acting in bad faith by repeatedly engaging in sexual misconduct himself.
The underlying fact pattern is all too familiar: a corporate executive engages in sexual harassment and gets a slap on the wrist and “final warning,” despite the company’s supposed zero-tolerance policy for such misconduct. Vice Chancellor Laster determined that claims against McDonald’s former Global Chief People Officer David Fairhurst could proceed because, “[t]he duty of good faith requires that a fiduciary subjectively act in the best interests of the entity. When engaging in sexual harassment, the harasser engages in reprehensible conduct for selfish reasons. By doing so, the fiduciary acts in bad faith and breaches the duty of loyalty.”
It’s a Good Time To Extend Caremark Claims to Corporate Officers
Legally, the decision is largely devoted to the logic underlying liability for corporate officers’ acts of bad faith and also their failure to exercise oversight on behalf of the company, also known as a Caremark claim. Caremark established the standards of oversight liability for directors as a two prong test, which requires a plaintiff to either allege facts showing that directors failed to implement a reporting system on matters of critical importance to the company; or, after adopting a necessary reporting system, failed to monitor for potential risks of a corporate trauma that required their attention. Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006). Under the latter portion of the test, a stockholder must allege that directors failed to act, even after the reporting system generated “red flags.”
VC Laster concluded that the same fiduciary duty applies to corporate officers, noting that they are responsible for managing the day-to-day affairs of the company and thus better situated to provide relevant, timely information to the board. The decision notes: “officers are far more able to spot problems than part-time directors who meet a handful of times a year.” (at 27). Accordingly, if an officer fails to share information about harm to the company with the board, the directors themselves may want to sue the officer for a breach of duty to the company. And, if the board has a potential claim, so too would a stockholder in derivative litigation, in which the shareholder sues for fiduciary breaches in the company’s stead.
Sexual Harassment Claims, A Party Atmosphere, Fear of Retaliation, EEOC Charges, and a 30-City Walkout at McDonald’s
VC Laster applied this newly-carved-out oversight theory of officer liability to McDonald’s Fairhurst, who served as the company’s Chief Global People Officer from 2015 until McDonald’s terminated him in 2019. As alleged in the complaint, Fairhurst had “day-to-day responsibility for ensuring” that the company provided a “safe and respectful workplace” for 200,000 people working at its corporate-owned restaurants and two million more employed by McDonald’s franchises – 55% of them women. Instead, he and then-CEO Steve Easterbrook turned the McDonald’s Chicago headquarters into a “boys’ club” where they and other executives sexually harassed female employees and HR officials ignored women’s reports of inappropriate conduct. They behaved this way despite a headline-grabbing 30-city employee walkout in 2016 to bring attention to more than a dozen complaints filed with the Equal Employment Opportunity Commission, a one-day strike by workers in 2018 after another flurry of EEOC complaints, and a letter of inquiry from a U.S. Senator.
The opinion concludes that Fairhurst was aware of incidents of sexual harassment and misconduct at the company as early as 2016. In addition, Fairhurst acted in bad faith by consciously ignoring those red flags, thereby acting with scienter. VC Laster highlighted the fact that not only did Fairhurst himself engage in sexual misconduct, but that he did so after receiving a final notice that such behavior was unacceptable. Therefore, VC Laster found it is reasonable to conclude that Fairhurst ignored the sexual misconduct of others and party atmosphere more broadly, particularly since Fairhurst and Easterbrook, who took over as CEO in 2015, actively fostered the culture.
The last four pages of the decision are perhaps the most significant for officer liability in the context of sexual harassment. VC Laster axiomatically wrote: “sexual harassment is bad faith conduct. Bad faith conduct is disloyal conduct. Disloyal conduct is actionable.” Thus, he ruled, the stockholders had properly stated a claim that Fairhurst acted in bad faith and disloyally to the company.
The decision notes that an officer cannot act in good faith while violating company policy, breaking the law, and exposing the company to liability. These features are hallmarks of sexual harassment and discrimination based derivative lawsuits that Cohen Milstein has worked on across the country, notably against such companies as Wynn Resorts, Alphabet, L Brands, and Pinterest. Going forward, VC Laster’s ruling will be relied upon not only to support the viability of cases where officers and directors materially support toxic, inequitable workplaces, but also where officers fail to protect a company from harm based on their own officer oversight duties.
Julie Goldsmith Reiser is a partner at Cohen Milstein and co-chair of the firm’s Securities Litigation & Investor Protection practice, which Law360 named this month as one of its 2022 Securities Groups of the Year.