General Counsel – Delaware Fiduciary Duties – Intersection of Developing Trends, Contributed by William R. Spalding and Robert J. Leclerc, King & Spalding LLP, and John D. Hopkins, Taylor English Duma LLP
Today’s general counsel is a remarkably busy person, with expanded responsibilities and a multiplicity of roles, frequently serving as a senior executive officer, with business responsibilities far outside the corporation’s legal and secretarial functions. The general counsel may sit on the senior management committee of the corporation and have roles as varied as acting as gate keeper to the public securities markets, manager of reputational risk and strategic advisor to the CEO, as well as having direct or indirect involvement with the compensation, compliance, ethics, privacy, risk management and governmental affairs functions.
Even beyond these more concrete roles, one prominent commentator has called on general counsel to “fix corporate America”1 and 76 percent of general counsel respondents in a 2008 survey2 believed they shared “equally in the responsibility for setting the ethical tone at the top.” All of these roles must be carried out while balancing the potential conflicts inherent in a dual reporting responsibility to the CEO and to the board of directors.3
Many of these expanded roles and responsibilities have been mandated by, or evolved as a result of, federal statutes such as the Sarbanes-Oxley Act of 2002, and the Foreign Corrupt Practices Act of 1977 that impose direct or indirect duties and obligations upon general counsel. Others have come about naturally over time as a result of the increasing complexity of the modern business and regulatory environment and the individual skill sets and experiences of those who have served as general counsel. With these expanded roles and responsibilities come conflicts and challenges that general counsel will need to navigate with considerable skill and political aplomb, while at the same time devoting appropriate time and attention to their primary duty of serving as chief legal officer to the corporation.
The prudent general counsel will consider (1) whether these expanded responsibilities have increased the potential likelihood of personal liability if something goes wrong, and (2) what the standard will be by which the general counsel will be judged, if something does go wrong. While there has been debate among commentators about officers’ fiduciary duties, the appropriate negligence standard and whether the business judgment rule should apply to officers,4 until relatively recently Delaware case law has provided minimal guidance about the standards applicable to officers, particularly general counsel. There have, however, been three recent Delaware cases that, while not settling the negligence standard question, should make it apparent that the potential personal liability risk of the general counsel position has increased and may provide guidance to general counsel seeking to avoid the pitfalls that could arise under Delaware law as a result of their expanded roles and responsibilities. These cases may also provide a useful framework for general counsel in advising other officers of the corporation on their fiduciary duties and obligations.
Recent Delaware Case Law
While most practitioners have long assumed that Delaware courts would impose the fiduciary duties of care and loyalty on officers, as they do on directors, it was only recently in Gantler v. Stephens5 that the Delaware Supreme Court settled this issue by explicitly holding that “officers of Delaware corporations, like directors, owe fiduciary duties of care and loyalty, and that the fiduciary duties of officers are the same as those of directors.”6
Historically, Delaware courts have articulated director duty of care obligations as requiring that the director become fully informed with respect to the matter at hand, and once so informed, exercise the requisite care that an ordinarily careful and prudent person would use in similar circumstances.7 In general, the concept of being fully informed includes obtaining and evaluating all material information reasonably available and bearing on the decision, as well as the overall deliberative process associated with such decision-making. Similarly, Delaware courts have interpreted the ordinarily careful and prudent person standard in the context of typical director due care claims as a “gross negligence” standard. In terms of director duty of loyalty obligations, the Delaware courts have articulated a standard that requires a director to act in good faith and in a manner that the director reasonably believes to be in the best interests of the corporation, without any taint of self interest or personal benefit not shared by the stockholders generally.
Duty of Loyalty and Job Preservation Self-Interest
The Gantler decision turned on issues implicating the duty of loyalty obligations owed by officers and directors, and not the duty of care. The Gantler court focused on, among other things, the acts and omissions of the corporate treasurer and noted that he was dependent upon the CEO’s “continued goodwill to retain his job and the benefits it generated.”8 By assisting the CEO, to whom the treasurer was beholden for job security, in sabotaging an auction process to sell the company in favor of a management led recapitalization and go-private transaction, the Gantler court found that the treasurer had breached his duty of loyalty.
One noteworthy aspect of this holding is that it could be read to be inconsistent with established precedent in director duty of loyalty questions, where Delaware courts have long held that a director’s self interest in maintaining his or her board position is not enough, in and of itself, to invoke duty of loyalty concerns. Perhaps the treasurer’s complicity in the CEO’s agenda to scuttle the auction process in favor of the management led recapitalization/go-private transaction, when coupled with the treasurer’s conflict over following the directives of the CEO to preserve his job, better explains the court’s holding on this point. And in considering the significance of the court’s discussion of the treasurer’s job concerns, it should be noted that in the subsequent Hampshire Group case,9 discussed below, the Chancery Court rejected a plaintiff’s argument that corporate officer subordinates had to prove their loyalty when accused of disloyalty in a matter involving their CEO. Finally, it is worthwhile to note that the Gantler court also observed that Section 102(b)(7) of the DGCL, which permits exculpation for personal liability for due care claims, is limited to directors. The Gantler court further stated that it would leave it to the Delaware legislature to determine whether such protection should be extended to officers.
Implications for General Counsel and Other Officers of Recent Delaware Fiduciary Duty Cases
In the Hampshire Group case, Vice Chancellor (now Chancellor) Strine considered a multiplicity of claims of alleged fiduciary duty violations by the former Hampshire Group chief financial officer and chief accounting officer, who were sued by their former employer (Hampshire Group) after their former CEO had paid a very substantial amount in settlement of his alleged wrongdoings. The court judged the defendants actions under both duty of care and duty of loyalty standards. By far the largest Hampshire Group claim was that the accounting officer had violated his fiduciary duties in carrying out an assignment to process and bring up to date the former CEO’s lavish expense reports after they had not been filed for many years. The court found that there was no evidence of a lack of good faith on the part of the executive in carrying out the expense project (and thus no violation of the duty of loyalty). And although there were many errors and highly questionable items that had been processed and paid, the court was sympathetic to the real world situation that required processing of expenses for many years under a tight deadline, and, applying a gross negligence standard, found that the executive had not been grossly negligent and therefore had not violated his duty of care.
In other rulings, the court found that the chief financial officer had breached his fiduciary duty of loyalty by knowingly causing the corporation to mischaracterize on its books and records certain payments to other employees as reimbursable business expenses, when in fact they were personal income to such employees, and by participating in and permitting to continue an improper program of in-kind donations to charitable organizations where individual employees took personal tax deductions for such donations. The court also found that the chief financial officer and principal accounting officer had each breached their duty of loyalty by improperly recording on the corporation’s books certain items as charitable contributions, where the evidence suggested that they were in fact tuition payments to a university and by signing various Sarbanes-Oxley Act certifications while in possession of knowledge of the foregoing errors in the corporation’s books and records.
Officers’ Fiduciary Duties Compared to Directors’
There are three other points of interest in the Hampshire Group decision. The first involves the officer duty of care standard. Chancellor Strine began his discussion by commenting that there “are important and interesting questions about the extent to which officers and employees should be more or less exposed to liability for breach of fiduciary duty than corporate directors” and cited the battling Business Lawyer articles on officer standard of care.10 He then declined to address the officer standard of care issue on the merits, but adopted a gross negligence standard because plaintiff Hampshire Group had embraced that standard in its pleadings. Even more interesting is that in an earlier reference to Gantler, Chancellor Strine said “our Supreme Court has found that the duties of corporate officers are similar to those of corporate directors,” while quoting in an accompanying footnote the Supreme Court’s actual language that they are “the same.”11 The fact that the Hampshire Group court went out of its way to raise the officer duty of care standard issue and did not comment on the Gantler language makes it seem apparent that the Chancellor views the issue as far from settled and may represent a flag to the Delaware plaintiffs’ bar for future pleadings purposes on officer duty of care claims.12
The second point of interest is that Chancellor Strine found “amazing” and “outrageously unfair” the plaintiff’s argument that corporate officer subordinates had to prove their loyalty when accused of disloyalty in a matter involving their CEO.13
The third point of interest in the Hampshire Group decision is the court’s finding that officers, like directors, have contextual obligations as fiduciaries, including the responsibility to disclose to their superior officer or principal material information relevant to the affairs of the agency entrusted to them. The court went on to note that whether officers have liability for failing to share information with superior officers or principals turns on the question of whether such failure was the product of gross negligence or disloyalty by such officer.14
Oversight Duties of General Counsel
The final decision of note on the subject of officer fiduciary duty under Delaware law is the Delaware Bankruptcy Court’s decision in World Health Alternatives, Inc.15 Because the World Health decision comes out of the Delaware Bankruptcy Court and the court applied Delaware law by analogy to a Florida corporation, its precedential value going forward may be limited. However, touthe facts in the case involve the acts and omissions of the general counsel of World Health prior to World Health’s bankruptcy filing. Of particular note in the World Health decision was the court’s imposition of Caremark oversight duties upon the general counsel and the linkage the court made between the general counsel’s duties and obligations under the Sarbanes-Oxley Act and his fiduciary duty of care under corporate law, stating that the general counsel had responsibilities in the area of internal controls and a duty to inspect the truthfulness of SEC filings.16
The World Health court denied the general counsel’s motions to dismiss on, among other things, claims brought by the bankruptcy trustee against the general counsel for corporate waste, aiding and abetting breach of fiduciary duty and fraud by the president of World Health and professional negligence by the general counsel.
Issues Left Unresolved and Trends Revealed by Recent Case Law
In reflecting upon the current state of officer fiduciary duty under Delaware law, a number of key observations can be made. First, officers, like directors, have a fiduciary duty of care and loyalty to the corporation. Second, the exact scope of an officer’s duty of care obligation has not yet been clearly defined in the Delaware case law, notwithstanding the references to officer fiduciary duty being the “same” or “similar” to director fiduciary duty in the Gantler and Hampshire Group cases. Whether officers of Delaware corporations will be afforded a “gross negligence” or some alternative standard on due care claims remains an open issue. However, what has been evident in the officer fiduciary duty case law to date is a tendency by the Delaware courts to look at the scope of an officer’s duties and responsibilities and, in particular, any duties or obligations placed upon the officer under Federal or other statutory law, in assessing whether the officer has satisfied his or her fiduciary duty of care obligations. Similarly, Delaware courts addressing officer fiduciary duty issues have begun to show a tendency evident for some time in the director fiduciary duty case law to blur the lines somewhat on duty of care and duty of loyalty issues. Namely, that officer conduct may be so egregious as to implicate duty of loyalty issues, (i.e., that the acts or omissions of the officer were so flagrant or egregious that they cannot be properly characterized as having been undertaken in good faith and/or with the best interests of the corporation in mind). Third, officer duty of loyalty issues are implicated under Delaware law in connection with superior/subordinate relationships, particularly where an officer’s acts or omissions have been motivated to advance the interests of a superior which may be at odds with the corporation’s best interests or where the conduct in question involves a knowing violation or failure by the officer to comply with, or cause the corporation to comply with, a statutory obligation or requirement.
Given the foregoing observations on the state of Delaware law, what thoughts come to mind on the question of potential personal liability for officers of Delaware corporations in terms of breach of fiduciary duty? Unlike directors, officers of Delaware corporations are not entitled to exculpation from personal liability for breaches of their duty of care obligations. Although officers likely should be able to satisfy the requisite requirements for indemnification from their corporations for certain failures on their part to satisfy their duty of care obligations, it is likely to prove difficult to satisfy such indemnification standards if the claim implicates duty of loyalty issues, including duty of loyalty issues that arise out of egregious or knowing conduct or mishaps encountered in superior/subordinate relationships. While it may be only in the rare and limited circumstance involving truly egregious officer conduct that an officer of a Delaware corporation will be held personally liable for money damages as a result of breach of fiduciary duty, it is not hard to speculate that we may see fiduciary duty claims being made against officers of Delaware corporations with increasing frequency, particularly in light of the populist surge in the current political environment around lavish executive compensation arrangements, including multi-million dollar severance packages for executives leaving corporations in the wake of significant shareholder losses.
Because most general counsel serve as an officer of the corporation, have direct or indirect involvement in varied roles and responsibilities that present conflicts and challenges and also now have various statutory duties placed upon them, it goes without saying that general counsel sit right at the intersection of a number of these developing trends. Fortunately, while they need to be proactively vigilant, most general counsel should be equipped with the skills and resources necessary to successfully navigate through such conflicts and challenges, as well as to advise other officers of the corporation of these developing trends and steps to be undertaken by them to appropriately discharge their fiduciary duties and obligations.
William R. Spalding is a partner at King & Spalding LLP and the former Executive Vice President – Strategy and Managed Care of CVS Caremark Corporation. Mr. Spalding may be reached at firstname.lastname@example.org. John D. Hopkins is a partner at Taylor English Duma LLP and the former Executive Vice President and General Counsel of Jefferson Pilot Corporation and a former partner at King & Spalding LLP. Mr. Hopkins may be reached at email@example.com. Robert J. Leclerc is an associate at King & Spalding LLP and may be reached at firstname.lastname@example.org.
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