Delaware Courts Beef Up Caremark Claims Involving Corporate Misconduct While Leaving Hot-Button Political and ESG Issues to the Boardroom

In 2023, Delaware courts continued to vigorously apply Caremark’s duty of oversight in cases involving corporate misconduct, expressly recognizing for the first time that such claims can be brought against officers in addition to directors.  While a Caremark claim does not necessarily require illegal conduct, Delaware courts continue to make clear that knowing inaction when confronted with illegal conduct is often enough to satisfy its bad faith requirement. This emphasis on bad faith and misconduct may suggest a more functional approach to Caremark claims by Delaware courts, and a departure from the more formal categories of Caremark claims that Delaware courts relied on in the past.  At the same time, we saw Delaware courts sidestep hot-button issues related to corporate political advocacy and defer to the business judgment of boards in order to navigate those sometimes controversial issues.  Finally, we ended 2023 with an uncertain understanding of the scope of MFW review, which has expanded beyond the squeeze-out context in recent years.  The Delaware Supreme Court is currently considering whether to cut back on such “MFW creep.”

Chancery Court Confirms Caremark Duties Extend To Officers, Leans Into More Functional Caremark Framework

In one of its most significant decisions of 2023, the Delaware Chancery Court in In re McDonald’s Corp. S’holder Derivative Litig.[1] confirmed that officers owe a duty of oversight.  Vice Chancellor Laster acknowledged that Delaware’s courts had never expressly extended so-called Caremark duties to officers, as opposed to directors, but nonetheless held that Caremark’s reasoning for imposing a duty of oversight on directors applied equally to officers.  Vice Chancellor Laster did, however, cabin the Caremark duty of officers to their area of authority and reiterated that such claims require a showing of bad faith, regardless of whether officers are subject to exculpation under Delaware General Corporation Law § 102(b)(7).  Turning to the facts of the case, the Chancery Court found that plaintiffs adequately pleaded bad faith on the part of an officer based on his knowledge of red flags concerning pervasive sexual harassment at the company and his own engagement in sexual harassment.  The Chancery Court further found that defendant’s engaging in sexual harassment at the company was not just evidence of his knowledge, but also a breach of fiduciary duty in and of itself.

A few months later, the Chancery Court heard a Caremark claim against directors and officers of Walmart for their failure to oversee the distribution of prescription opioids at Walmart facilities in violation of prior settlements and federal law.[2]  Because the defendants moved to dismiss the claims on demand futility grounds, a substantial likelihood of liability on the part of a majority of directors was sufficient to allow the claims to proceed.  Vice Chancellor Laster found that the plaintiffs adequately pleaded that the majority of Walmart’s directors faced potential Caremark liability with respect to a bulk of the claims because of their knowing disregard of serious compliance issues, and Vice Chancellor Laster therefore refused to dismiss those claims on demand futility grounds.  Notably, Chancellor Laster discarded the three traditional categories of Caremark claims—so-called Massey claims, Red-Flag claims, and Information-Systems claims—in favor of a unified bad faith analysis.  And while the Chancery Court stopped short of saying that a violation law was required for such a claim, it found sufficient allegations that Walmart’s directors and officers consciously ignored the company’s noncompliance with law.

The Chancery Court’s recognition that officers owe a duty of oversight, however, did not lower the standard for such claims.  In Segway,[3] Vice Chancellor Will dismissed a Caremark claim against the president of a personal transportation device company for failing to recognize “financial struggles” at the company.  Emphasizing the requirement that a Caremark claim plead a lack of good faith to detect “central compliance risks” within an officer’s remit, Vice Chancellor Will stressed that “[t]he Caremark doctrine is not a tool to hold fiduciaries liable for everyday business problems.”  Vice Chancellor Will notably distinguished McDonalds by pointing out that plaintiffs here failed to plead knowledge of any violations of law.

Read together, McDonalds, Walton and Segway reflect both an expansion of Caremark claims to new actors as well as an renewed emphasis on their traditional principles and limits.  Illegality and misconduct continue to feature prominently in a more functional analysis that focuses on whether directors and officers participated in, knew of, or were willfully blind to such conduct.

Chancery Court Knocks Down Section 220 Claim Over Response To Controversial Florida Law

In Simeone v. Walt Disney Company,[4] the Delaware Chancery Court addressed a Section 220 request directed at records concerning Disney’s opposition to a Florida law limiting instruction on sexual orientation and gender identity in Florida schools.  Vice Chancellor Will held that the stockholder lacked a proper purpose for demanding the records, reasoning that the requests were actually driven by the stockholder’s counsel.  Vice Chancellor Will further held that the stated reason for the request, which was understanding Disney’s response to the Florida law, lacked a credible basis of wrongdoing.  To the contrary, the Vice Chancellor found the actions of the board to be precisely the type of decisions best entrusted to its business judgment.

Vice Chancellor Will reached a different result in Greenlight Capital Offshore Partners, Ltd. v. Brighthouse Financial, Inc.[5] and partially allowed the request.  The plaintiff hedge fund in that case filed a books and records request for information it claimed that it needed to value its shares in the company.  Even though the company insisted that the stockholder was motivated by activism, Vice Chancellor Will found any such ulterior motive to be irrelevant and ordered the partial release of records.  Vice Chancellor Will was satisfied that there was at least one legitimate purpose for the request, in part because Delaware courts have recognized requests for share valuation purposes to be proper, in contrast to Walt Disney where she found the only stated stockholder purpose to be pretextual. 

While Delaware courts continue to scrutinize a stockholder’s stated purpose for a Section 220 request, the subject matter of the request appears to be an important factor in that analysis.  Delaware courts appear hesitant to order the release of records that are loosely related to a company’s business operations or financial performance, especially when those requests touch upon political or ESG issues.  This approach to Section 220 requests is consistent with the Delaware courts’ focus on providing robust remedies in instances of misconduct while deferring to boards on potentially controversial political or ESG issues.

Important MFW Questions Remain For Next Year

At the end of 2023, the Delaware Supreme Court heard arguments in In re Match Grp., Inc. Derivative Litig.,[6] a case set to decide whether conflicted transactions outside of the squeeze-out merger context must be approved by both an independent committee and a majority of minority shareholders in order to avoid entire fairness review, or whether it is enough for such transactions to use just one so-called “cleansing mechanism”—(1) approval by a majority of independent directors, (2) approval by a special committee of independent directors or (3) approval by a majority of disinterested shareholders—to get the benefit of business judgment review.  Following the emergence of the MFW standard in 2014,[7] courts have steadily increased its application to a growing number of conflicted transactions beyond squeeze-out mergers (so-called “MFW creep”).  The Delaware Supreme Court’s decision to hear the case raises the possibility that boards may be able to avoid entire fairness review with fewer procedural hurdles than the MFW standard requires.

While this question will be answered in the coming year, 2023 already saw two decisions that arguably chip away at the centrality of the MFW process.  In In re Tesla Motors, Inc. S’holder Litig.,[8] the Delaware Supreme Court held that Tesla satisfied the strenuous entire fairness standard with respect to its purchase of a solar company.  Notably, the Delaware Supreme Court found that Tesla’s failure to satisfy MFW’s procedural requirements did not imply lack of entire fairness.  On the flipside of the same coin, in HBK Master Fund v. Pivitol,[9] the Chancery Court found the merger price resulting from a transaction that did comply with MFW nonetheless was not sufficiently reliable to determine fair value for purposes of a subsequent appraisal action.

Key Takeaways For Boards In 2023

• Delaware courts remain focused on providing robust remedies for corporate misconduct.  Where misconduct occurs, Delaware courts remain willing to apply existing principles in new ways to hold directors and officers accountable.  Boards should expect increased shareholder suits following the public reporting of misconduct, especially when directors and officers have themselves engaged in such misconduct.  
• Delaware courts remain hesitant to get involved in boardroom decision-making where there are no signs of misconduct, especially on hot-button political or ESG issues. But courts will not conduct a freewheeling inquiry into the motivation of Section 220 requests where stockholders present a legitimate purpose for the request.
• Companies with controlling stockholders should pay attention to whether the Delaware Supreme Court decides to cut back on the scope of MFW in 2024.  That may impact the way such companies structure conflicted transactions outside of the squeeze-out context.

[1] In re McDonald’s Corp. S’holder Derivative Litig., 289 A.3d 343 (Del. Ch. 2023).

[2] Ontario Provincial Council of Carpenters’ Pension Tr. Fund v. Walton, No. 2021-0827-JTL, 2023 WL 3093500 (Del. Ch. Apr. 26, 2023).

[3] Segway Inc. v. Cai, No. 2022-1110-LWW, 2023 WL 8643017 (Del. Ch. Dec. 14, 2023).

[4] Simeone v. Walt Disney Co., 302 A.3d 956 (Del. Ch. 2023).

[5] Greenlight Cap. Offshore Partners, Ltd. v. Brighthouse Fin., Inc., No. 2022-1067-LWW, 2023 WL 8009057 (Del. Ch. Nov. 20, 2023).

[6] In re Match Grp., Inc. Derivative Litig., No. 2020-0505-MTZ, 2022 WL 3970159 (Del. Ch. Sept. 1, 2022).

[7] See Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014).

[8] In re Tesla Motors, Inc. S’holder Litig., 298 A.3d 667 (Del. 2023).

[9] HBK Master Fund L.P. v. Pivotal Software, Inc., No. 2020-0165-KSJM, 2023 WL 5199634 (Del. Ch. Aug. 14, 2023).