CURRENT MONTH (February 2023)
Court of Chancery Declines to Dismiss Plaintiffs’ Derivative Claims and Confirms that Corporate Officers Owe a Fiduciary Duty of Oversight Under Delaware Law
In re McDonald’s Corporation Stockholder Derivative Litigation, C.A. No. 2021-0324-JTL (Del. Ch. Jan. 26, 2023) (Laster, V.C.)
By Pamela L. Millard, Alyssa Gerace Frank, Charles R. Hallinan, and Charles P. Wood, Potter Anderson & Corroon LLP
In this memorandum opinion, the Delaware Court of Chancery denied defendant’s motion to dismiss plaintiffs’ derivative claims after confirming that corporate officers of a Delaware corporation owe a fiduciary duty of oversight. The Court held that plaintiffs sufficiently pled that officer-defendant David Fairhurst consciously ignored red flags concerning endemic sexual harassment within McDonald’s Corporation (the “Company”), and allegations of Fairhurst’s own pattern of sexual harassment independently supported a claim for breach of the duty of loyalty.
Fairhurst became the Company’s chief human resources officer in 2015 shortly after the Company promoted Stephen J. Easterbrook to Chief Executive Officer. Easterbrook, in turn, promoted Fairhurst to Global Chief People Officer, charged with ensuring a safe and respectful workplace. As longtime employees of the Company, Easterbrook and Fairhurst had an existing relationship and used their new positions to promote a “party atmosphere” at the Company’s headquarters. Employees complained of inappropriate behavior by male employees—including Easterbrook and Fairhurst—at these events, but the complaints were ignored.
Beginning in 2016, the Company faced increased public scrutiny regarding sexual harassment throughout the Company. Dozens of employees filed complaints with the Equal Employment Opportunity Commission (“EEOC”) alleging sexual harassment in the Company’s restaurants. In 2018, the EEOC received more complaints that further detailed systemic issues related to reporting harassment within the Company, and the Company’s alleged environment of sexual harassment prompted a December 2018 Senate inquiry. After the Company received additional reports that Fairhurst had engaged in sexual harassment, the Company entered into a letter agreement with Fairhurst (the “Last Chance Letter”) pursuant to which any further instances of misconduct would be cause for termination.
In 2019, as the Company developed its response to the Senate inquiry, the board received a report outlining the Company’s sexual harassment and misconduct issues and its remedial efforts, which Fairhurst participated in developing and implementing. The board fired Easterbrook in October 2019 due to a prohibited relationship with an employee. One month later, the board fired Fairhurst for cause. Given the terms of the Last Chance Letter, the Court found it reasonable to infer that Fairhurst’s termination was due to further instances of sexual harassment.
Various plaintiffs filed class action lawsuits beginning in 2019 in connection with sexual harassment issues at the Company, and in 2021, plaintiffs filed the present lawsuit alleging that Fairhurst’s conduct constituted a breach of his fiduciary duties. Fairhurst moved to dismiss on the grounds that officers do not owe a duty of oversight under Delaware law.
With respect to the duty of oversight claim, the Court confirmed that corporate officers owe a fiduciary duty of oversight flowing from multiple sources of authority, including (i) the Caremark decision’s reasoning, which it found logically extended to officers, (ii) the fact that officers share the same duties as directors, as recognized by the Delaware Supreme Court in Gantler v. Stephens, (iii) agency principles requiring officers to disclose material information to directors or superior officers, and (iv) the role officers play in corporate oversight structures and the need for officers to be accountable to the board. The Court also noted the absence of express authority holding that officers do not owe oversight duties. Other than officers with company-wide roles, the Court noted that the scope of officers’ oversight duties would generally be limited to such officers’ areas of authority (i.e., financial oversight by a chief financial officer). However, the Court clarified that officers still have a duty to report egregious red flags of which they are aware, even if beyond their area of management expertise.
The Court also determined that plaintiffs’ oversight allegations against Fairhurst set forth a “red flags claim” under Caremark that Fairhurst was aware of sexual harassment issues within the Company, but consciously ignored them. First, the Court explained that plaintiffs pled facts supporting a reasonable inference that Fairhurst was aware of misconduct at the Company based on, among other things, the number of EEOC complaints filed by employees, the ensuing publicity, the fact that Fairhurst himself had engaged in problematic behavior, and the Senate inquiry. The Court then found that Fairhurst’s own acts of sexual misconduct, which allegedly occurred following each round of EEOC complaints and internal efforts to address the Company’s sexual harassment issues, supported an inference that Fairhurst consciously ignored these red flags.
Relatedly, the Court explained that Fairhurst’s misconduct, along with his efforts to promote an alcohol-fueled “party atmosphere,” bolstered allegations that the Company ignored complaints and made employees fear retaliation. The Court also noted the lack of any evidence from a prior Section 220 demand indicating that Fairhurst took any action to report sexual harassment issues to the board before June 2019, by which time the Company was already working on a response to the Senate inquiry. Fairhurst’s presumed sexual misconduct in 2019 further suggested that Fairhurst continued to turn a blind eye, notwithstanding his participation in the Company’s remedial efforts. Ultimately, given the pleadings stage posture of the case, the Court held that plaintiffs had sufficiently pled a claim against Fairhurst for breach of his duty of oversight.
Finally, the Court determined that plaintiffs pled facts sufficient to state a claim for breach of the duty of loyalty. The Court explained that sexual harassment is bad faith conduct, and bad faith conduct is disloyal conduct, which is actionable under Delaware law.
Interpreting the Contractual Duty of Good Faith: Latest Clarifications from the English Court of Appeal
By Louise Nash, Partner, Covington & Burling LLP; Luciana Griebel, Associate, Covington & Burling LLP
English law does not recognize an implied duty on contracting parties to deal with one another in good faith, so parties frequently include an express contractual obligation. The English Court of Appeal’s judgment in Re Compound Photonics Group Ltd; Faulkner v. Vollin Holdings Ltd  EWCA Civ 1371 provides clarity on the interpretation of such clauses; at a minimum parties must act honestly. Any further obligations must be capable of being derived as a matter of interpretation or implication from the other terms of the contract.
Compound Photonics Group Limited (“CPGL”) was in the business of developing and commercializing a very small projector. CPGL’s shareholders documented their relationship in an agreement (the “SHA”), which included the following obligation:
Each Shareholder undertakes to the other Shareholders and the Company that it will at all times act in good faith in all dealings with the other Shareholders and with the Company in relation to the matters contained in this Agreement.
After disappointing results, CPGL’s majority investors demanded that Dr. Sachs step down as CEO and removed M. Faulkner as a director. Dr. Sachs and M. Faulkner (who were also shareholders in CPGL) claimed that their removal was in breach of the good faith provision contained in the SHA.
The English High Court found in favour of the claimants, who had been “entrenched” as directors by CPGL’s constitutional documents. Mr. Justice Adam Johnson held that the SHA obligation imported the minimum standards of good faith from Unwin v. Bond  EWHC 1768 (Comm).
Court of Appeal Judgment
The English Court of Appeal overturned the judgment, finding that the interpretation of the contractual duty of good faith was too broad and stepping away from the “formulaic” approach established in Unwin. The English Court of Appeal found that:
- the duty of good faith imposes a core requirement that the parties act honestly towards each other;
- the duty of good faith may, in certain circumstances, include a duty not to act in bad faith or in a way “that reasonable and honest people would regard as commercially unacceptable, but not necessarily dishonest”; and
- a duty of fidelity to the bargain in the context of changes to the constitution of a company or the composition of its board is not inherent in a good faith clause, as articles and directors “are not cast in stone when the company is incorporated.”
Lord Justice Snowden noted that the concepts of fidelity to the bargain and a requirement to have regard to the interests of the other contracting party were first introduced in a commentary on US contract law. The concepts were then developed in New South Wales; however, this was outside the context of individually negotiated contracts. Therefore, parties to an English law governed contract should not automatically be presumed to have intended to incorporate such terms into their agreement.
The Court of Appeal endorsed existing case law, noting that cases from other areas of law and commerce may be of “limited value” in interpreting good-faith provisions and “must be treated with considerable caution.”
Court of Chancery Grants Section 205 Petition Validating and Declaring Effective Amendments to the Certificate of Incorporation of Lordstown Motors Corporation in Connection with a de-SPAC Merger
In re Lordstown Motors Corp., C.A. No. 2023-0083-LWW (Del. Ch. Feb. 21, 2023) (Will, V.C.)
By Pamela L. Millard, Potter Anderson & Corroon LLP
On February 21, 2023, Vice Chancellor Will granted a petition made by Lordstown Motors Corporation (the “Company”) under Section 205 of the DGCL to validate and declare effective the Company’s certificate of incorporation as amended in connection with a 2020 “de-SPAC” merger transaction.
In a de-SPAC merger, companies generally propose amendments to their certificates of incorporation to increase the number of Class A common shares, which are issued following the merger. Based on a belief that the Class A shares represented a series of common stock, the Company—along with many other Delaware corporations that consummated similar de-SPAC mergers—failed to hold a separate Class A vote on the proposed amendments; instead, the charter amendments were approved by a majority of the common shares entitled to vote, voting as a single class. Following the stockholder votes, the amendments were made effective, and “billions of shares were issued with the understanding that they were authorized by the companies’ certificates of incorporation.”
In December 2022, in Garfield v. Boxed, the Court of Chancery considered a fee petition filed after a stockholder demand challenging a similar stockholder vote caused the company to secure a separate vote of the Class A holders in connection with similarly proposed de-SPAC charter amendments. In considering whether the demand was meritorious when made, the Court determined that the company’s Class A shares were a separate class of stock, rather than a separate series, and awarded a fee of $850,000 to plaintiff.
Given the “pervasive uncertainty” created with respect to de-SPAC capital structures and the validity of shares issued in past de-SPAC mergers, the Company along with numerous other Delaware corporations filed petitions in the Court of Chancery under Section 205 of the DGCL to validate and declare effective prior charter amendments and share issuances, as well as the related disclosures made in connection with the requested stockholder actions. As the Court noted, Section 205 grants the Court of Chancery “the authority to declare corporate acts and putative stock be valid” and to “consider any factors it deems just and equitable.”
Finding that the corporate acts at issue to be “the sort that Section 205 was intended to address,” the Court reviewed five factors set forth in the statute to conclude that the corporate acts at issue should be validated pursuant to Section 205 of the DGCL:
- Good Faith Belief in Validity. The Court found that the Company had a good faith belief that the charter amendments complied with Delaware law and the previous charter. The board of directors not only relied on the advice provided by numerous law firms, but also received a legal opinion from Delaware counsel.
- Treatment of Corporate Acts as Valid. The Court similarly determined that both the Company and the board of directors consistently treated the charter amendments as valid, including through (i) the issuance of shares, (ii) Company public filings discussing the share issuances, and (iii) reliance on the charter amendments by participants in the Company’s de-SPAC merger.
- Harm from Validation. The Court found there was no harm in validating the charter amendments since no Company stockholder objected to the petition and the Court could not conceive of any legitimate harm imposed.
- Harm Without Validation. In the absence of the validation, however, the resulting harm would be significant: the Company’s capital structure would be called into doubt, the Company risked being delisted from NASDAQ, and the Company could encounter issues with future financing sources.
- Other Factors. Finding the requested validation to be “‘just and equitable,’” the Court concluded that “[r]elief under Section 205 is the most efficient and conclusive—and perhaps the only—recourse available to the Company.”
Noting that the opinion was specific to the relief sought by the Company, the Court nonetheless opined, without reaching the merits of the Court’s holding in Garfield v. Boxed, that the legal analysis set forth in the Lordstown opinion should “prove instructive” to other companies seeking to validate similar corporate acts.
Court of Chancery Finds Non-Compete Related Provisions in Partnership Agreement Unenforceable
Ainslie v. Cantor Fitzgerald, L.P., 2023 WL 106923 (Del. Ch. Jan. 4, 2023)
In a recent Delaware Court of Chancery opinion, the Court of Chancery considered the tension between employment law and partnership law, in the context of non-compete provisions set forth in a partnership agreement. In Ainslie v. Cantor Fitzgerald, plaintiffs, who were former partners of Cantor Fitzgerald Limited Partnership (the “Partnership” or “Cantor Fitzgerald”), challenged provisions contained in the Partnership’s limited partnership agreement that restricted partners from competing, soliciting clients or employees, or using the confidential information for a period of time after leaving the Partnership. The Partnership Agreement restricted competitive activities in two ways. First, the Partnership prohibited certain competitive activities (the “non-compete provisions”) for up to two years, and a breach of such provisions entitled the Partnership to seek injunctive relief and damages. Second, the Partnership was permitted to withhold certain compensation payable to a former partner if such person (i) breached the non-compete provisions or (ii) engaged in any competitive activity during a four-year period, whether or not such activities constituted a breach of the non-compete provisions (the “Conditioned Payment Device”).
Each of the plaintiffs withdrew from the Partnership and within a year accepted employment or otherwise began performing services for a competing business. Due to such activities and in reliance upon the Conditioned Payment Device, Cantor Fitzgerald did not provide the additional compensation that would otherwise be paid to the plaintiffs. Plaintiffs filed a complaint in the Court of Chancery for breach of contract against the Partnership for failure to pay the additional amounts and sought a declaration that the Conditioned Payment Device is a restraint of trade and unenforceable. Cantor Fitzgerald argued that the Conditioned Payment Device provisions are not non-compete agreements, arguing that the Conditioned Payment Device simply conditions the Partnership’s duty to pay additional amounts on the non-occurrence of certain events, and the non-compete provisions are relevant only insofar as they define conditions regarding the Conditioned Payment Device. The Partnership argued that the Conditioned Payment Device should be enforced without any public policy review. The Court of Chancery, however, noted that whether the Conditioned Payment Device is a damages provision enforcing a promise not to compete or a condition triggered by breaching a promise not to compete, “the underlying promise must be enforceable.”
The Court of Chancery found that the condition triggered by a breach of the non-compete provisions was predicated on an unenforceable promise because such non-compete provisions were unreasonable and therefore unenforceable. Similarly, although the Court of Chancery wrestled with the tension between enforcing private agreements on the one hand and disfavoring restraints on trade on the other hand, the Court of Chancery concluded that provisions like the competitive activity condition, which allowed the Partnership to avoid making additional payments if a withdrawing partner engaged in any competitive activity during a four-year period, must be interpreted for reasonableness as restraints on trade. The Court of Chancery, however, noted that it would evaluate such provision under the “employer-friendly” review applied in a sale of a business context. In applying such lenient standard, the Court of Chancery found the provision unreasonable and therefore unenforceable, and the Partnership could not rely on such condition to withhold payments.
In reaching its conclusion, the Court of Chancery rejected the Partnership’s argument that provisions like the Conditioned Payment Device should be interpreted differently in partnership agreements because Sections 17-306 and 17-502 of the Delaware Revised Uniform Limited Partnership Act permit partnership agreements to impose penalties that would not otherwise be enforceable under common law. The Court of Chancery concluded that the leniency provided by such provisions does not extend to consequences to conditions precedent, which inform a Partnership’s duty but impose no duties on the partner. Based on the foregoing, the Court of Chancery granted the plaintiffs’ Motion for Summary Judgment regarding the claims described above.