Author: Priya Cherian Huskins
The Delaware legislature has expanded protection from monetary liability in certain circumstances to senior officers.
It's a banner year for Delaware corporations when it comes to protecting their directors and officers. Earlier this year, the Delaware legislature took steps that will allow captives to become a more viable alternative to traditional Directors and Officers (D&O) insurance. More recently, the Delaware legislature has expanded the ability of corporations to protect officers from monetary liability in some circumstances.1 Delaware corporations should take steps to implement this newest protection as soon as possible.
Quick background
In 1985, most businesspeople were disturbed by the outcome of Smith v. Van Gorkom.This case involved a cash-out merger of TransUnion for a substantial premium over the market price of this publicly traded stock.
Nevertheless, in a 3-2 decision, the Delaware Supreme Court found that the Court of Chancery erred in dismissing the fiduciary duty of care suit against the TransUnion directors. The parties ended up settling the case for $23.5 million, which was $13.5 million more than the company's D&O insurance policy.
To be sure, the record reflects hasty decision-making on the part of the board. Nevertheless, a major post-Van Gorkom concern was whether this decision would cause businesspeople to be reluctant to serve on corporate boards.2
While public reporting indicates that the individual directors did not, in fact, end up paying all of the settlement personally due to the beneficence of the acquiror,3 the threat of personal financial liability was all too real.
The Delaware legislature reacted swiftly to the threat of losing competent directors. By 1986, Delaware General Corporation Law Section 102(b)(7) was in place.
As originally constructed, DGCL Section 102(b)(7) allows Delaware corporations to include in their certificates of incorporation a provision that greatly reduces the possibility of a director facing personal monetary liability for breaches of fiduciary duty, particularly the duty of care.4
While the Van Gorkom case was a direct suit, Section 102(b)(7)'s provisions for directors apply to both direct and derivative suits.
Referred to as "exculpation provisions," Section 102(b)(7) isn't a free pass for directors. Directors can still be held personally liable for breaches of their duty of loyalty and good faith (i.e., Caremark claims), intentional misconduct or knowing violations of law, transactions involving improper personal benefits and Section 174 violations concerning lawful dividends, stock repurchases and redemptions.5
Plaintiffs' bar innovation
When plaintiffs have tried to bring duty of care suits against directors, exculpatory provisions have allowed corporations and their directors to win their motions to dismiss quickly and efficiently. This has, as intended, discouraged the plaintiffs' bar from bringing these suits.
However, as the plaintiffs' bar knows, officers of a corporation have the same fiduciary duties that directors have, as clarified by a 2009 Delaware Supreme Court decision (Gantler v. Stephens)6. Realizing this, the plaintiffs' bar has pursued a strategy of bringing duty of care claims against officers, knowing Section 102(b)(7) doesn't protect them.
Amendments to Delaware General Corporation Law
Amendments to Section 102(b)(7) enable corporations to protect certain officers from personal monetary liability for stockholder claims related to the breach of the duty of care. The Delaware legislature has given corporations the ability to expand exculpation provisions to certain senior officers,7 such as:
- Chief executive officer
- President
- Chief operating officer
- Chief financial officer
- Chief legal officer
- Controller
- Treasurer
- Chief accounting officer
- The most highly compensated executive officers as identified by public filings with the SEC
- People who consent to be identified as an officer
Exculpation of corporate officers has the same limitations that the exculpation provision has for directors, ensuring that officers also do not have a free pass. In addition, and unlike the case for corporate directors, exculpation for officers only applies to direct suits and not to derivative suits.
Next steps
Similar to the situation for corporate directors, senior corporate officers can have the benefit of the new exculpation provisions only if the corporation takes the affirmative step of putting these provisions in its certificate of incorporation.
Such a step will be relatively easy for companies that are just being formed. Officer exculpation provisions will become as ubiquitous as director exculpation provisions over time.
Existing private companies will want to ask their stockholders to vote to approve officer exculpation provisions after their boards meet and confirm that they want to make such an amendment to their certificates of incorporation.
Existing public companies can also ask stockholders to vote to approve officer exculpation provision amendments to their certificates of incorporation. This vote might be a good thing to put on the agenda for the next annual stockholder meeting.
Of course, public companies have to think whether proxy advisory firms such as ISS and Glass Lewis will recommend that their clients vote to approve these amendments. At the time of this writing, neither has published a position on the topic.
As a general matter, other matters that tend to reduce frivolous litigation, such as federal choice of forum and state choice of forum provisions have (ultimately) been supported by proxy advisory services.8
A good practice for both public and private boards will be to take the time to discuss and record, in official board meeting minutes, the reasons for adopting officer exculpation provisions.
There are, of course, all the typical reasons companies promise to protect directors and officers, such as the desire to recruit and retain the best talent, as well as the concern that directors and officers be able to make decisions without fear of personal financial liability due to unmeritorious claims.
An additional reason is that, while D&O insurance is a good backstop to the concern for financial liability, it can be expensive, may not always be available and cannot address the time wasted by frivolous litigation. Moreover, one law firm notes that officer exculpation is allowed in some other states. Finally, adding officer exculpation at least partially remedies the inconsistent treatment of directors and officers, both of whom have fiduciary duty obligations.
Published August 2022
