Who Is Responsible for Toxic Workplace Culture? New Ruling May Surprise You

Last month the Delaware Court of Chancery ruled that the duty of oversight applies to both officers (executive-level employees) and directors (members of the Board of Directors) of an organization.

Here’s an overview of the decision, what it means, and how it might impact you.

David Fairhurst, former chief people officer at McDonald’s Corporation, was fired in 2019 for both participating in and “consciously ignoring red flags” about pervasive sexual misconduct at the company. He wasn’t necessarily an ethical leader, but was he the one ultimately responsible for upholding McDonald’s corporate culture?

Oversight has traditionally been the obligation of an organization’s board of directors. But, on January 25, 2023, the Delaware Court of Chancery decided that shareholders will be able to sue Fairhurst for allowing a culture of sexual harassment during his tenure.

This is the first time that a corporate officer may be held accountable for oversight – bringing up some necessary questions about what happens next.

To get some additional clarity on this issue, I sat down this week with Partners Jonathan Stemerman and Andrew Lolli of Armstrong Teasdale LLP, a prominent law firm.

According to Lolli, “There are really two kinds of claims that have existed under Delaware law for a long time.”

• Red Flag Claim: According to a decision in 1963, Graham v. Allis-Chalmers, a company’s Board of Directors has a duty to do something about any information it receives to protect the company. “But, the Board of Directors doesn’t have a duty to go out and actively seek that information,” said Lolli.

• Information Systems Claim: Fast forward 33 years to the In re Caremark Intern, Inc. Derivative Litigation case, which expands the duty of the Board of Directors to put Information Systems in place to actively seek information – and then act on it.

The McDonald’s decision said – for the first time – that officers owe these same duties to their corporations as a Board of Directors. “The reason everyone is talking about this decision is because a Delaware court has said for the first time that corporate officers – like directors – have the duty of oversight,” said Stemerman. “This means that corporate officers now have a legal obligation to report and address red flags within the area of the company they operate.”

Some familiar with the case are wondering why the duty of oversight has been extended to officers.

Lolli assured me: “A company’s Board of Directors doesn’t typically run the day-to-day operations of the company; that’s the role of professional managers and the c-suite. In the real world, the c-suite executives are the people that implement information systems and take action on any red flags they may uncover internally – not the Board of Directors.”

The McDonald’s decision extends the role of oversight explicitly to officers, but this is something that ostensibly takes place now. Lolli said, “There might be CEOs and CFOs looking over their shoulder that weren’t before, but this ruling just formalizes an existing framework that many people thought should already be applicable to officers.”

Stemerman agreed, adding: “It’s not a huge leap to say that officers also have duty of oversight. It just took a long time to get there legally.” But, for those who might be worried about potential repercussions, he hastened to add: “As an officer, as long as you do something in good faith when you learn of a situation to address it, you’ve probably insulated yourself to being found liable down the road.”

According to the court records, McDonald’s displayed a pattern of bad behavior that started around 2016. It is likely that the #MeToo movement helped to bring the company’s pervasive culture of sexual harassment into focus, and by 2018 employees in ten cities went on strike in protest.

At that point, the company finally acted – putting policies and training programs into place to address employee concerns. Fairhurst was a part of those efforts, so the court will limit his liability to before he acted. But is it reasonable to infer that even though Fairhurst was a part of the remediation process that he only paid lip service to it?

Does your organization have training programs in place for a safe, inclusive workplace?

Lolli posed the question: “When an officer, or a director for that matter, has taken action to address a known problem – is that good enough? Do we take them at their word?”

The McDonald’s decision suggests otherwise. What McDonald’s was saying it was doing to mitigate sexual harassment was at odds with what employees said was happening on the ground. That’s one reason why it is so important for organizations to do a 360-degree review of the systems they have in place, their corporate culture, their work environments, how they deal with big problems. Talk to individuals on the ground, in your offices. Empower people to understand what sexual harassment looks like and how to report it.

McDonald’s had a zero-tolerance policy in place against sexual harassment. Yet, instead of enforcing the policy as it was written, the Board of Directors simply docked Fairhurst’s compensation – essentially giving him a slap on the wrist.

What is your organization’s policy on workplace harassment?

“If your policy is zero tolerance, and you respond with something other than zero tolerance, have you addressed the problem at all?” questioned Lolli. “As [Stermerman] correctly pointed out, traditionally, taking any remedial action to address a red flag provided directors with a degree of insulation from liability. But McDonald’s took remedial action against Fairhurst and the claim still survived a motion to dismiss. In theory, the decision opens up a potential crack in the foundation of the law as it has existed until now. It’s possible that remedial action which is inconsistent with the company’s own policies is incapable of providing a safe harbor to officers and directors in the wake of the McDonald’s decision. Only time will tell.”

Lolli urges corporate officers to be proactive in light of the McDonald’s decision:

• Review your Directors & Officers (D&O) Liability Insurance. D&O is often issued to protect the personal assets of corporate directors and officers, and their spouses, in the event they are personally sued for actual or alleged wrongful acts in managing a company. Lolli suggests that officers “get out your D&O policy, read it carefully, bring to your General Counsel, or private outside counsel, and make sure there is not some exception to coverage. Carriers may rewrite policies, challenge coverage, etc. You need to know where you stand.”
• Meet with your General Counsel/Chief Legal Officer. Work with the legal team to perform a total review of your company’s existing information systems (which include your compliance systems) to ensure they are functioning properly. “No system is perfect, but companies need to demonstrate in good faith that they are following the law,” he said. “They can do so by periodically reviewing their information systems and reforming them where necessary. Additionally, it may be advisable to review any red flags that have been addressed recently to ensure that any remedial action is consistent with the company’s policies,” he added.
  

At the end of the day, Stemerman isn’t too concerned. “The business judgement rule is alive and well in Delaware,” he said. “The court will not second-guess good faith decisions made by the Board of Directors or other corporate officers. If you act in good faith and try to do what is right, you will be insulated from liability.”

The takeaway for directors and officers? If you find out about sexual harassment in your organization, do something about it. “If you can show you are actively handling the problem, you can likely have the case thrown out at the pleadings stage,” said Stemerman.

In closing, Lolli echoes this sentiment. His advice to companies? “Mean it. When you put company policies in place, mean it. You have to have real corporate values, to put in the work internally. Don’t be a test case. Nobody wants to be a test case.”

About Jonathan Stemerman

Jonathan Stemerman advises clients in a wide variety of complex litigation, transactional and insolvency matters. He concentrates his practice in the areas of corporate, commercial and bankruptcy litigation, as well as corporate transactions, workouts and restructurings.

Jon has represented clients in numerous corporate and complex commercial litigation cases in Delaware and Pennsylvania. He frequently litigates matters in Delaware’s Court of Chancery, including actions involving breach of fiduciary duty, business divorce, receiverships, and books and records requests. Additionally, he represents both plaintiffs and defendants in breach of contract actions and other complex commercial disputes in state and federal courts.

About Andrew Lolli

Andrew Lolli primarily focuses on complex commercial litigation, including securities, corporate, partnership structure and dissolution matters. He also has extensive experience with construction litigation, estate litigation, insurance litigation and electronic discovery.

Andrew is admitted in New York, but has appeared pro hac vice in Delaware.