Corporate Officers’ Role in Corporate Governance: What Officers Need to Know

The recent Delaware Court of Chancery decision, In re McDonald’s Corporate Stockholder Derivative Litigation is a reminder of corporate officer duties and the vital role that corporate officers play in corporate governance, at both publicly and privately held corporations. These duties stem from officers’ status as both agents and fiduciaries. For boards of directors and other officers to perform their roles effectively, it is critical for officers to understand and satisfy their duties. Failure to do so may deprive boards of directors of information they need to monitor operations, mitigate risks and establish strategy and can expose officers to personal liability.

Duties as Agents

As agents, officers are obligated to keep their principals (i.e., superior officers or the board) informed of material information relevant to their roles as officers. This encompasses not only information officers actually know, but also information they have reason to know or should know that would be necessary for the board in its monitoring and decision-making functions. The board must rely on officers for information because officers are close to day-to-day management and, thus, have access to the information necessary for boards to analyze and act on critical issues. If an officer fails to gather and to, directly or indirectly, provide material information to the board, the officer could face personal liability.

Duties as Officers

For many years, Delaware courts have been clear that both officers and directors owe fiduciary duties of care and loyalty. In broad terms, the duty of care is the obligation to consider all material information that is reasonably available and to act on an informed basis with the degree of care of an ordinarily prudent person in a like position under similar circumstances. The duty of loyalty is the obligation to act in a disinterested basis, in good faith and in a manner honestly believed to be in the corporation’s best interests.

There can be severe consequences for breaching these duties. For example, if an officer breaches the duty of loyalty, the officer may face personal liability for monetary damages. Damages awarded for these breaches typically cannot be satisfied through indemnification by the corporation because officers are generally not entitled to indemnification unless they act in a manner that they reasonably believe to be in the best interest of the corporation. Although corporations can buy insurance to protect directors and officers from losses when indemnification is unavailable, many policies will not cover intentionally dishonest conduct, fraud or willful violations of law.

Officers may be surprised by what could be considered a breach of the duty of loyalty. Fraud and criminal conduct are obvious breaches. However, any activity designed to further a personal interest such as sharing confidential information or trade secrets, embezzlement, engaging in sexual harassment or breaching non-solicitation agreements may constitute a breach of the duty of loyalty, because the actions are at odds with the corporation’s best interests

A component of the fiduciary duty of loyalty is the duty of oversight. As confirmed in the McDonald’s case, a breach of this duty would occur if an officer (1) fails to make a good faith effort to implement a reporting or information system designed to provide the officer with the information necessary to perform such officer’s job or (2) consciously fails to monitor such a reporting or information system or consciously ignores red flags emerging from such a system. The decision makes clear that, as day-to-day managers, officers are an essential link in the corporate oversight structure.

Unlike directors, who have “plenary authority” over the business and affairs of a corporation, the extent of an officer’s oversight duty depends on the officer’s area of responsibility. Officers generally will be responsible for addressing or reporting “red flags” within their areas of responsibility. However, there may be some signals that are sufficiently prominent that any officer might have a duty to report it upward. This serves to prevent officers from turning a blind eye and dismissing glaring issues as “not in their area”

Action Items for Corporations

• Consider providing officer training covering officer fiduciary duties and officer responsibilities as agents of the corporation.
  • Include real-world scenarios and Q&As to help officers understand their duties in practice.
  • Ensure officers know when and how to report up regarding “red flags.”
• Because officers’ duty of oversight is context-driven, ensure that roles and responsibilities are clearly defined and understood, both by the board and by management.
• Consider whether the processes for developing board materials is sufficiently robust to cover major areas of potential risk and which officers should regularly report to the board.
• Ensure that board materials and minutes reflect that the board has been informed of potential risks, how they are addressed and which officers are responsible.
• If permitted under applicable law (as in Delaware since 2022), consider amending the corporate charter to provide for officer exculpation.

Action Items for Officers

• When acting as a corporate officer, prioritize the corporation and its interests over your own desires and preferences.
• Remember that the board’s reputation is in your hands.
• Make sure you help the board understand the business and the context of risk and opportunities.
• Supply timely information that is accurate, complete and understandable. Always put yourself in the directors’ shoes in assessing the information flow and, for any information provided to the board, have a firm understanding of its purpose.
• Help ensure that the board is never surprised (by good or bad news).
• Make sure you have asked yourself the tough questions before the board does.
• Embrace process (including documentation).
• Consider ways to standardize the creation and distribution of information to improve quality and save time.
• If you have any questions about reporting to the board or regarding your duties or responsibilities as a corporate officer, ask your General Counsel.

Beth Berg is a Corporate partner in the Chicago office of Sidley Austin LLP. Her practice focuses on advising public companies on M&A, corporate governance and disclosure matters as well as activism defense. She is a member of the ABA’s Corporate Laws Committee. John Howard served as W.W. Grainger, Inc.’s General Counsel for 23 years. He is a fellow of the American College of Governance Counsel. Hannah Ellis is an associate in the Chicago office of Sidley Austin LLP. She is a member of the firm’s Corporate group.

Reprinted with permission from the May 31, 2023 issue of Corporate Counsel. ©2023 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.