Delaware to Expand Liability Protections to Senior Officers

POMERANTZ MONITOR | JULY AUGUST 2022

By Gustavo F. Bruckner and Carolyn Fontana

On June 14, 2022, the Delaware Legislature passed legislation that would allow Delaware corporations to adopt exculpation clauses limiting or eliminating the monetary liability of certain officers of corporations. If approved by Delaware Governor John Carney, the proposed changes to the Delaware General Corporation Law (DGCL) would expand liability protections to officers that are similar to those currently granted to directors. This proposed expansion has caused concern in some corners that the amendment will encourage bad behavior by company officers who will now have a shield protecting them.

Under Delaware law, directors and officers owe certain fiduciary duties to their corporations and stockholders, including duties of care and loyalty. Section 102(b)(7) of the DGCL authorizes Delaware corporations to include in their certificates of incorporation “[a] provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director,” otherwise known as an exculpatory clause. Under current law, such exculpatory clauses cannot eliminate or limit the liability of a director for any breach of the duty of loyalty, for any acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, for unlawful payment of dividends or unlawful stock repurchases, or where a director receives an improper personal benefit.

These liability protections for breaches of the duty of loyalty and the duty of care given to directors are not currently afforded to officers. Rather, officers currently face potential personal liability for both duty of care and duty of loyalty claims. Duty of care claims can include, for example, alleged disclosure violations. Duty of loyalty claims, meanwhile, often occur when a director profits at the expense of the corporation.

If the proposed changes were enacted, the liability shield for senior officers would expand, thus eliminating or limiting their personal liability in stockholder actions seeking damages for alleged duty of care breaches, but not breaches of the duty of loyalty. The senior officers covered by the new changes are chief executive officers, presidents, chief financial, operating, and legal officers, controllers, treasurers, and chief accounting officers, as well as any other persons identified as “named executive officers” in the corporation’s most recent SEC filings. These senior officers would remain at risk for derivative suits for loyalty breaches pursued in the company’s name and for the company’s benefit.

These proposed changes arose due to criticism over the difference in liability faced by directors and officers. That is, stockholder plaintiffs have increasingly asserted breach of fiduciary duty claims against officers rather than directors, despite officers and directors owing the same fiduciary duties of loyalty. As a result of these claims, Delaware courts have denied motions to dismiss brought by officers, while granting those same motions with respect to the company’s directors.

Proponents of the amendment include firms representing corporations whose officers may now be protected with this liability shield. These firms further argue that these officer duty of care claims are merely new litigation tactics by shareholder plaintiffs’ lawyers to garner potentially lucrative fee awards in cases where these proponents believe any damages case should be dismissed.

Plaintiffs firms have voiced strong opposition to these proposed changes, arguing that they are at best unwarranted. In addition to their lack of necessity, they argue that the changes also needlessly exculpate a range of careless or reckless behavior for which an officer should face potential liability. Without the risk of facing potential liability, senior officers lack a personal motive to act with due care, undermining their crucial role as gatekeepers for the company by preventing corporate misconduct from occurring under their watch.

The changes have also been criticized as creating a solution for a problem that does not exist. More specifically, opponents argue that the drafters conflate the necessary protections for directors with those for officers, as directors face problems with potential liability that officers of the corporation do not face. This can be seen when looking at the origins of director protections, which were expanded in the 1980s following the Delaware Supreme Court’s 1986 decision in Smith v. Van Gorkom. Van Gorkom identified two problems created by holding directors personally liable for negligence: (1) decreasing the pool of qualified people willing to serve as directors of Delaware corporations out of fear of personal liability for corporate actions, and (2) drastically increasing the cost of director and officer liability insurance. To prevent these problems, Delaware enacted strong director liability protections.

Delaware, as the state of incorporation of most corporations in the United States, maintains some of the strongest liability protections in the country, although states like New York have strong director liability protections.

Later, in 2009, the Delaware Supreme Court clarified the duties of officers in Gantler v. Stephens, explaining that officers owe the same fiduciary duties as directors, but do not have comparable exculpatory clauses to protect them from personal liability. This distinction comes from the fact that officers do not face the same problems as certain directors when it comes to personal liability. That is, the changes put in place after Van Gorkom were created to allow independent directors who are not employees of the company to serve on the board of that company without any concern of potential liability for breaches of their duty of care. Officers, on the other hand, don’t have this problem because they lack independence and are actively involved in the day-to-day operations of the corporation.

In addition to the issues regarding differences between officers and directors, opponents of the proposed expansion of liability protections raise the question of why officers can be liable in some situations but not others. For example, a CEO of a corporation making millions of dollars a year could, conceivably, be potentially liable to a customer if they acted negligently and injured that customer. At the same time, if these proposed changes go through, that same CEO would not be liable for acting grossly negligently with respect to stockholders in connection with a sale of company assets.

Moreover, opponents argue, claims of gross negligence are already rare, with only a few cases in recent years permitting a duty of care claim to move forward against a corporate officer, and those cases involved unique situations in which the plaintiffs had the burden to prove their claims. So, the argument that officer duty of care claims are merely litigation tactics for getting higher fee awards is unfounded, they contend, as the claims are few and those which have survived a motion to dismiss have been properly pleaded by stockholder plaintiffs trying to remedy bad business behavior.

These proposed changes, if approved by Governor Carney during the current legislative session, will present significant challenges for shareholder plaintiffs trying to sue officers for allegedly careless behavior. Meanwhile, the changes could also save companies from having to defend claims that they believe have no merit and thus should not warrant damages. Now that the legislation has passed both the Delaware Senate and General Assembly, there is pressure on the Governor to sign it this year, before the legislative session ends. Bills left on the table unsigned when a session concludes must start the process anew.