A Quick Guide to Officer Exculpation Under Delaware Law

A Quick Guide to Officer Exculpation Under Delaware Law

We have provided below a series of Q&A relating to the recent amendment to the Delaware General Corporation Law (the “DGCL”) authorizing a provision in a certificate of incorporation eliminating liability of corporate officers. This is a significant development but, as explained below, officers are not entitled to the same broad protection afforded to directors and it is not clear that stockholders will approve these provisions.

What did Delaware do?

Section 102(b)(7) of the DGCL was amended to authorize a provision in a certificate of incorporation limiting the personal liability of corporate officers for monetary damages. The amendment is effective.

What types of officer liability can be eliminated?

The amendment is similar to the protections afforded to directors. The certificate of incorporation cannot eliminate personal liability of officers for (i) a breach of the duty of loyalty, (ii) acts not in good faith or that involve intentional misconduct or a knowing violation or law, or (iii) receipt of an improper personal benefit.

Put differently, the statute eliminates liability for monetary damages for an officer’s breach of the duty of care, subject to an important caveat: liability for duty of care violations is eliminated only in so-called “direct claims,” meaning claims brought directly by stockholders in that capacity. Unlike the protection afforded to directors—which extends to any claim for monetary damages for breach of the duty of care—the amended statute does not eliminate officer liability in an action brought “by or in the right of the corporation.” This means officers are not exculpated from derivative claims. Typically, derivative lawsuits must be authorized by the board, which should provide some comfort to officers, but stockholders can bring derivative lawsuits if they can show the board is incapable of objectively considering the litigation demand.

Effectively, Delaware has provided an important but tailored shield for officers against direct claims brought by stockholders. As an example, the exculpatory provision would eliminate monetary liability for a stockholder’s claim that an officer breached his or her duty of care by negligently preparing corporate disclosures, which was the impetus for the amendment. Delaware, however, preserved completely the board’s ability to hold officers liable for duty of care violations. In addition, by preserving liability in all derivative suits, officers remain exposed to, for example, claims arising from corporate crises because such claims are typically derivative (i.e., they are brought in the name of the corporation, even if done so derivatively by a stockholder).

Why did Delaware do this?

Historically, corporate officers were rarely targeted in litigation by stockholders and the plaintiffs’ bar. In fact, officers’ duties have not been well-defined; it was not until 2009 that the Delaware Supreme Court held that officers owe the same duties as directors. Thus, most corporate litigation instead has been brought against directors. Since 1986, the DGCL has protected directors from duty of care claims by allowing certificates of incorporation to eliminate the directors’ personal liability to the corporation or its stockholders, a provision found in nearly all corporate charters. This scheme has generally worked well to protect directors from being second-guessed while preserving liability where a director is disloyal or acts in bad faith.

In recent years, however, there has been an uptick in claims—primarily in the M&A context—seeking to hold officers personally liable to a stockholder class. Many of these claims were based on allegedly negligent disclosure violations. In addition, we have seen cases where plaintiffs focused on inside-directors (e.g., the chair/CEO or executive chair) alleging that they were acting in their officer capacity (and thus not entitled to exculpation) rather than their director capacity (in which case they would be entitled to exculpation) in connection with the challenged matter.

Why has there been an increase in officer claims?

It is difficult to identify a single reason. One factor is that, unlike directors who have long been subject to the jurisdiction of the Delaware courts, executive officers did not automatically consent to jurisdiction in Delaware until 2004. Thus, it used to be more difficult to name all of the requisite parties in a single action. Another likely factor is increasingly aggressive tactics of the plaintiffs’ bar to create settlement value. Duty of care claims are necessarily easier to plead than duty of loyalty claims. Thus, by bringing duty of care claims against officers, plaintiffs have been able to pursue litigation even when their claims against directors were dismissed at the pleading stage.

Is this a sea change in Delaware law?

It depends on who you ask. As noted above, historically stockholders have not brought suits against officers. The amendment also preserves the board’s ability to sue and recover from an officer for breach of fiduciary duty. In addition, many of the recent cases involving officer exposure have involved conflicts of interest, which suggests that the result in most of those cases may have been the same, even if an officer exculpation provision was in effect. On the other hand, the plaintiffs’ bar opposed the amendment, arguing that officers are differently situated from directors and should not be shielded from their negligence in performing their duties.

In our review, a fair conclusion is that this is a significant development in Delaware but it was a measured action in response to a new and concerning litigation trend.

How does a corporation take advancement of the amendment to exculpate officers?

Because the provision must be included in the certificate of incorporation, it requires board and stockholder approval.

Will stockholders and proxy advisory firms support officer exculpation?

That is the big question. Some commentators hope institutional investors will vote in favor of charter amendments to permit officer exculpation. Institutional Shareholder Services (“ISS”), however, currently votes on a “case-by-case” basis on proposals to indemnify or exculpate directors and officers and generally recommends “against” proposals that would “eliminate entirely directors’ and officers’ liability for monetary damages for violating the duty of care.” Thus, if ISS is not supportive of director exculpation—which is ubiquitous among public corporations—there is reason to be skeptical that it will support increasing officer protections. 

Glass Lewis & Co.’s voting guidelines suggest a more measured approach, noting that “some protection from liability is reasonable to protect [directors and officers] against certain suits so that these officers feel comfortable taking measured risks that may benefit shareholders” and, “[a]s such, we find it appropriate for a company to provide indemnification.” Still, it is not clear whether Glass Lewis would recommend in favor of charter amendments to exculpate officers.

Are corporations going to present these charter amendments for stockholder approval in the upcoming proxy season?

We shall see. In light of the above questions as to how proxy advisory firms and institutional investors will react, many corporations are taking a wait-and-see approach. Corporations that pursue these proposals should engage with their institutional investors on the matter. If the proxy advisory firms support these proposals, we expect most companies will pursue the charter amendments.

Which officers would be protected?

The short answer is that the protection is limited to executive officers. 

The longer answer is that officers who consent to service of process under Delaware’s long-arm statute are considered “officers” entitled to the protections of an exculpatory clause. This includes, for example, the president, CEO, COO, CFO, CLO, controller, and treasurer, named executive officers in SEC filings, and other officers who consent to being identified as an officer for purposes of service of process.

Assuming the certificate of incorporation is amended to exculpate officers, is the protection retroactive?

No, the new statute specifically says that it is not retroactive.