In a March 1, 2023 opinion (In re McDonald’s Corp. Stockholder Derivative Litig., C.A. No. 2021-0324-JTL), the Delaware Court of Chancery dismissed duty of oversight claims against director defendants and provided helpful guidance on “mission critical” risks, the “gross negligence” standard under the business judgment rule, and redactions in productions of books and records under DGCL Section 220, including the potential that a motion to dismiss relying on overly redacted documents from a 220 production could be converted to a motion for summary judgment by the court. The court also entered an order on the same day, granting the defendants’ Rule 23.1 motion and dismissing the action in its entirety, including claims against the company’s former Global Chief People Officer. The court had previously denied a motion to dismiss those claims under Rule 12(b)(6) on January 25, 2023, as discussed further here, underscoring the important role of Rule 23.1 in derivative cases.
Oversight Duties Extend Beyond Responding to “Mission Critical” Risks. There are two types of director oversight liability claims: (1) a claim that an officer or director failed to establish reasonable information systems and controls, and (2) a claim that an officer or director was aware of red flags indicating a risk to the company, and consciously disregarded the red flags. Recent cases have highlighted that in a red flags claim, the court is particularly focused on red flags concerning “mission critical” risks, such as food safety for a food production company. The court in McDonald’s clarified, however, that a plaintiff need not establish that a red flag is related to a mission critical risk in order to state a red flag director oversight claim. Rather, director and officer oversight responsibilities extend beyond “mission critical” risks to all “central compliance risks,” and if a red flag related to a risk other than a central compliance risk arises, directors and officers still have a duty to respond to it. Practically, however, it will be easier for a plaintiff to allege that the director’s or officer’s failure to respond was in bad faith for a red flags claim if the red flags concern a central compliance risk or mission critical risk.
Importantly, the court also noted that it may draw a pleadings stage inference that the risk to a company from sexual harassment or misconduct is “mission critical.” In such situations, oversight claims may not be dismissed unless the board or officers can demonstrate that they took action and did not consciously disregard the red flags.
Gross Negligence Under the Business Judgment Rule Is a Higher Standard Than Criminal Negligence. Liability for a breach of fiduciary duty requires a director or officer to have acted, at a minimum, with gross negligence. The court in the McDonald’s opinion explained that “gross negligence” in this context is a misnomer because “in the corporate context, gross negligence has its own special meaning that is akin to recklessness.” In fact, under Delaware law, “[t]o hold a director liable for gross negligence requires conduct more serious than what is necessary to secure a conviction for criminal negligence.”
Non-Responsiveness Redactions in Books and Records Productions Can Complicate Incorporation by Reference. Delaware corporations routinely redact books and records produced to stockholders pursuant to DGCL Section 220 for non-responsiveness and privilege. It is also routine for confidentiality agreements accompanying 220 productions to include — and Delaware courts have upheld — an incorporation by reference condition, pursuant to which books and records produced to the stockholder will be incorporated into any follow-on derivative complaint filed by the stockholder. The McDonald’s plaintiff had agreed to such an incorporation by reference provision in connection with the books and records production preceding the filing of that action. The court discussed the possibility of converting the defendants’ motion to dismiss to a motion for summary judgment, noting that “extensive use of the redaction tool makes a Rule 56 conversion more attractive.” The court clarified that it was not referring to redactions for privilege. Ultimately, the court granted the motion to dismiss and did not convert it to a motion for summary judgment, including because the unredacted portions of the books and records produced did not allow for a reasonable inference that the McDonald’s board had failed to act in response to red flags. In light of this opinion, corporate defendants should continue to consider whether redactions to books and records may complicate the defendants’ ability to rely on those documents on a motion to dismiss any subsequently-filed derivative lawsuit.