Delaware has reigned as the preeminent corporate law jurisdiction in the United States for over a century, weathering the rivalry of eager state competitors (such as Maryland and Nevada) and the looming presence of – and occasional intervention by – the federal government.  Various explanations have been provided as to why Delaware continues to dominate.  And various assessments have been offered as to whether, overall, Delaware’s corporate law jurisprudence is beneficial or detrimental for investors.  These explanations and assessments typically focus on what Delaware has done well over the years to retain its supremacy, not on what, deliberately or fortuitously, it has failed to do.

Yet an ironic feature of Delaware law is that neither its corporation statute nor its case law says very much about the responsibilities of the most influential actors – for good or bad – in corporate affairs, i.e., executive officers.  By way of contrast, many statutory provisions and a vast body of (ever-growing) case law address director responsibilities.  This perplexing absence of Delaware law, moreover, has endured for many decades.

It was only in 2009 that the Delaware Supreme Court finally held in Gantler v. Stephens that officers do owe fiduciary duties.[1]  Nine years later, however, little else has been clarified with respect to officers.  Strikingly, the court in Gantler did not deploy the Business Judgment Rule in its review of claims against the officers, as it presumptively does with respect to breach of duty claims against directors.  In 2016 a Delaware federal court came clean and acknowledged there simply is no case law in Delaware supporting application of the Business Judgment Rule standard of review to officers,[2] a point the Court of Chancery also had repeatedly noted.[3]  Remarkably, in 2017, this very basic issue remains open under Delaware law.

Several other issues pertaining to officer duties also remain unclear under Delaware law, even though these matters have repeatedly been addressed with respect to directors.  These include:  Whether the appropriate standard of care for an officer is the traditional agency law standard of ordinary care/negligence – officers being agents of the corporation – or the more deferential director-like standard of gross negligence; the nature and contour of officer monitoring and oversight duties and whether any such duties fall within the duty of care or duty of loyalty or some combination; the scope of an officer’s duty of disclosure in various contexts, whether in dealing with the board of directors or superior officers or stockholders; whether officers qua officers might have their conduct reviewed under the Unocal or Revlon standards; whether in carrying out their various responsibilities officers may consider the interests of non-shareholder constituencies in the same manner and degree as directors; and whether, if officers are agents of the corporation, not of stockholders, they nonetheless owe fiduciary duties directly to stockholders that may be pursued in a class action or only owe duties to the corporation such that claims for wrongdoing must be pursued exclusively via derivative litigation.

The stakes are large because, unlike the case with directors, officers may not be exculpated from liability for duty of care or duty of loyalty breaches.  Claims against officers may trigger coverage under D&O policies as well, an especially attractive asset in bankruptcy proceedings.

There are many reasons for the dearth of Delaware law on the distinctive status of corporate officers as fiduciaries.  First, until January 1, 2004, the Delaware Court of Chancery did not have personal jurisdiction over officers as such.  Legal action against officers who were not also directors could not – absent other jurisdictional means – be brought in the Chancery Court.  This was not problematic for most of the twentieth century, when boards of directors included numerous officers, because jurisdiction could be obtained over them in their capacity as directors.  As boards became increasingly independent in the 1980s and 1990s, however, no officer-specific basis for jurisdiction existed.

Second, boards of directors likely deal with most officer misconduct by contractual means.  Boards may settle with wrongdoing (or underperforming) officers as part of an intracorporate sanction, whether outright discharge, reprimand, compensation “clawback,” demotion, or delayed promotion.  Increasingly, this may occur under pressure from activist investors to oust CEOs.  Relatedly, executive employment agreements entered ex ante may address grounds for termination and severance issues, including compensation.  It should be recalled, however, that employment law notions of “cause” do not necessarily align with the obligations of fiduciary duties.

The upshot is that, although from a business success standpoint, corporate well-being is predominantly officer-centric, from a legal and corporate governance standpoint – including the resolution of officer-related legal issues – Delaware law reflects a strong commitment to director-primacy.  The very absence of much law on corporate officers, therefore, is an advantageous byproduct and reflection of Delaware’s board-centric corporate governance philosophy.  Just as Delaware’s deferential Business Judgment Rule more generally reflects a governance approach that keeps judges from substantively evaluating business decisions made by a board, so too that judicial hands-off approach precludes judges from even having the opportunity to rule on officer-related legal issues that already have been addressed by the board.

The third reason for the sparse supply of officer-oriented law is that the demand side of the market for officer law has been weak.  Lawyers for plaintiff shareholders, and perhaps lawyers for boards of directors, simply may not, historically, have appreciated the distinctive (and strict) agency-type fiduciary obligations owed to the corporation by officers as full-time operational managers, obligations arising quite apart from any contractual arrangements and differing in their demands from the governance duties owed by non-employee directors.  This is exemplified by the striking failure of plaintiff’s counsel in the high-profile Disney litigation to argue the inapplicability of the Business Judgment Rule to the officer defendants in that case until the appeal stage, where the Supreme Court held that it was too late.

Finally, unless fiduciary duty claims against officers can be successfully fashioned as direct claims, they likely must be brought as derivative actions.  As such, they face daunting procedural hurdles, including the need to successfully plead demand futility or, short of that, actually make a demand on the board of directors.  Once demand is made, the decision of an independent board (or committee) is given Business Judgment Rule deference. That is a very high hurdle for any plaintiff to clear.

Even though Delaware’s inaction on officers is not attributable to a deliberate public policy choice, it likely has bolstered Delaware’s corporate law preeminence in the “market” for corporate law.   Delaware has achieved a desirable sort of “Goldilocks effect” on the subject of corporate officers.  The law – being unsettled – may not clearly be “just right,” but it also cannot be said to be either “too hot” (too strict) or “too cold” (too lax).  Critics cannot charge Delaware with unduly favoring officers, and counter-critics cannot contend that Delaware is too harsh on corporate officials such as officers, and thus threaten to pull up stakes and leave.  Uncertainty became a plus in building market dominance, not a drawback.

Key questions about this unusual absence of answers on issues associated with executive officers still remain.  Is Delaware’s long silence likely to continue?  How are Delaware courts likely to decide these open issues?  And how, if at all, might Delaware’s resolution of these unanswered questions affect its seemingly unassailable position of corporate law dominance?  Holding officers to a fairly strict, ordinary care standard of conduct and a non-Business Judgment Rule standard of review would, in our current era, likely reinforce Delaware’s foundational director primacy philosophy.  It would emphasize how effective discharge of the board’s central governance role demands that those officers to whom directors delegate business management, and on whom they depend for full and accurate information in complex operational settings, must behave carefully.  Without that, the board simply cannot properly fulfill its own statutory and fiduciary responsibilities.  The stakes for the company and its stockholders are simply too high to permit reckless conduct by senior managers.  Holding senior executives to a customary standard of care to which all other agents of organizations are already held also would signal Delaware’s seriousness about ensuring executive accountability and overall corporate integrity, giving it a modern reputational boost.

Doing so, however, is unlikely to lead to much additional litigation against officers in Delaware.  Since boards do not typically initiate many actions against officers, boards and officers likely will continue to negotiate resolutions outside court.  A few strong judicial rulings on officer duties would, to be sure, considerably strengthen the board’s hand when bargaining with an executive whom the board believes is failing to discharge his or her responsibilities.

Such a fleshing out of the law of officers will be helpful to all actors in Delaware corporations and can be done in a way that is beneficial for the law’s development, while also remaining true to Delaware’s board-centric approach to governance and leading to no significant upsurge in officer-related litigation.  Importantly, it is doubtful that clarifying officer duties will weaken Delaware’s continuing dominance in corporate law.  It is precisely Delaware’s long and well-established stature that, today, permits it to advance modest corporate law reform on this important subject, while also reassuring investors that those at the top are held to appropriate standards.  This may not have been so easy many decades ago.

ENDNOTES

[1]  Gantler v. Stephens, 965 A2d 695, 708-09 (Del. 2009)(describing the issue as “a matter of first impression.”).

[2]  Palmer v. Reali, 2016 U. S. Dist. Lexis 134005, n. 8 (D. Del. Sept. 29, 2016) (“Defendants have cited to no cases where a Delaware court has held that the Business Judgment Rule applies to corporate officers;…”).

[3]  See, e.g., Chen v. Howard-Anderson, 87 A.3d 648, 666 n. 2 (Del. Ch. 2014).

This post comes to us from Professor Lyman Johnson at Washington and Lee University School of Law. It is based on his recent article, “Dominance by Inaction: Delaware’s Long Silence on Corporate Officers,” available here.