Shareholders Allowed to Sue CHRO for Fiduciary Duty Violations

The Delaware Court of Chancery ruled that a shareholder suit against a former chief human resource officer alleging he failed to discharge his duty of care and oversight may proceed, extending monitoring and compliance obligations previously applicable to corporate directors to senior officers. Regardless of whether the suit proceeds or is settled, the decision highlights the importance of CHROs’ monitoring and compliance legal duties.

Background: The case involved a shareholder derivative suit against former McDonald’s Executive Vice President and Global Chief People Officer, David Fairhurst. Fairhurst, along with CEO Stephen Easterbrook and other McDonald’s directors, were alleged to have breached their fiduciary duties by maintaining a “toxic culture” that included allegations of widespread and continuous sexual harassment over a sustained period of time.

“Blind eye”: The suit against Fairhurst claimed that the CHRO had direct and indirect knowledge of continuous corporate misconduct including widespread sexual harassment and a “party culture,” and both ignored and failed to adequately address such “red flags.” The judge found that such allegations supported a claim that Fairhurst breached his duty of oversight, and allowed the suit to proceed.

Under longstanding corporate law precedent, corporate directors have a legal obligation to monitor corporate legal compliance, and can be held liable for violating such duty where they have “sustained or systematic” ignorance of “red flags” signaling serious problems. In other words, corporate directors can be held responsible for ignoring and/or failing to address corporate misconduct that they were or should have been aware of.

In the current case, and for the first time, this legal obligation has been explicitly extended to corporate officers, including CHROs. The judge reasoned that “as the day to day managers of the entity, officers are optimally positioned to identify red flags and either address them or report upward to more senior officers or to the board.” According to the judge, this duty is generally limited to an officer’s “areas of responsibility,” with “possible exceptions” for “sufficiently prominent” red flags on broader issues. The failure to address such issues needs to rise to the level of bad faith for shareholders to recover in a derivative suit.

Outlook: The landmark decision clears the way for shareholder suits against corporate officers, including CHROs, for failure to adequately address corporate misconduct resulting in harms to the company, and may result in increased Board scrutiny of CHROs.  More than ever, it is imperative for CHROs to ensure that they are engaged in continuous oversight of areas within their responsibility and at minimum, address “red flags” or report them upward.