Why Canadian Officers and Boards Should Follow a U.S. Decision on an Officer’s “Duty of Oversight”

Published on: May 2023 | What's Trending

Business team looking down with head in hands looking very upset.

The traditional role for officers of a company is to manage the day-to-day operation of the business. But do those officers also have a duty to “oversee” aspects of the company, such as whether corporate culture tolerates or overlooks sexual harassment and misconduct?

According to a recent decision from the influential Delaware Court of Chancery (DCC), officers, just as well as directors, have a duty of oversight as part of their broader fiduciary obligations to a company. While this expanded duty is not yet law in Canada, Canadian corporate law tends to follow U.S. and particularly Delaware decisions. As a result, officers and directors of Canadian companies should take heed in preparation.

What Happened in the Case

The decision from this year, In re McDonald’s Corporation Stockholder Derivative Litigation, (“McDonald’s”) builds on the obligations established decades ago in the milestone case In re Caremark International Inc. Derivative Litigation (Caremark), 698 A.2d 959 (Del. Ch. 1996). In McDonald’s, shareholders of McDonald’s Corporation brought a derivative action against the Company’s Executive Vice President and Global Chief People Officer, alleging he had breached his fiduciary duties by allowing the development of a corporate culture that condoned sexual harassment and misconduct.

Specifically, they asserted that the officer had a duty of oversight as part of his fiduciary duties, and that this oversight duty included an obligation to address or report upward any red flags regarding sexual harassment and misconduct. The officer moved to dismiss the claim arguing that, as an officer, he did not have a duty of oversight (i.e. in the way that a member of the Board of Directors would).

The DCC disagreed. Writing the decision, Vice Chancellor J. Travis Laster specifically found that “corporate officers owe a duty of oversight” and that the same principles that led the court to acknowledge a duty of oversight for directors in Caremark applied equally, if not more, to company officers.[1] The court noted that this duty was not only essential to the Board being able to discharge its duty to oversee, but also to hold officers accountable. The court also suggested that this duty was considerably expansive, noting that even though the duty of oversight would generally be limited to the officer’s specific areas of responsibility, a “particularly egregious red flag might require an officer to say something even if it fell outside the officer’s domain.”[2]

Why this Case Matters

The Court cited a business law principle that officers, rather than directors, are “charged with and responsible for” running the business of a corporation. For that reason, the oversight role is “more suited” to corporate officers than directors. With their feet on the ground in day-to-day operations, officers are simply better positioned to observe problems and to act on them in a timelier fashion than a board that meets only a handful of times per year. “Officers who are running the business on a full-time basis,” the Vice Chancellor explains, “have a duty to address or report upward regarding what they see.”[3]

In addition, the decision to impose oversight obligations on officers is also based on the reasoning that officers and directors both owe the same fiduciary duties to the company, a concept that is generally shared in Canadian jurisdictions as well. For example, the (Ontario) Business Corporations Act establishes its fiduciary duty for both directors and officers in one shot, noting no distinction: “134(1) Every director and officer of a corporation in exercising his or her powers and discharging his or her duties to the corporation shall, (a)  act honestly and in good faith with a view to the best interests of the corporation; and (b)  exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.

Given the similarities in Canadian and Delaware corporate law, the reasons given, and the tendency of Canadian jurisprudence to follow major U.S. decisions – particularly on corporate governance matters – it may be only a matter of time before domestic courts begin to formally recognize this same “duty of oversight” on part of officers. Officers would be prudent to foresee their duty to ensure matters within their responsibility and beyond do not develop a toxic or problematic culture. Boards, for their part, should understand that encouraging a culture of oversight among management is an indispensable element in discharging their fiduciary obligations and, by extension, mitigating their legal risk.

Call To Action

It is important that Canadian officers (including executives and management) and directors alike understand their evolving duties in a dynamic corporate legal environment. Cases like McDonald’s only underscore that legal expectations on upper management and boards continue to grow. If you need assistance understanding your duties in a particular context, or want to ensure you are meeting your fiduciary obligations, a member of our business law group would be happy to answer questions or discuss good governance practices in general.

[1] In Re McDonald’s Corporation Stock Derivative Litigation C.A. No. 2021-0324-JTL, Page 2

[2] Ibid, Page 2

[3] Ibid, Page 27