We strongly recommend each Delaware corporation consider implementing an amendment to its certificate of incorporation to exculpate its officers from personal liability from monetary damages, and that newly formed Delaware corporations include a charter provision to the same effect, as newly permitted by Delaware law. Like exculpation for directors, we believe this protection, for the benefit not only of the officers but also of the corporation and its stockholders, will quickly become standard practice among Delaware corporations and demanded by sophisticated and well-advised officer candidates prior to accepting (and often continuing) their roles at any Delaware corporation.
Importantly, this change does not permit officers to be exculpated from liability (1) for the same types of claims with respect to which exculpation of directors is not permissible or (2) in any action by or in the right of the corporation, such as derivative litigation. As a result, the traditional checks against officers remain, as claims may still be brought for breach of the fiduciary duty of loyalty or actions taken in bad faith and the board and stockholders (bringing suits derivatively on behalf of the corporation subject to demand requirements) may still bring fiduciary claims against officers. We see these protections as key to obtaining stockholder and proxy advisor support to extend exculpation to officers.
For existing Delaware corporations, implementation typically requires an amendment to the corporation’s certificate of incorporation, approved by the board of directors and adopted by stockholders at a meeting (or, more commonly for a private corporation, by written consent). Newly formed Delaware corporations would adopt a charter that includes a provision for the exculpation of officers. The sooner the exculpatory provisions are implemented, the sooner that officers, the corporation and its stockholders can benefit from this important protection.
FREQUENTLY ASKED QUESTIONS
For more than 35 years , Delaware law has permitted Delaware corporations to exculpate directors from personal liability for monetary damages associated with breaches of the duty of care. Until now, that protection did not extend to a Delaware corporation’s officers. As a result, stockholder plaintiffs have had an incentive to single out officers for duty of care claims, and in recent years, they have deployed that tactic to extract settlement leverage. To avoid inconsistent treatment between officers and directors and address rising litigation and insurance costs for stockholders, Delaware has now extended the ability of a Delaware corporation to exculpate its officers, as well as its directors, under certain conditions.
What is “exculpation”?
Directors and officers may be subject to personal liability for claims against them for actions they take (or do not take) for the corporation. Although many corporations offer directors and officers (D&O) insurance, indemnification and advancement of expenses to protect directors and officers from some of these risks, the first line of defense can be found in the corporation’s certificate of incorporation. Specifically, Section 102(b)(7) of the Delaware General Corporation Law authorizes corporations to include in their certificates of incorporation, “[a] provision eliminating or limiting the personal liability of a director or officer to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director or officer” (emphasis added). This is referred to as “exculpation.”
Why is this coming up now in 2022?
Prior to August 1, Section 102(b)(7) of the Delaware General Corporation Law permitted exculpation of directors only, and “director exculpation” is now ubiquitous. Effective August 1, a recent amendment expanded exculpation to officers as well, and we expect “officer exculpation” to become ubiquitous as well.
Historically, claims brought against directors for exculpated claims for negligence or breach of fiduciary duties would be subject to an early-stage motion to dismiss, allowing for a quick and efficient dismissal of the claims without a protracted legal fight or settlement costs. However, stockholder plaintiffs have in recent years increasingly exploited the lack of officer exculpation by bringing the same claims against officers that would otherwise be quickly dismissed against directors. The Delaware legislature then moved to close the gap in exculpation between officers and directors with the amendments effective August 1.
Which Delaware corporations are eligible to benefit from officer exculpation?
Only Delaware corporations whose certificates of incorporations are amended to adopt language exculpating officers (and newly formed Delaware corporations whose charter includes a provision for the exculpation of officers) are eligible. The August 1 amendments to the Delaware General Corporation Law do not automatically extend officer exculpation to all Delaware corporations. We discuss the typical process for amending the certificate of incorporation below under, “When and how should we consider adopting the proposed amendment?”
Which officers are eligible to benefit?
The scope of officers eligible for exculpation will include the chief executive officer, president, chief operating officer, chief financial officer, chief legal officer, controller, treasurer or chief accounting officer, the company’s most highly compensated executive officers (as identified in SEC filings) and certain officers who consent (or are deemed to consent) to be identified as an officer and to service of process. When in doubt, we recommend officers consult the company’s general counsel to know whether they are individually eligible for exculpation.
What claims against officers are/are not eligible for exculpation?
The scope of exculpation covers any claim for breach of fiduciary duty as an officer except for:
Claims Excluded from Exculpation
Exclusions Shared with Director Exculpation
New Exclusions Only from Officer Exculpations
By analogy, in the context of directors, the Delaware Supreme Court has further explained that, “claims that do not benefit from exculpation include those that the director acted in subjective bad faith when the conduct is motivated by an actual intent to do harm, or when there is an intentional dereliction of duty, a conscious disregard for one’s responsibilities. Pleading bad faith is a difficult task and requires that a director acted inconsistent with his fiduciary duties and, most importantly, that the director knew he was so acting. Gross negligence, without more, is insufficient to get out from under an exculpated breach of the duty of care.” McElrath v. Kalanick, 224 A.3d 982, 991-92 (Del. 2020). Importantly, it is these negligence and gross negligence claims, as extensions of a breach of the duty of care, that are most commonly subject to exculpation.
As noted in the table above, there is an important difference between exculpation of directors and officers: officers may not be exculpated from liability in “any action by or in the right of the corporation.” Put simply, unlike director exculpation, this means the board itself and stockholders (bringing suits derivatively on behalf of the corporation where permitted) may still bring fiduciary claims against officers. This is important so that the corporation itself (through the directors or derivatively through stockholders) may seek monetary remedies from abusive officers who violate their fiduciary duties.
Are “Caremark” claims subject to exculpation?
Generally, no. “Caremark” claims refer to claims that a director or officer has breached the duty of loyalty (which is not subject to exculpation as discussed above) by not making “a good faith effort to oversee the company’s operations.” This is often when the conduct is motivated “by an actual intent to do harm,” or when there is an “intentional dereliction of duty, a conscious disregard for one’s responsibilities.”
Are officers requesting the adoption of these amendments?
Yes, just as directors have for decades.
Similar to the impetus for the adoption of director exculpation by the Delaware legislature and by Delaware corporations, we expect officers, like directors, of Delaware corporations—particularly public corporations—will demand officer exculpation. Corporations that do not adopt officer exculpation will likely face increased costs in terms of having to compensate talent for the incremental risk, as well as confronting the prospect of increased litigation and associated insurance costs.
How does officer exculpation affect the other protections for officers and their related costs?
Where implemented, officers will continue to benefit from any indemnification agreements they have with the corporation and insurance policies (including D&O liability policies). The presence of exculpation (or lack thereof) does not reduce the effectiveness of these other protections and instead serves to reinforce these protections.
Officer exculpation is not a panacea for all litigation risk, but it mitigates one formidable tool in the plaintiff’s arsenal and may help temper litigation costs on a going forward basis.
As a result, corporations (for their own benefit and, indirectly, the stockholders’) that adopt officer exculpation, where already obligated to indemnify or insure those officers, are expected to see benefits in terms of tempered insurance premiums and reduced settlement costs over time as compared to those who do not adopt officer exculpation.
How do you expect ISS, Glass Lewis and large institutional investors to react to these amendments?
We expect proxy advisors, including Institutional Shareholder Services (ISS) and Glass Lewis, to update their voting guidelines to recommend stockholders of Delaware corporations vote in favor of amendments to the certificate of incorporation that extend to officers exculpation from monetary liability for breach of fiduciary duties, as permitted under Section 102(b)(7) of the Delaware General Corporation Law. We also anticipate widespread support among large institutional investors such as Blackrock and Vanguard for officer exculpation. Additionally, we believe most controlling stockholders and private equity sponsors will be supportive of officer exculpation.
Importantly, the amendments to Section 102(b)(7) of the Delaware General Corporation Law that permit a corporation to authorize officer exculpation do not restrict any action by or in the right of the corporation (unlike for director exculpation). This maintains the traditional scope of oversight and liability at Delaware corporations. Specifically, stockholders elect the directors of the board, who in turn appoint the officers to whom they delegate authority to manage the corporation. The corporation, either at the direction of the board or stockholders (via a derivative claim where well-known demand requirements have been met), will still enjoy the traditional ability to seek monetary remedies from abusive officers who violate their fiduciary duties.
When and how should we consider adopting the proposed amendment?
Publicly Traded Delaware Corporations
Publicly traded companies may propose amending the certificate of incorporation to extend the protection of exculpation to corporate officers at their next stockholder meeting. Typically, this will be the next annual general meeting of stockholders. This would generally be expected to require the filing of a preliminary proxy statement (in advance of the ordinary definitive proxy statement), so officers of publicly traded companies should build the related additional two-week review period into their corporate calendar. We expect many companies will see these proposals on their board agendas beginning in September.
We note that exculpation does not extend to any act or omission occurring prior to the date when the exculpation provision in the certificate of incorporation becomes effective. As a result, while we expect many boards to wait until the next annual general meeting of stockholders, earlier inclusion in the proxy statement of an upcoming special meeting of stockholders may be appropriate.
Note also that any privately held subsidiaries (whether wholly owned or joint ventures) of a publicly traded Delaware corporation may adopt amendments to their certificate of incorporation earlier.
Privately Owned Delaware Corporations
Privately held corporations may propose amending the certificate of incorporation to extend the protection of exculpation to corporate officers either at their next stockholder meeting or, if permitted, earlier via a stockholder written consent.
For corporations anticipating an initial public offering, a “DeSPAC” business combination, a spinoff, carveout sale, or similar transactions, stockholder consent for such amendments may be sought in connection with approval for those transactions or by the parent company for newly formed corporations. Note however that because exculpation does not extend to any act or omission occurring prior to the date when the exculpation provision in the certificate of incorporation becomes effective, we expect many privately held corporations anticipating such transactions will seek an amendment even in advance of approval of such transactions.
What would example language look like to provide officer exculpation?
Because director exculpation is typically already included in the certificate of incorporation of most Delaware corporations, we expect that most corporations will seek assistance from external counsel to tailor an amendment to their existing certificate of incorporation to extend exculpation to officers.
For new corporations, or the rare example of corporations without director exculpation, below is an example provision that may be proposed:
“No director or officer of the Company shall be liable to the Company or its stockholders for monetary damages for breach of fiduciary duty as a director or officer, as applicable, except to the extent such an exemption from liability or limitation thereof is not permitted under the Delaware General Corporation Law (the “DGCL”) as presently in effect or as the same may hereafter be amended. No amendment to or repeal of this provision shall apply to or have any effect on the liability or alleged liability of any director or officer of the Company for or with respect to any acts or omissions of such director or officer occurring prior to such amendment or repeal.”
Where can I find the full text of the amendments to the Delaware statute permitting exculpation?
The amendments to Section 102(b)(7) (as well as other amendments adopted at that time) can be found at the following link.
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