Should Delaware Corporate Officers Take Advantage of “Shield” Amendment to DGCL Section 102(b)(7) Allowing for Limited Exculpation of Officers?

Should Delaware Corporate Officers Take Advantage of “Shield” Amendment to DGCL Section 102(b)(7)?

When is it not a good time for corporations to conduct an annual review of their governing documents to determine if any changes are needed? Entering 2023, Delaware corporations should consider amending their certificates of incorporation to exculpate officers from personal liability for monetary damages associated with breaches of the duty of care prong of fiduciary duty.[1]

Let’s Review Basics of Fiduciary Duties Owed to a Delaware Corporation

Members of a corporation’s board of directors, as well as its corporate officers, owe fiduciary duties to the corporation.  There are two separate prongs of fiduciary duty: a duty of loyalty and a duty of care.

Violating fiduciary duties can result in significant personal liability, which can make business people reluctant to serve as directors and officers. As a result, many states have laws in place that allow corporations to shield their officers and directors from potential liability. For more than three decades, Delaware has authorized corporations to exculpate directors but not officers from personal liability for monetary damages associated with breaches of the duty of care. Because officers were not entitled to such limited protections enjoyed by directors, they were often targeted in litigation. See, Amalgamated Bank v. Yahoo! Inc., 132 A 3d 752, 787 (Del. Ch. 2016). 

Delaware’s New Law Regarding Exculpation of Officers

Delaware amended its General Corporation Law to close the “loophole”. Effective August 1, 2022, Section 102(b)(7) of the Delaware General Corporation Law provides that corporations may 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.” The amendment is not self-effectuating, it must be elected by the Corporation through a charter amendment. Stockholders must approve amendments of certificates of incorporation.

Extending the same exculpatory protection that directors receive to certain officers, includes – President, CEO, COO, CFO, CLO, controller, treasurer or CAO, plus other individuals that public filings identify as the Company’s “most highly compensated officers”.

Notably, Delaware’s officer exculpation provisions only cover breaches of the duty of care and do not apply to an officer’s breach of the duty of loyalty. Accordingly, exculpation provisions will not shield an officer from liability for acts or omissions not in good faith or for any transaction from which the officer derived an improper personal benefit. Additionally, Section 102(b)(7) expressly provides that exculpation provisions may not eliminate or limit the liability of “[an] officer for acts or omissions . . . which involve intentional misconduct or knowing violation of law.” Exculpation is also not available for derivative claims brought by stockholders on behalf of the corporation. The amendment does not limit or eliminate an officer’s liability for breaches of the duty of loyalty, or infraction of federal law, including damages under federal securities laws, anti-trust laws or RICO.  Disgorgement of profits resulting from breach of loyalty is usually imposed.

Amending Articles of Incorporation to Obtain Shield

Corporations must take action to avail their officers of the protections of the new law. For public corporations, implementation typically requires an amendment to the corporation’s certificate of incorporation. Any such amendment must by approved by the board of directors and adopted by stockholders at a meeting and then filed with the Delaware Department of State in order for the provision to become effective. For companies going public via an IPO or similar transaction, an officer and director exculpation provision may be included in the new company’s certificate of incorporation. 

Weighing the Pros and Cons

In considering whether to adopt an exculpation provision, corporations should be aware of the advantages as well as the risks. To start, the new law aims to establish consistency in the treatment of directors and officers. This not only helps deter costly claims against officers, but also makes it easier to recruit and retain qualified officers who may be deterred by the prospect of personal financial liability. Potential risks include a greater likelihood that officers will act carelessly. Given increased shareholder and media focus on corporate accountability and transparency, corporations should also be aware that efforts to adopt an exculpation provision may be met with suspicion.

If you have any questions or if you would like to discuss these issues further,
please contact Paul A. Lieberman or the Scarinci Hollenbeck attorney with whom you work, at (201) 896-4100.

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[1] Jonathan W. Groessl, Delaware’s New Section 102(b)(7): Boon or Bane for Corporate Directors?, 37 DePaul L. Rev. 411 (1988).