Delaware corporations can now limit the liability of senior officers for breaches of the duty of care

This article will take a closer look at this significant development in Delaware corporate law.

Directors and officers of Delaware corporations owe fiduciary duties

The directors and officers of Delaware corporations owe the corporation and its shareholders a fiduciary duty of loyalty and a fiduciary duty of care. The duty of loyalty requires them to put the best interests of the corporation and shareholders above their personal interests and to act in good faith. The duty of care requires directors and officers to make informed decisions.

Although both directors and officers owe a duty of care, for 35 years the consequences of a breach of this duty have been very different depending upon whether the person being accused was a director or officer.

Delaware authorizes exculpation of directors

In 1986 the Delaware General Corporation Law (GCL) was amended to add Sec. 102(b)(7). Sec. 102(b)(7) which authorized a corporation to include a provision in its certificate of incorporation eliminating the personal liability of directors for monetary damages for a breach of the duty of care — although not for breaches of the duty of loyalty or acts not in good faith.

Sec. 102(b)(7) was added to the GCL as a response to a 1985 Delaware Supreme Court decision holding directors of a Delaware corporation liable for millions of dollars in damages for violating the duty of care by approving a merger hastily and without considering all of the material information.

That decision led to fears that Delaware corporations would have trouble finding qualified people willing to be directors and would be unable to find affordable directors and officers (D&O) insurance. After considering several options, the legislature chose to allow corporations to adopt exculpation clauses in their certificate of incorporation.

Exculpation was not originally extended to officers

Sec. 102(b)(7) applied only to directors — not to officers. And it stayed that way for over 35 years, even after the Delaware Supreme Court in 2009 reaffirmed that officers owe the same fiduciary duties as directors.

However, that has now changed.

Senate Bill 273 amends Sec. 102(b)(7) to include officers

On July 27, 2022, Delaware’s governor signed Senate Bill 273, which went into effect August 1, 2022. The bill amends Sec. 102(b)(7) to state that a corporation may include a provision in its certificate of incorporation eliminating or limiting the personal liability of officers to the corporation or its stockholders for monetary damages for a breach of fiduciary duty.

However, not all officers are included and not all fiduciary duty breaches can be exculpated. These exceptions make the protections provided to officers by Sec. 102(b)(7) narrower than those provided to directors.

What duties cannot be exculpated?

The certificate of incorporation cannot eliminate an officer’s personal liability for the following:

1. A breach of the duty of the loyalty
2. Acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law
3. Any transaction from which the officer derived an improper personal benefit, and
4. In any action brought by or in the right of the corporation

The first three exceptions also apply to directors.

However, the fourth — which provides that liability cannot be eliminated in actions brought against the officer by the corporation itself or by a shareholder filing a derivative suit — does not. This is a significant difference in how the legislature chose to authorize protections of officers versus directors.

Which officers can be protected from liability?

Sec. 102(b)(7), as amended, does not apply to all officers. The section applies to officers, whether they are Delaware residents or non-residents, who have consented to service of process on the corporation’s registered agent pursuant to Title 10, Sec. 3114(b). That means Sec. 102(b)(7), as amended, applies to a person who was (during the course of conduct alleged to be wrongful):

1. The president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, controller, treasurer, or chief accounting officer
2. Anyone identified in the corporation’s SEC filing as one of the most highly compensated executive officers, or
3. Anyone who has, by agreement with the corporation, consented to be identified as an officer

Why amend Sec. 102(b)(7) to include officers now?

The decision to allow corporations to provide senior officers with some protections from liability for breaches of the duty of care seems to be motivated by (1) a recent increase in litigation, particularly class actions, alleging officers violated their duty of care, (2) the increasing difficulty in obtaining D&O insurance, and (3) the perceived unfairness in allowing directors to escape personal liability, but not officers, for the same alleged breach of duty.

How to take advantage of amended Sec. 102(b)(7)

The protection authorized by amended Sec. 102(b)(7) is not granted by default. An existing corporation must amend its certificate of incorporation to add a provision eliminating the personal liability of officers to the extent allowed by the GCL.

The procedure for amending a certificate of incorporation generally involves the board of directors adopting a resolution setting forth the proposed amendment and declaring its advisability. The resolution is submitted to the shareholders who must approve by a majority of the voting power of the outstanding shares entitled to vote on the amendment and by each class, if any, entitled to vote as a separate class on the amendment.

After approval, a certificate of amendment must be filed with the Secretary of State for the amendment to be effective.

Conclusion

Anyone advising or managing a Delaware corporation should determine whether the corporation should include a provision in its certificate of incorporation eliminating the personal liability of officers as authorized by Sec. 102(b)(7) as amended by Senate Bill 273.

If so, then newly forming corporations should include the provision in the certificate of incorporation they will file with the Secretary of State to create the corporation. Existing corporations, if they decide the corporation should exculpate officers to the extent allowed, should take the necessary steps to amend their certificate of incorporation.