TRANSCRIPT:
Greg Corombos: Hi, I'm Greg Corombos. So, our guest in this edition of Expert Insights is Sandra Feldman, Publications Attorney at CT Corporation. Sandra is here to discuss a significant change in Delaware law that allows corporations to protect top officials from liability over a breach of their duties. And why are we talking about this? It's because it impacts a lot of firms, and so many are formally registered in Delaware. And Sandra, thanks so much for being with us.
Sandra Feldman: Well, thank you, Greg. On August first, an amendment to section 102(b)(7) of the Delaware Corporation Law went into effect, allowing corporations to have a provision in their certificate of incorporation that eliminates the personal liability of officers for breaching their fiduciary duties, subject to a number of important exceptions and restrictions. And we call this kind of charter provision an exculpation clause. And when you take into account the exceptions and restrictions, this new officer exculpation clause has a rather narrow application.
It basically applies to direct shareholder suits, alleging that certain senior officers breached the duty of care. Nevertheless, it still allows corporations to provide more protection from liability for their officers than they could before. And I think it's important for the directors, officers, shareholders and lawyers of all Delaware corporations to be aware of the amendments to section 102(b)(7) because they may soon be considering with their corporation should adopt an officer exculpation clause.
So, I'm going to take a closer look at what section 102(b)(7) as amended actually says, and then I'll discuss what a corporation has to do if it wants to adopt an officer exculpation clause.
GC: Well, Sandra, there might be some listeners who are unfamiliar with what we're talking about here. And before they get buried mentally in section 102(b)(7), let's bring them up to speed as to where we are right now. So, before we get into the details about this amended section of Corporation Law, give us a little bit of background on where we were.
SF: Sure, sounds like a good idea. Well, the first thing you need to know is that the directors and officers of Delaware corporations owe the corporation and its shareholders a fiduciary duty of loyalty and the fiduciary duty of care. And the duty of loyalty basically means they have to put the interests of the corporation and its shareholders above any personal interests. And the duty of care basically requires that they make informed decisions. And the corporation or its shareholders can sue the directors and the officers if they believe they breached those fiduciary duties.
In 1985, Delaware Supreme Court issued a decision in which directors were held liable for millions of dollars in damages for breaching their duty of care. And Greg, that decision sent shockwaves through the Delaware corporate community. They were concerned that corporations wouldn't be able to get directors and officers liability insurance, or find any qualified people willing to serve as directors. So Delaware's legislature reacted to those concerns in 1986 by enacting section 102(b)(7), which essentially let corporations have a provision in their certificate of incorporation exculpating directors for breaches of their duty of care. In section 102(b)(7), as enacted in 1986, applied only to directors, not officers, and it remained that way for 36 years.
But now we can look forward to August 1st, 2022, and we'll see that that has changed.
GC: So how did this change come about?
SF: On July 27, Delaware's governor signed Senate Bill 273, which amended section 102(b)(7) to allow an exculpation clause for officers. However, as I mentioned earlier, there are also important exceptions.
GC: And what are those exceptions?
SF: Well, for one, section 102(b)(7) provides that the clause cannot limit or eliminate an officer's personal liability for a breach of the duty of loyalty for acts or omissions not in good faith, which involves intentional misconduct, or knowing violation of law, or for any transaction from which the officer derived an improper personal benefit. And if you're wondering what's left, the clause can limit or eliminate liability for a breach of the duty of care.
GC: Sandra, you mentioned earlier that it doesn't apply to all officers. So which officers does it apply to?
SF: We're going to have to return to the text of section 102(b)(7) and it tells us to look at the definition of officer that's found in title 10, section 3114 B of the Delaware code. And those two sections combined tell us that this protection from liability is available only to the President, Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, Chief Legal Officer, Controller, Treasurer or Chief Accounting Officer, a person identified in the corporation's SEC filing as one of the most highly compensated executive officers, or a person who agreed to be identified as an officer for purposes of section 31 14 D. So basically, as you can see, we're talking about senior officers and executive officers.
GC: Are there any other restrictions that we and other business owners need to know about?
SF: Yes, a very important one. Section 102(b)(7) says that a corporation cannot eliminate or limit liability in a suit brought by or in the right of the corporation. So, if it's the corporation suing the officer, or shareholders suing derivatively, the exculpation clause will not provide a defense. However, if the shareholder suing directly, or shareholder class action, the clause can apply.
And what's important to remember is that this is the main difference between a director exculpation clause and an officer exculpation clause because section 102(b)(7) does not prohibit a corporation from eliminating liability for a director in suits brought by, are in the right of the corporation.
And finally, these clauses only apply to actions seeking monetary damages. So, if a shareholder is seeking other than monetary damages, such as injunctive relief, or the rescission of an agreement, the exculpation clause would not provide a defense.
GC: We're speaking with Sandra Feldman, Publications Attorney at CT Corporation and Sandra, do we know why the legislature decided to expand protection to officers 36 years after this law was originally passed?
SF: I can only speculate on that. But it may have something to do with a recent increase in the number of shareholder class actions alleging offices breached their duty of care. And once again, corporations are finding it hard to get directors and officers liability insurance. I think there may also be a sense that it's unfair to dismiss claims against directors but not executive officers, when they're being accused of the exact same conduct.
GC: Could be. Could be. What does a corporation have to do now if it wants to provide officers with this protection from liability?
SF: A corporation being formed on or after August 1st can include an officer exculpation clause in the certificate of incorporation of files to create the corporation. A corporation existing before August 1st, will have to amend the certificate of incorporation as the clause. And keep in mind, if the corporation already has a 102(b)(7) clause with directors, and many do, that will not automatically be extended to officers. The corporation will still have to amend that certificate of incorporation if it wants to exculpate officers too.
GC: That's an important clarification too. What is the procedure for amending the certificate of incorporation?
SF: Amending a certificate of incorporation requires compliance with the Delaware corporation law. And in particular, section 242. In general, an amendment is affected by the Board of Directors adopting a resolution setting forth the proposed amendment and declaring its advisability. That resolution must then be approved by the shareholders. And typically, that's by the vote of a majority of outstanding shares.
And that's followed by the filing of a certificate of amendments with the Delaware Secretary of State. And the amendment goes into effect upon the date of filing unless a future effective date set forth on the certificate of amendment. And it's important to remember that the officer exculpation clause cannot eliminate or limit the liability of an officer for any act or omission that occurred before the clause became effective.
GC: A lot of good information here and important for everyone to know about this change in law. Any final thoughts that you want to make sure people know about here?
SF: Yeah, I think it's going to be interesting to see how many existing Delaware corporations choose to amend their certificate of incorporation to add this officer exculpation clause, and also how many new corporations will decide to include it in the certificate of incorporation, a file upon formation.
And I would be remiss if I didn't end by reminding the listeners that CT Corporation can assist with the filing of certificates of amendments, and certificates of incorporation, as well as providing many other services and solutions to Delaware corporations.
GC: Sandra, there's always a lot to keep track of. It's great to know CT Corporation is there to help. Thanks very much for your time today. We always appreciate it.
SF: Thank you, Greg.
GC: Sandra Feldman is publications attorney for CT Corporation. I'm Greg Corombos reporting for Expert Insights. For more information on this topic, please contact CT Corporation.
