What Litigators Need to Know About the Amendments to Section 102(b)(7)

The Delaware legislature has passed a bill to amend Section 102(b)(7) of the General Corporation Law of the State of Delaware to alter the scope of monetary liability for officers of Delaware corporations. Specifically, the amendments extend the opportunity for Delaware corporations to exculpate their officers, in addition to their directors, for monetary liability for certain breaches of fiduciary duty.

The scope of permitted exculpation for officers, however, is not coextensive with the scope of exculpation permitted for directors. Litigators will need to be familiar with the contours of the newly permitted exculpation when determining whether and to what extent a Section 102(b)(7) defense may be available in response to fiduciary claims against officers. This article is intended to provide a practical guide to navigating the recent changes.

Why Is Section 102(b)(7) Being Changed?

Section 102(b)(7) was enacted in the wake of the Delaware Supreme Court’s decision in Smith v. Van Gorkom. In that case, the Delaware Supreme Court reversed the Delaware Court of Chancery’s post-trial ruling in favor of defendant directors, finding the record rendered “clearly erroneous” the Court of Chancery’s determination that the directors had satisfied their duty of care in approving a 62% premium deal. The decision drew immediate and harsh criticism, with Prof. Daniel Fischel calling it “one of the worst decisions in the history of corporate law.”

Pertinently here, the decision was also widely credited as causing a shock to the market for liability insurance for directors, rendering it difficult or impracticable for companies to obtain coverage at reasonable premiums. Therefore, as it was perceived at the time, the decision threatened to chill participation by well-qualified individuals on boards of Delaware corporations.

In 1986, the Delaware legislature responded to these concerns by enacting Section 102(b)(7) of the General Corporation Law of the State of Delaware. Rather than legislatively overturning Smith v. Van Gorkom, the legislature opted to give control over the scope of director fiduciary liability to the stockholders of Delaware corporations, allowing them to adopt via a charter amendment provisions exculpating directors for monetary liability for certain breaches of fiduciary duty. Specifically, Section 102(b)(7) permits charters of Delaware corporations to contain:

A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director:

(i) For any breach of the director’s duty of loyalty to the corporation or its stockholders;

(ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law;

(iii) under § 174 of this title [pertaining to unlawful dividends and redemptions]; or

(iv) for any transaction from which the director derived an improper personal benefit.

Section 102(b)(7), by its plain language, permitted exculpation only for directors and not officers. That is because, at the time it was enacted, the legislature was focused on the recent decisions by the Delaware courts concerning the scope of director liability for breach of fiduciary duty. It was not until more than two decades later, in Gantler v. Stephens, that the Delaware Supreme Court squarely held that officers of Delaware corporations owe the same fiduciary duties as directors.

Although Gantler did not precipitate an immediate crisis similar to that following the Van Gorkom decision, since then, a confluence of factors—including a trend away from deal injunctions in non-hostile situations and toward post-closing damages cases, as well as the adoption of various cleansing doctrines and limitations on cases that may be pursued against directors—has caused some practitioners to observe that, recently, there has been an increasing trend among stockholder plaintiffs to attempt to bring claims against officers for breach of the duty of care. Partly in response to this trend, the Corporation Law Section of the Delaware State Bar Association voted on April 12 to recommend amendments to Section 102(b)(7) that would allow stockholders to exculpate officers for duty of care breaches in certain circumstances. Those proposed amendments were adopted by the Delaware legislature in a bill passed on June 14.

Checklist for Litigators

Below are the key considerations to bear in mind when determining whether an officer may be exculpated for alleged fiduciary misconduct.

• Does the Corporation’s Charter Include a Provision Exculpating Officers?

The first step in assessing the availability of a 102(b)(7) defense for officers is confirming that the corporation allows for such exculpation. As when Section 102(b)(7) was first enacted, the exculpation available to Delaware officers is not automatic, but rather requires a provision to be adopted in the corporation’s charter affording such exculpation. For the vast majority of existing corporations, adoption of an officer exculpatory provision will therefore require stockholder approval. The potential for lag time between the passage of the amendments and the approval by the corporation’s stockholders of the permitted charter provision makes it imperative to obtain a copy of the corporation’s charter and confirm that an officer exculpatory provision has been validly adopted.

• Is the Defendant an “Officer” as Defined by the Statute?

The amendments straightforwardly alter Section 102(b)(7) to provide, where relevant, that a corporation’s charter may contain a provision exculpating “a director or officer.”

Although the term “director” leaves little room for ambiguity, it may not be immediately apparent which employees of a Delaware corporation may be considered “officers.” The amendments clarify that the definition of “officer” under the new version of Section 102(b)(7) tracks that of “officer” under Delaware’s consent-to-jurisdiction statute, 10 Del. C. Section 3114. In particular, the amendments provide: All references in this paragraph to an officer shall mean only a person who at the time of an act or omission as to which liability is asserted is deemed to have consented to service by the delivery of process to the registered agent of the corporation pursuant to Section 3114(b) of Title 10 (for purposes of this sentence only, treating residents of this State as if they were nonresidents to apply Section 3114(b) of Title 10 to this sentence).

Section 3114(b) defines an officer as a person who:

• Is or was the president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, controller, treasurer or chief accounting officer of the corporation at any time during the course of conduct alleged in the action or proceeding to be wrongful;
• Is or was identified in the corporation’s public filings with the United States Securities and Exchange Commission because such person is or was one of the most highly compensated executive officers of the corporation at any time during the course of conduct alleged in the action or proceeding to be wrongful; or
• Has, by written agreement with the corporation, consented to be identified as an officer for purposes of this section.Under federal law, the “three most highly compensated executive officers other than the [Principal Executive Officer] and the [Principal Financial Officer]” must be identified in the corporation’s public filings. These individuals would therefore qualify as “officers” under Section 3114(b)(2). Moreover, although there is little case law interpreting this definition, one Delaware decision has clarified that a person is not an officer for purposes of Section 3114 solely by virtue of having “officer” in his or her title.

Did The Alleged Conduct Occur After the Corporation’s Adoption of the Officer Exculpatory Provision?

The amendments also provide, as with Section 102(b)(7) as originally written, that exculpatory provisions cannot take effect retroactively: “No [exculpatory] provision shall eliminate or limit the liability of a director or officer for any act or omission occurring prior to the date when such provision becomes effective.” As with other amendments to corporate charters, the effective date of any provision exculpating officers will likely be the date that the amendment is filed with the Secretary of State. Accordingly, it will be important to check the date on which the corporation’s officer exculpatory provision was adopted to ensure it predates the officer’s conduct challenged in a lawsuit.

Are the Alleged Claims Within the Scope of Permitted Exculpation?

As with directors, the amendments permit the adoption of corporate charter provisions exculpating officers from liability “for monetary damages for breach of fiduciary duty.” The same four carveouts for directors apply equally to officers, precluding exculpation for officers from: breaches of the duty of loyalty; acts or omissions not in good faith, intentional misconduct, or a knowing violations of law; liability under Section 174 (pertaining to unlawful dividends and redemptions); or transactions in which the officer derived an improper personal benefit.

The proposed amendments add a fifth carveout, however, applying solely to officers and not directors. Specifically, the amendments do not permit charter provisions to exculpate officers “in any action by or in the right of the corporation.” In other words, the corporation retains the right to sue its officers for breaches of the duty of care, and stockholders retain the right, where otherwise permissible, to bring derivative claims on behalf of the corporation against officers concerning breaches of the duty of care. In effect, the exculpation extends only to direct stockholder claims (including those brought on behalf of a stockholder class).

Notably, as with director exculpation, the permitted exculpation for officers pertains only to monetary damages. Section 102(b)(7) does not pertain to injunctive relief. Nor would the amendments likely affect the various cleansing doctrines that the Delaware courts have adopted in the last decade. For example, under Kahn v. M & F Worldwide, the standard of review for a controller-conflicted transaction is reduced from entire fairness to the business judgment rule “where the merger is conditioned ab initio upon both the approval of an independent, adequately-empowered special committee that fulfills its duty of care; and the uncoerced, informed vote of a majority of the minority stockholders.” M & F Worldwide cleansing can be defeated by an adequate showing that the special committee did not satisfy its duty of care, despite that the committee members would be exculpated for those duty of care breaches. It is difficult to see why a different result would obtain when, for example, an officer causes a corporation to issue false or misleading disclosures in a manner that does not implicate bad faith or the duty of loyalty. The cleansing standards in M & F Worldwide, as well as Corwin v. KKR Financial Holdings, are focused on whether the stockholder vote was generally an informed one—not whether anyone is liable for monetary damages arising solely from the offending disclosures.

Conclusion

The changes to Section 102(b)(7) promise to reduce the scope of officer liability under Delaware law—but not completely and not immediately. The policy balance struck by the legislature largely exculpates officers coextensively with directors for direct claims (including class actions) but not for derivative claims or claims by the corporation. And, as when Section 102(b)(7) was first enacted, it will be incumbent upon Delaware corporations to adopt charter amendments to extend the newly available exculpation for officers. Conduct predating that adoption will not be exculpated. Particularly during the years following the passing of the amendments, it will be important for litigators to understand the contours of the Section 102(b)(7) amendments so that they can properly determine whether officers possess an exculpation defense to conduct challenged in a lawsuit.

Reprinted with permission from the August 3, 2022 edition of the Delaware Business Court Insider © 2022 ALM Media Properties, LLC. All rights reserved.

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