Why “Care” About the Duty of Care? A Look at Delaware’s New Amendments to DGCL § 102(b)(7)

By Jacob Limaldi, Class of 2024

Introduction

The history of corporate law in America contains a large body of work devoted to the legal interpretations regarding personal liability as it relates to fiduciary duties and agency relationships. Of these duties, the duty of care takes its roots from the earliest traditions of Anglo-American common law.[1] Traditionally, this standard of “care” has typically been seen as requiring corporate directors to act with “the care of an ordinarily prudent person in . . . similar circumstances” in all matters concerning their corporate duties.[2] Recently, however, new amendments to the Delaware General Corporation Law ("DGCL") have extended personal liability protections to corporate officers for breaches of duty of care. These new changes to DGCL § 102(b)(7) present a worthwhile opportunity to reflect on how we have historically viewed agency costs in the context of corporations, but also to consider how we may find ourselves thinking about them going forward.

Background

For decades, Delaware has consistently stood at the forefront in the world of corporate law insomuch as the duty of care and personal liability are related. In a similar vein, Delaware courts have contributed significantly to the universally accepted idea behind the business judgment rule, wherein the main tenet holds that “[c]ourts should not second-guess good-faith decisions made by independent and disinterested directors.”[3]

Naturally, the business judgment rule plays a critical role in how we think about a corporate board’s duty of care. Consider, for example, the concerns that shareholders may have when they feel as though their board is too conservative in its approach to risk taking. Because most shareholders are, in theory, fully capable of diversifying the risks of their own investments, they should prefer a board that is not overly risk averse.[4] This makes sense given that common shareholders, as residual claimants, arguably have the largest incentives to make sure that their board takes steps to increase the value of the corporation and maximize shareholder return.

However, the business judgment rule focuses on the process of a board’s decisionmaking, not the given business decision itself. Courts will presume that a board acted on an informed basis, in good faith and in the honest belief that the action in question was taken to advance the corporate interests.[5] In this regard, the seminal case of Smith v. Van Gorkom largely shaped the way Delaware courts view the duty of care.[6] There, the Delaware Supreme Court held that a corporate board breaches its duty of care and does not benefit from the business judgment rule if a plaintiff can show that the directors were “grossly negligent” in not informing themselves “of all material information reasonably available to them.”[7] This decision, along with subsequent legal developments resulting from it, transformed the landscape of fiduciary duties.

Van Gorkom Aftermath, § 102(b)(7), and Beyond

With Van Gorkom, Delaware ushered in a new era of legal precedent concerning corporate fiduciary duties. Even though it has historically been seen as a case about the duty of care in takeover cases, it offers valuable insights concerning the business judgment rule and a corporate board's underlying obligations to its shareholders more generally. In the wake of the decision, Delaware–likely under pressure from nervous directors facing new possibilities of personal liability–adopted section 102(b)(7) to the DGCL in 1986, permitting corporate charters to exculpate directors for monetary damages in duty of care cases.[8] By 1990, over 90 percent of Delaware corporations had already adopted exculpatory provisions in their charters to the full extent allowed under the statute.[9] Since then, these provisions have granted directors a strong personal liability protection against claims asserting a breach of the duty of care.

Not until over two decades later did Delaware courts provide an answer as to where officers stood in connection with fiduciary duties. This came in 2009 when the Delaware Supreme Court definitively confirmed in Gantler v. Stephens that “corporate officers owe fiduciary duties that are identical to those owed by corporate directors.”[10] From the time of that decision until the August 1, 2022 amendment to section 102(b)(7), officers remained subject to claims of breach of duty of care without the same exculpatory provisions afforded to directors.[11]

That brings us to today. The newly amended section 102(b)(7) now allows Delaware corporations to adopt exculpatory provisions in connection with breaches of duty of care for officers, as well as directors. Officers eligible for exculpation include: “(i) the corporation’s

president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, controller, treasurer or chief accounting officer, (ii) ‘named executive officers’ identified in the corporation’s SEC filings, and (iii) individuals who have agreed to be identified as officers of the corporation.”[12] While the officer exculpatory provision is not required under the DGCL, a corporation seeking to include one must first amend its charter to reflect adoption, even if the corporation already has a director exculpatory provision in place.[13]

Conclusion

The amended section 102(b)(7) prompts an interesting question: how much should these changes really matter for how we view agency relationships? From a general perspective, the effectiveness of nearly all legal innovations is subject only to the test of time. Whether the new exculpatory provisions for officers drastically alter fiduciary duties going forward is anyone’s guess, but I personally doubt that they will. At the same time, the sheer number of Delaware corporations that had adopted exculpatory provisions for directors after Van Gorkom lends some weight to the idea that perhaps shareholders are not actually as concerned with the duty of care as one would think. After all, it was the shareholders that had to approve the proposal of these charter amendments in the first place… amendments that gave directors even more liability protection for breaching the duty of care that they owed to those very same shareholders. It could be that the pre-Van Gorkom standards were better from a corporate governance perspective, or maybe shareholders were incentivized to adopt 102(b)(7) clauses by way of a healthy one-time dividend. In any case, what is glaringly obvious is that the duty of care has become one of the weaker devices for regulating board behavior.

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[1] Charitable Corp. v. Sutton, 2 Atk. 400, 406, 26 Eng. Rep. 642, 645 (Ch. 1742) (holding that “if one voluntarily accepts a trust, he must execute it with fidelity, integrity, and diligence…”).

[2] William T. Allen et al., Commentaries and Cases on the Law of Business Organizations 273 (6th ed. 2021).

[3] Id.

[4] Gagliardi v. TriFoods Intern., Inc., 683 A.2d 1049, 1052 (Del. Ch. 1996) (explaining that “[s]hareholders don’t want (or shouldn’t rationally want) directors to be risk averse.”).

[5] Corporate Laws Committee, ABA Business Law Section, Corporate Director’s Guidebook 2765 (7th ed. 2020).

[6] Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).

[7] Id. at 872 (quoting Aronson v. Lewis 473 A.2d 805, 812 (Del. 1984)).

[8] Del. Code Ann. tit. 8, § 102(b)(7) (2022) (enacted 1986).

[9] William T. Allen et al., Commentaries and Cases on the Law of Business Organizations 276-277 (6th ed. 2021).

[10] Gantler v. Stephens, 965 A.2d 695, 708 (2009).

[11] Covington & Burling LLP, Delaware Permits Exculpation of Officers (Aug. 11, 2022), https://www.cov.com/-/media/files/corporate/publications/2022/08/delaware-permits-exculpation-of-officers.pdf.

[12] Id.

[13] Id.