Delaware law allows companies to limit officer liability 

The law allows Delaware-based companies to limit the monetary liability of certain officers in cases where they fail to fulfill their fiduciary duty of care. The protections for officers are similar to but less generous than the limits on director liability under Delaware law that were in place before 2022. Companies view officers’ liability protection as important given the recent trend of plaintiffs naming corporate officers as defendants in shareholder litigation, which might deter individuals from serving as officers or deter officers from making business decisions that involve risk, due to their potential exposure for business decisions that were unsuccessful. Amendments to a company’s certificate of incorporation to limit officer liability must be approved by a majority of shareholders (or a supermajority if the company has a higher standard). It is likely that as more companies adopt these provisions, it will become more difficult for companies to recruit executives if they don’t have these protections against liability for officers.

Background

The 2022 Delaware law permits exculpation of certain officers only for direct claims brought by shareholders for an officer’s breach of the fiduciary duty of care, including class actions. It doesn’t allow limits on officer monetary liability in any of the following circumstances:

• Breach of the duty of loyalty
• Acts and omissions not in good faith or that involve intentional misconduct or a knowing violation of law
• Any transaction in which the officer derived an improper personal benefit
• Claims brought by the company itself or for derivative claims brought by shareholders in the name of the company

The liability protections provision applies to any officer of the Company who (i) is or was president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, controller, treasurer and chief accounting officer at any time during the course of the alleged wrongful conduct, (ii) is or was identified in the company’s public filings with the SEC because the officer is or was one of the mostly highly compensated executive officers of the company at any time during the alleged wrongful conduct, or (iii) has by written agreement with the company consented to being identified as an officer for purposes of being deemed to have consented to service of process in Delaware by the delivery of process to the registered agent of the company. 

Proxy advisor views

Proxy advisors Institutional Shareholder Services (ISS) and Glass Lewis & Co. (Glass Lewis) revised their voting policies in 2023 in anticipation of management proposals to amend company charters to add an officer exculpation provision. Both proxy advisors evaluate the proposals case by case, but ISS typically recommends shareholders support their adoption and Glass Lewis typically recommends shareholders vote against them.

ISS. ISS assesses these proposals case by case, considering the reasons behind the proposed changes but generally supports them. Factors ISS considers in its recommendations include whether the proposals would:

• Eliminate directors' and officers' liability for monetary damages for violating the duty of care or duty of loyalty
• Expand coverage beyond legal expenses to liability for acts that are more serious violations of fiduciary obligation than mere carelessness
• Provide mandatory indemnification for acts where the company’s board previously had discretion.

Also, in certain cases, ISS will recommend against a proposal if it raises governance concerns, e.g., where the company has a controlling shareholder and the board is not majority-independent. If there is a controlling shareholder and minority shareholders are unable to remove or replace directors or amend the governing documents against the wishes of the controlling shareholder, ISS may recommend against the proposal since shareholders may need to rely on the courts to hold directors and officers accountable for actions detrimental to minority shareholders.

Glass Lewis. Glass Lewis also evaluates these proposals case by case, but generally advises voting against them unless the board provides a compelling rationale and the provisions are reasonable.

Support for management proposals

Positive results from the 2022 and 2023 proxy seasons indicate strong shareholder support for officer exculpation amendments, suggesting there may be more proposals this year. Mercer reviewed 330 proposals addressing officer exculpation provisions filed for shareholder meetings between August 1, 2022 (when the law went into effect) and April 22, 2024.  ISS recommended against these proposals at a small percentage of companies: one (9%) in 2022, 54 (18%) in 2023 and two (10%) so far in 2024.

In 2023, 82% of proposals passed, up from 73% in 2022. As of March 31, 2024, the pass rate is 91%. Vote results for the second quarter of 2024 will reveal if support continues to rise this year. Some companies require a two-thirds supermajority to amend their charters, making it harder to obtain the necessary shareholder support than proposals that require only majority support.

Adopting an exculpation provision

Companies considering amending their certificate of incorporation to adopt an officer exculpation provision should consider the following:

• Peer company provisions and support levels for proposed amendments
• Proxy season results and proxy advisor support levels
• Shareholder views gleaned through engagement
• Rationale for adding an exculpatory provision for officers

Although some Delaware companies have been taking a wait and see approach to adopting these provisions, more companies are likely to seek shareholder approval for these amendments given the high levels of proxy advisor and shareholder support over the past few years.