Revisiting HR Policies in the Wake of the McDonald’s Ruling

The Court of Chancery of the State of Delaware handed down a landmark case on January 26, 2023. The case is a stockholder lawsuit against David Fairhurst, the former Chief People Officer of McDonalds, in which the plaintiffs alleged that Fairhurst breached his fiduciary duties by allowing a culture of harassment to persist and go unabated.

The plaintiffs argue that Fairhurst had a duty of oversight in the same way boards of directors do, and which was established in a similar landmark decision in 1996, In re Caremark International Inc. Derivative Litigation (Caremark). Fairhurst’s defense was that corporate officers don’t have a comparable duty of oversight and that Caremark creates this obligation only for corporate boards. The court disagreed.

Since the last time we discussed this important case, we’ve received a number of questions on how executives (and boards) should respond from a policy perspective. It’s a terrific question because the Fairhurst case involved a number of unique facts and circumstances, not least that the CPO himself was alleged to be the proximate cause of many of the problems.

Here we take a moment to suggest some practical considerations for companies and their leaders to take. It’s an open question as to how the Fairhurst decision will be expanded or narrowed in future court opinions, or whether the Delaware court even intended its decision to apply to cases that are different in kind and not only degree.

Evaluating Oversight Duty by Role

We’ll focus on the human capital function in this article because the case itself was against a CPO and our own expertise is more concentrated in the human capital space. However, a key point in the court’s analysis is that the duty of oversight varies by role. That means a chief technology officer has a different oversight responsibility than a chief people officer.

As companies digest the broader ramifications of the Fairhurst case, it’ll be important to look at each executive domain and consider the oversight responsibilities they entail. For example, a chief lending officer at a bank could be accused of failing to meet their duty of oversight during the period leading up to a mortgage crisis if there are not systems in place for monitoring loan delinquencies and quality degradation. In the same vein, a chief science officer at a healthcare company has a duty of oversight to follow FDA procedures. The standard of care will be defined in the context of an executive’s functional role and locus of responsibility.

Detecting Red Flags and Acting on Red Flags

The Fairhurst case unpacks two types of oversight responsibilities.

The first is a responsibility to install “reasonable information and reporting systems” that identify breakdowns in corporate policy and egregious erosion of the corporate culture. This is called an “Information-Systems Obligation.” The second is a duty to notice and act on red flags. Systems may exist to detect and flag problems, but if the officer is a part of the problem or simply oblivious to those red flags, then this would breach a “Red-Flags Obligation.”

The Fairhurst case was a Red-Flags Obligation. There were systems in place to detect sexual harassment and misconduct. The plaintiffs didn’t dispute the existence of information reporting systems to identify breakdowns in policy and culture. Rather, they contended that Fairhurst systematically ignored the red flags from these systems—and even became one of the red flags.

In many respects, this makes the Fairhurst case simpler. Most companies find it harder to install systems at scale that allow problems to be reliably detected and reported to the right leaders within the organization. Most companies don’t have a chief people officer who is part of the problem.

In the wake of the Fairhurst case, many clients have asked us how they should be adapting policies and protocols. We think the Information-Systems Obligation will usually be the key challenge.

Action Items In The Wake of Fairhurst

Here’s our running list of suggested policy responses. (Remember that we’re focused on the human capital function and these suggestions are likely to evolve as the Fairhurst case is cited in future litigation.)

1. Regularly train corporate officers on their oversight obligations. The human capital field is seeing fast-changing legal and regulatory developments around pay transparency, hiring practices, whistleblowers, and more. Document training as it occurs to create a record of what you did to stay abreast of changing practices.

2. Review and validate whistleblower processes for receiving and investigating allegations of harassment, discrimination, and other malfeasance. Geographically distributed enterprises in particular should test that these processes are functioning across the entire organization. Although the Fairhurst case was about ignoring red flags, we think the more likely scenario for most companies is the detection of those red flags.

3. Review and update controls to ensure compliance with state and national employment laws. Recently, for example, there have been changes pertaining to restrictive covenants, pay transparency, and separation agreements.

4. Ensure there have not been complaints to the Equal Employment Opportunity Commission, National Labor Relations Board, or other labor organizations that have gone unaddressed. Similarly, if there has been employment-related litigation, study the totality of allegations to ensure there are no trends or patterns.

5. Regularly test pay equity for substantially similar work. When we do these studies, we conduct them under legal privilege, but the results are shared with the compensation (human capital) committee and executive officers. That creates an essential feedback loop as to whether pay practices are operating the way they should be.

6. Test for adverse impact in hiring, promotion, and termination decisions. The models we use for these studies piggyback off those used in pay equity, but focus on the fairness of different HR decision-making processes.

Parting Thoughts

Most of our clients have concluded they’re in good shape. For example, more companies are studying their annual pay equity. Many are even extending those studies to other areas of adverse impact.

Most important is to involve senior management in the processes we just described. Although these topics are technically very complex, human resources chiefs and compensation committees are getting into the details. This puts the onus on service providers like us to convey these topics in everyday language.

The role that corporate officers play in detecting and acting on an Information-Systems Obligation is bound to evolve. Processes need to be recurring without being rote—no one benefits from a rubber-stamp exercise. The way to get there, in our view, is through exceptional project coordination internally and non-transactional vendor relationships externally.