By Anne Sherry, J.D.
When McDonald’s head of human resources—the person specifically charged with promoting a culture of inclusion and respect—repeatedly engaged in sexual harassment, it threw up “the most vibrant of red flags,” the Delaware Court of Chancery observed. But a stockholder complaint did not support an inference that the defendant directors failed to respond to these warnings, nor that they breached their fiduciary duties by terminating the company’s CEO without cause after learning he had engaged in an inappropriate relationship with a subordinate. The chancery court accordingly dismissed the complaint for failure to state a claim (In re McDonald’s Corporation Stockholder Derivative Litigation, March 1, 2023, Laster, J.).
Scandals. The complaint revolves around two recent corporate governance scandals at McDonald’s. First, in 2018, a wave of coordinated complaints to the EEOC alleged widespread sexual harassment and retaliation at the company. Workers across ten cities held strikes, and U.S. Senator Tammy Duckworth (D-Ill.) sent an inquiry about the reports to the then-CEO, Stephen Easterbrook. The allegations culminated in the “brutal” revelation in December 2018 that McDonald’s Global Chief People Officer—and head of HR—had engaged in multiple acts of sexual harassment and had been warned about his alcohol consumption at company events.
Then, in November 2019, McDonald’s terminated Easterbrook after learning that he had engaged in a relationship with an employee. Easterbrook had insisted that this was his only personal relationship with an employee and that it consisted only of texts and video calls, and no physical contact. Wanting to avoid litigation over a close case, the board terminated Easterbrook without cause, entitling him to severance. When the company learned that Easterbrook had had multiple physical sexual relationships with employees while he was CEO, it sued him to claw back the severance payments. Easterbrook later agreed to repay $105 million.
Fiduciary duties. According to the derivative complaint, McDonald’s directors breached their fiduciary duties by ignoring red flags of sexual harassment. Then, they approved a no-cause termination of Easterbrook to avoid a lawsuit that could expose their failures of oversight of the harassment issues.
In the court’s reasoning, though, the directors did not ignore the red flags or show a total failure of oversight. McDonald’s engaged the Rape, Abuse & Incest National Network (RAINN), the largest anti-sexual-violence organization in the U.S., to advise the company on preventing sexual misconduct and harassment. It also revised its policies and training programs, provided more resources and support to franchisees, and ended a policy requiring mandatory arbitration of harassment and discrimination claims. Because of these efforts, the court could not infer that the director defendants acted in bad faith, a necessary predicate to a red-flags claim for breach of the duty of oversight.
The court also held that the business judgment rule protected challenged board decisions, including the decision to terminate Easterbrook without cause. Even if the director defendants made a bad decision by not investigating Easterbrook’s misconduct more thoroughly, this does not mean they breached their duties. Directors are liable to make mistakes, even when acting diligently, loyally, and in good faith. The directors did not face a threat of liability for their response to the issues of sexual harassment and misconduct, and they could have believed in good faith that an amicable termination of Easterbrook was in the company’s best interests.
Dismissal. Finally, the court addressed a procedural matter: whether the motion to dismiss should be converted to a motion for summary judgment because the defendants relied on matters outside of the pleadings. Rather than meaningfully engage with the complaint, the directors argued from 93 exhibits totaling 1400 pages.
The defendants countered, however, that when they produced books and records, they did so under a confidentiality agreement that deemed the full production incorporated by reference into any subsequent complaint. Therefore, they argued, they merely relied on documents that the complaint had incorporated by reference. While the company engaged in “questionable redaction practices,” including redacting partial sentences, the facts of the case still did not warrant conversion. Among other things, it would not be reasonable to infer that the redacted information could affect the outcome of the motion to dismiss.
The case is No. 2021-0324-JTL.