Navigating Officer Exculpation: Trends, Implications, and Future Considerations

Many public companies have longstanding director exculpation clauses within their company bylaws or charters designed to limit or eliminate the personal liability of directors. These clauses aim to shield directors from legal action arising from alleged breaches of fiduciary duties, including the duty of care and the duty of loyalty, which directors owe to the company and its shareholders.

Exculpation clauses help attract qualified individuals to serve on a company board by mitigating the risk of personal liability. Talented directors may be reluctant to join boards if they fear legal repercussions for decisions they believe were made in the best interest of the company.  By reducing the threat of litigation, exculpation provisions can encourage directors to make bold decisions without fear of personal legal consequences.  Proponents also argue that director exculpation enhances shareholder confidence by ensuring that individuals willing to serve on the board are not deterred by the potential personal risks associated with their roles.

Historically, these exculpation provisions were limited to the board of directors only.  Therefore, stockholder plaintiffs would often employ the tactic of bringing certain claims, that would otherwise be exculpated if brought against directors, against individual officers to avoid dismissal of such claims in court.  Recent changes made by the Delaware General Assembly, however, paved the way for these protections to be expanded to the executive level as well.  Effective August 1, 2022, Section 102(b)(7) of the General Corporation Law of the State of Delaware (the “DGCL”) was amended to permit a corporation to include within its certificate of incorporation a provision eliminating or limiting the monetary liability of named executive officers for a breach of the duty of care under certain circumstances.  The amendment intends to address inconsistent treatment between officers and directors and rising litigation and insurance costs for companies and their stockholders. Officers covered under this amendment are: (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.

Following the DGCL amendment, public companies, incorporated in Delaware, began to add officer exculpation proposals to their Annual Meeting ballots.  Between August 2022 and December 2023, 27 companies in the S&P 500 submitted officer exculpation proposals to a shareholder vote.  All but one of those proposals received the requisite number of votes for passage – a success rate of 96.3%.  Average support for the proposals was approximately 85.6% of votes cast, and 69.9% of outstanding shares.  The one proposal that failed (Paycom Software, Inc.) required a supermajority rather than a simple majority of the outstanding shares.

For Russell 3000 companies, there were a total of 213 proposals submitted, with 191 of those proposals passing – a success rate of 89.7%.  Average support for these proposals within the Russell 3000 index was 88.1% of votes cast and 70.65% of the outstanding shares.

Most of the submitted officer exculpation proposals require an affirmative vote of a majority of shares outstanding, however, there several companies  had a supermajority threshold.  Of the 22 failed proposals at Russell 3000 companies, 15 of them required a supermajority of anywhere from 2/3 of shares outstanding to as high as 80% of the shares outstanding.

Both ISS and Glass Lewis updated their voting guidelines in response to the DGCL amendment. According to their published policy, ISS will vote case-by-case on exculpation proposals, considering the stated rationale for the proposed change. They will also consider, among other factors, the extent to which the proposal would:

• Eliminate directors' and officers' liability for monetary damages for violating the duty of care.
• Eliminate directors’ and officers’ liability for monetary damages for violating the duty of loyalty.
• Expand coverage beyond just legal expenses to liability for acts that are more serious violations of fiduciary obligation than mere carelessness.
• Expand the scope of indemnification to provide for mandatory indemnification of company officials in connection with acts that previously the company was permitted to provide indemnification for, at the discretion of the company's board (i.e., "permissive indemnification"), but that previously the company was not required to indemnify.

ISS also noted that they would recommend a vote for those proposals providing such expanded coverage in cases when a director’s or officer’s legal defense was unsuccessful if both of the following apply:

• If the individual was found to have acted in good faith and in a manner that the individual reasonably believed was in the best interests of the company; and
• If only the individual’s legal expenses would be covered.

Of the 213 proposals submitted by Russell 3000 companies, ISS recommended a vote in support of 179 of them.

Compared to ISS, Glass Lewis is less supportive of officer exculpation.  According to their policy, Glass Lewis will closely evaluate proposals to adopt officer exculpation provisions on a case-by-case basis and will generally recommend voting against such proposals, eliminating monetary liability for breaches of the duty of care for certain corporate officers unless a compelling and reasonable rationale for the adoption is provided by the board.  They state that they “generally believe that some protection from liability may be reasonable to protect directors against certain suits so that these directors feel comfortable taking measured risks that may benefit shareholders. However, given the differences in the roles of directors and officers, we have adopted a more cautious stance when providing recommendations on the adoption of such provisions for officers.  We believe that the officers of public companies are well-compensated for the risk of litigation they take on and identify this factor as an important contrast between the roles of corporate officers and their director counterparts. Shareholders should be reluctant to relinquish their rights to pursue claims for breaches of duty of care against corporate officers without some clear demonstration of the benefit to the company and its shareholders of adopting such provisions.”

Looking ahead:

Many companies took a ‘wait and see’ approach to officer exculpation in 2023, opting to hold off on putting the proposal to a vote until seeing how the voting played out at other companies.  We expect many companies to have the proposal on the ballot for their 2024 Annual Meeting.

If not already underway, companies should start to discuss and decide if they will have the proposal on the agenda at their 2024 Annual Meeting.  In general, the proposal requires a majority of the outstanding shares to be approved, but in some cases, the requirement may be a supermajority vote which will make passage more difficult.  The proposal is non-discretionary for the brokerage firms, which makes obtaining the required vote much more difficult.

Given the vote requirements, companies will need to have a good understanding of the make-up of their shareholder base.  Knowing the retail vs. institutional investor ratio is crucial.  Companies with higher institutional ownership will need to be mindful of the level of influence that Glass Lewis has over their top institutional holders.  Companies with a higher retail component may have to employ additional solicitation to achieve the required vote.