The news that McDonald’s had filed a lawsuit against its former CEO, Stephen Easterbrook, to recoup severance compensation the company had paid Easterbrook, made the front page of the Wall Street Journal. The company contends that Easterbrook had only been terminated last November “without cause” – entitling him to a full severance package – because he had lied to investigators about the nature and extent of his relationship with company employees. The lawsuit contends — based on evidence of three additional sexual relationships Easterbrook had with company employees that only came to light this summer — that Easterbrook should have been terminated for cause. As discussed below, the lawsuit raises a number of interesting issues. A copy of the company’s August 10, 2020 filing on Form 8-K about the lawsuit can be found here, and a copy of the complaint, which was attached to the 8-K, can be found here.
According to the complaint the company recently filed against Easterbrook, on October 16, 2019, the Company “was notified of an allegation” that Easterbrook had engaged in a relationship with a company employee. The board’s independent directors convened and engaged an independent outside counsel to investigate.
The employee told the investigator that her relationship with Easterbrook was entirely consensual, consisted of text messages and video calls, and never included a physical relationship. Easterbrook confirmed the employee’s account, and Easterbrook also told the investigator had never engaged in a sexual relationship, whether physical or non-physical, with any other company employee. As part of the investigation, the investigator also searched Easterbrook’s company-provided mobile phone; the search did not reveal any evidence contradicting Easterbrook’s representations.
The independent directors met again on October 26, 2019, and they resolved to terminate Easterbrook for violating company policies prohibiting intimate interactions between employees in a reporting relationship. The complaint contains extensive allegations about the board’s decision whether or not to terminate Easterbrook for cause. The board concluded that it would have difficulty meeting the high bar for termination for cause (conduct constituting “dishonesty, fraud, illegality, or moral turpitude”) and would likely embroil the company in lengthy litigation with Easterbrook, so it elected to make the termination “without cause.” Representatives of the board negotiated a separation agreement with Easterbrook, in which he was to receive substantial termination benefits. The company announced Easterbrook’s termination on November 3, 2020.
In July 2020, the company “received an anonymous report” that Easterbook had engaged in a sexual relationship with a different company employee while Easterbrook was CEO. An internal investigation discovered photographic evidence that Easterbrook had engaged in physical relationships with at least three company employees in the year before his termination. The evidence consisted of nude or partially nude videos and photographs that had been sent as attachments to messages from his company email account to his personal email account. The date and time stamps on the images of the three company employees shows that the photographs were all taken in late 2018 or early 2019. Further investigation also showed that Easterbrook authorized a special discretionary grant of restricted stock units to one of the three employees between the time of his first sexual encounter with her and the second.
The complaint alleges that the images show that Easterbrook repeatedly violated company policies against relationships with company employees and that he had lied to the company’s investigator about the extent and nature of his relationships with company employees.
In the lawsuit it filed in the Delaware Court of Chancery on August 10, 2020 against Easterbrook, the company alleges that it would not have entered the Separation Agreement with Easterbrook if it had been aware of Easterbrook’s relationships with the three employees, as the conduct, the complaint alleges, “constituted a clear legal basis to terminate Easterbrook for cause.”
The complaint recites that the separation agreement contains a provision allowing the company to clawback the severance compensation if the company discovers that Easterbrook committed an act that constitutes “cause” while employed by the company.
The complaint asserts two causes of action. The first for breach of fiduciary duty, alleges that “Easterbrook’s silence and lies – a clear breach of the duty of candor – were calculated to induce the Company to separate him on terms much more favorable to him than those the Company would have offered and agreed to had it known the full truth of his behavior.”
The complaint alleges that the company “justifiably relied on Easterbrook’s false denial in approving the Separation Agreement. That reliance cause the Company injury.”
The complaint seeks compensatory damages, or in the alternative, rescission of the separation agreement and return of all cash and stock awards granted under the agreement.
Easterbrook’s lawyers have responded in the press to the complaint, asserting that McDonald’s is a sophisticated entity that engaged numerous internal and external experts to negotiate the separation agreement, and knowing that it could not prevail in a breach of contract claim against Easterbrook, it has “manufactured” a breach of fiduciary duty claim.
There is much that might be said about this sequence of events and the allegations the company has raised in its lawsuit. One thing for sure, these events show how much pressure corporate boards are under in this post-#MeToo era. Boards today, aware of allegations that have been raised in the past that directors have been accused of turning a blind eye or sweeping allegations of sexual harassment or sexual misconduct under the rug, are under pressure to act promptly and decisively in response to these types of allegations. It does seem here that the company’s board was committed to acting quickly and demonstrating that it would not tolerate the kind of conduct that had come to light about Easterbrook’s conduct.
The lawsuit itself is extraordinary. It is highly unusual for a company to so publicly and dramatically sue its own former highest-ranking officer, a fact that seems all the more extraordinary given the nature of the allegations. The lawsuit itself seems a further expression of the board and of the company to try to demonstrate that the allegations against Easterbrook are against the company’s values.
Indeed, an August 10, 2020 New York Times article (here) notes that “The lawsuit represents an extraordinary departure from the traditional disclose-it-and-move-on decorum that American corporate executives have often embraced when confronted with allegations of wrongdoing by senior executives. More than a few chief executives in recent years have lost their jobs after allegations of sexual or other misconduct, but for the most part they have departed quietly and the companies haven’t aired the ugly details.” The article goes on to note that in the #MeToo and Black Lives Matter era, companies and their boards are under pressure to try to position themselves as “good corporate citizens,” compelling the companies to do more than might have been viewed as sufficient in the past.
Of course, it may also be relevant that last November, just after Easterbrook was terminated, a class action lawsuit was filed against the company alleging “systemic” sexual harassment. The company may recognize that it may be under special scrutiny right now.
Just the same, in the wake of the lawsuit’s filing, the board has received criticism, as Liz Dunshee noted in an August 14, 2020 post on TheCorporateCounsel.net blog (here). An August 11, 2020 Wall Street Journal article (here) quotes several institutional investors as raising questions about the board’s initial decision to terminate Easterbrook “without cause” and also raising questions about the extent of the board’s initial investigation. The investors also question the board’s focus on avoiding a fight with Easterbrook by terminating him without cause.
(Just as an aside, I do have to say that as I read the company’s complaint against Easterbrook, the fact that the initial investigation included a search of Easterbrook’s mobile phone but apparently didn’t also include a review of his company email account made me scratch my head a little bit. Perhaps this oversight had something to do with the fact the investigation was completed in just ten days.)
For students of D&O insurance, this lawsuit raises a number of potential coverage thought-problems. For example, I have no idea whether Easterbrook has any intent to try to seek protection under McDonald’s D&O insurance policy for the claims asserted against him in the lawsuit, but the fact is that the group of individuals insured under a D&O insurance policy include former directors and officers of the company. Insurers protect themselves from the problems this arrangement might otherwise create by including a standard insured vs. insured exclusion, precluding coverage for claims brought by one insured against another insured. In the current era, this standard provision has been revised in many public company policies to restrict the exclusion to precluding coverage only for claims brought by the insured corporate entity against an insured person. An insurer might well contend that the lawsuit against Easterbrook is an entity vs. insured lawsuit.
Even if the Insured vs. Insured exclusion (or Entity vs. Insured exclusion) did not preclude coverage for the lawsuit, there are other potentially applicable policy exclusions and provisions that might preclude coverage as well. For example, most D&O insurance policies contain an exclusion precluding coverage for claims seeking the return of compensation to which the insured individual is not legally entitled. However, these days, most of these exclusions are written such that the preclusive effect applies only after a final adjudication that the precluded conduct has taken place. Since disputes of this type rarely go to trial, an adjudication might never take place, and even if the company and Easterbrook reach a settlement, the exclusion still might not be triggered.
There are other grounds on which an insurer might dispute coverage for this claim as well, including the argument that insurers often raise in these kinds of situation that this lawsuit seeks restitution or disgorgement, which amounts do not represent covered Loss under the policy.
Regardless of the question whether or not Easterbrook has coverage for the lawsuit the company has filed against him (coverage that Easterbrook himself might not even seek to invoke), there is the further question about possible future claims that might be brought against the board itself. To be sure, this question might be thoroughly hypothetical, and the likelihood that the concerns raised about board’s decision and its investigation might result in litigation seems remote (at least at this point), the fact is that corporate boards in several instances have been sued in claims alleging that the directors violated their duties in responding to allegations that company executives engaged in sexual misconduct. I raise this possibility here just to make the point that while there might not be coverage under the policy for the claims the company has raised against Easterbrook, there could still be a covered claim under the policy if the current concerns about the way the company’s board handled these circumstances ultimately do result in a lawsuit against the board.