Since the foundational decision in In re Caremark Intern. Inc. Derivative Litig.,[1] Delaware corporate law has required boards of directors to establish reasonable legal compliance programs. Although Caremark has been applied almost exclusively with respect to law and accounting compliance, the original Caremark decision contemplated applying the oversight duty to the corporation’s “business performance.”[2] Accordingly, Caremark claims plausibly could lie in cases in which the corporation suffered losses, not due to a failure to comply with applicable laws, but rather due to lax risk management.

In fact, several commentators have argued that Caremark liability extends—or, at least, should extend—to board oversight failures with respect to ESG issues.[3] Among those suggesting Caremark should be so extended are such prominent figures as former Delaware Chief Justice Norman Veasey and former Justice Randy Holland, who opine that a “board’s oversight responsibilities also require it to establish and monitor programs relating to matters such as . . . ESG . . ..”[4] SEC Commissioner Allison Herren Lee likewise asserts that directors’ fiduciary duties include oversight with respect to ESG risks.[5]

Obviously, where existing legislation or regulations impose compliance obligations in ESG-related areas, such as human resources, the environment, or worker safety, Caremark already applies. As such, boards must “ensure that compliance and monitoring systems are in place” to oversee corporate compliance with those laws.[6]

Many ESG issues are not yet subject to legal requirements, however. The question addressed in my article, Don’t Compound the Caremark Mistake by Extending it to ESG Oversight,[7] is whether the board’s Caremark obligations should be extended to encompass oversight of corporate performance on such issues. In other words, should the board face potential liability not just for failing to ensure that the company has adequate reporting and monitoring systems to ensure compliance with ESG-related legal requirements, but also for failing to monitor ESG risks in areas where corporate compliance would be voluntary or aspirational?

Such an extension would be highly undesirable. First, Caremark was wrong from the outset. Caremark’s unique procedural posture, which precluded any appeal, gave Chancellor Allen an opportunity to write “an opinion filled almost entirely with dicta” that “drastically expanded directors’ oversight liability.”[8] In doing so, Allen misinterpreted binding Delaware Supreme Court precedent and ignored the important policy justifications underlying that precedent.

Second, Caremark was further mangled by subsequent decisions. The underlying fiduciary duty was changed from care to loyalty, with multiple adverse effects. In recent years, moreover, there has been a steady expansion of Caremark liability. Even though the risk of actual liability probably remains low,[9] there is substantial risk that changing perceptions of that risk induces directors to take excessive precautions.[10]

Finally, applying Caremark to ESG issues will undermine Delaware’s clear law of corporate purpose by extending director oversight duties to areas of social responsibility unrelated to corporate profit. Caremark can be justified as ensuring that a corporation complies with applicable laws, but ESG compliance remains voluntary. Advocates of extending Caremark to encompass ESG compliance thus likely hope doing so will push companies to adopt what they regard as socially responsible policies but which they have not been able to mandate through the political process.[11] Asking corporate executives to take on governmental functions not only asks them to undertake tasks for which they are untrained and for which their enterprise is unsuited, it also subverts the basis of a liberal democracy. Government efforts to solve social problems are inherently limited by the checks and balances baked into the American political system. Mandated board attention to ESG risks would erode those checks and balances by asking unelected executives to undertake solving social ills

Taken together, these negatives—the errors embedded in the original Caremark decision, the recharacterization of the oversight obligation as a duty of loyalty, and its potential extension to aspirational rather than binding obligations—add up to a whole that is much worse than the individual elements. There has long been a risk that expansive readings of Caremark will “undermine the long established protections of the business judgment rule.”[12] Expanding Caremark to ESG issues would continue the process of undermining those protections and, more generally, threaten the board-centric model of corporate governance that lies at the heart of Delaware’s dominance of the market for corporate charters. In practice, extending Caremark to ESG considerations would subordinate the board’s view of how much it should measure and manage to the views of external standard setters or consultants. The likely result would be a regime in which following “best practices” as defined by expert bodies would be the only sure-fire protection against duty of loyalty suits.

ENDNOTES

[1] 698 A.2d 959 (Del. Ch. 1996).

[2] Id. at 970.

[3] See, e.g., Stavros Gadinis & Amelia Miazad, Corporate Law and Social Risk, 73 Vand. L. Rev. 1401, 1467 (2020) (“Similar to Caremark‘s first prong, . . . our proposal requires boards to set up a process for overseeing social risks arising out of companies’ operations.”); Eduardo Gallardo, Boards of Directors’ Duty of Oversight and ESG Matters: “Caremark” Revisited, The CLS Blue Sky Blog (July 2, 2019) (suggesting that, “given societal concerns around ESG matters, Caremark might come to play a more prominent role in gently guiding boards and corporations towards more actively incorporating these concerns in their decision-making process”), https://clsbluesky.law.columbia.edu/2019/07/02/boards-of-directors-duty-of-oversight-and-esg-matters-caremark-revisited/; Geoffrey Christopher Rapp, A New Direction for Shareholder Environmental Activism: The Aftermath of Caremark, 31 Wm. & Mary Envtl. L. & Policy Rev. 163, 164 (2006) (arguing that Caremark’s “application in the environmental context seems clear”).

[4] E. Norman Veasey & Randy J. Holland, Caremark at the Quarter-Century Watershed: Modern-Day Compliance Realities Frame Corporate Directors’ Duty of Good Faith Oversight, Providing New Dynamics for Respecting Chancellor Allen’s 1996 Caremark Landmark, 76 Bus. Law. 1, 27 (2021).

[5] Soyoung Ho, SEC Commissioner: Board of Directors Have Big Role to Play on ESG, WGL-ACCTALERT Vol. 15 No. 127 (July 6, 2021).

[6] William D. Regner, The Duty of US Company Directors to Consider Relevant ESG Factors 4 (2020), https://www.unpri.org/download?ac=11696.

[7] Stephen M. Bainbridge, Don’t Compound the Caremark Mistake by Extending it to ESG Oversight, ___ Bus. Law. ___ (forthcoming), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3899528.

[8] Todd Haugh, Caremark’s Behavioral Legacy, 90 Temp. L. Rev. 611, 618 (2018).

[9] See William Savitt, Wachtell Lipton Discusses Tectonic Forces to Watch in Corporate Litigation, The CLS Blue Sky Blog (Jan 30, 2020), https://clsbluesky.law.columbia.edu/2020/01/30/wachtell-lipton-discusses-tectonic-forces-to-watch-in-corporate-litigation/ (opining that “boards have ample means to anticipate and thereby minimize the risk of Caremark exposure through appropriate prophylactic corporate governance”).

[10] See, e.g., Brett McDonnell et. al., Green Boardrooms?, 53 Conn. L. Rev. 335, 389 (2021) (“Even if the risk of legal liability is negligible, a threatened Caremark suit could still affect director behavior.”).

[11] Cf. Paul G. Mahoney & Julia D. Mahoney, The New Separation of Ownership and Control: Institutional Investors and ESG, ­­­__ Colum. Bus. L. Rev. ___ (2021) (arguing that “political activists . . . want to use [mandated ESG disclosures] to prod companies to change policies in socially-motivated directions”).

[12] In re Citigroup Inc. Shareholder Derivative Litig., 964 A.2d 106, 130 (Del. Ch. 2009).

This post comes to us from Stephen M. Bainbridge, the William D. Warren Distinguished Professor of Law at the UCLA School of Law. It is based on his new paper, “Don’t Compound the Caremark Mistake by Extending it to ESG Oversight,” available here.