To Whom Are Caremark Duties Owed?

A while ago, the National Center for Public Policy Research – a conservative organization that focuses its advocacy in the corporate and securities space – filed a lawsuit against Starbucks, arguing that its diversity equity and inclusion program ran afoul of Title VII of the Civil Rights Act of 1964, and Section 1981.

Conservative organizations have been launching a number of Section 1981-based challenges to DEI programs, but usually these are on behalf of workers.  The NCPPR case was unusual in that it brought its claims derivatively, as a Starbucks shareholder, on the ground that the directors’ illegal conduct violated their fiduciary duties to the company.

The judge dismissed NCPPR’s complaint in August, but only recently got around to issuing the opinion, and I find it fascinating.

Starbucks’s key argument was that NCPPR did not, in fact, represent the interests of Starbucks shareholders, and therefore was not a proper representative in a derivative action.  In particular, Starbucks argued that the NCPPR’s concerns were personal, due to its general opposition to DEI policies, and that Starbucks’s major shareholders supported its DEI efforts.  Starbucks cited the fact that BlackRock and Vanguard have both argued that companies should address DEI risks, and that NCPPR’s anti-diversity shareholder proposals had been voted down in prior years.  (In response, NCPPR argued among other things that BlackRock and Vanguard may not in fact be representing the interests of the investors in its funds.)

The judge agreed with Starbucks.  He relied on Larson v. Dumke, 900 F.2d 1363 (9th Cir. 1990) for the proposition that derivative plaintiffs are not appropriate representatives if they are advancing their personal interests, demonstrate vindictiveness, and hold only a few shares.  Here, that combination of factors was met:

This Court is not an investment counselor. Nor is it a political attaché. Courts of law have no business involving themselves with reasonable and legal decisions made by the board of directors of public corporations…It is clear Plaintiff is pursuing its personal interests rather than those of Starbucks. It has shown obvious vindictiveness toward Starbucks, that it would rather cause significant harm to Starbucks and other investors in the form of a declaratory judgment, and that it lacks the support of the vast majority of Starbucks shareholders.

Plaintiff has a clear goal of dismantling what it sees as destructive DEI and ESG initiatives in corporate America. Contempt for DEI and ESG programming and practices is clear in Plaintiff’s publications and literature. In fact, Plaintiff specifically calls for voting against every current member of Starbucks Board based primarily on support for these DEI Initiatives. Based on the briefing and nature of Plaintiff’s self-described political interests, it is clear to the Court that Plaintiff did not file this action to enforce the interests of Starbucks, but to advance its own political and public policy agendas.

Furthermore, Plaintiff owns only 56 shares of approximately 1.15 billion outstanding shares of Starbucks stock. Plaintiff’s shares are worth approximately $6,000 of a company with a market capitalization of more than $121 billion. Plaintiff’s dislike of DEI and ESG Initiatives has little support from Starbucks’ other shareholders and no support from Starbucks’ Board. In this action, Plaintiff seeks to override the authority of the Starbucks Board and obtain disproportionate control of Starbucks’ decision making to advance its own agenda….

Plaintiff is apparently unhappy with its investment decisions in so-called “woke” corporations. This Court is uncertain what that term means but Plaintiff uses it repeatedly as somehow negative. This Complaint has no business being before this Court and resembles nothing more than a political platform. Whether DEI and ESG initiatives are good for addressing long simmering inequalities in American society is up for the political branches to decide. If Plaintiff remains so concerned with Starbucks’ DEI and ESG initiatives and programs, the American version of capitalism allows them to freely reallocate their capital elsewhere…

I can’t say I disagree with this, exactly, but I do wonder how it gels with a claim of the type brought by NCPPR.  Now, Starbucks is not organized in Delaware – it’s a Washington company – but NCPPR claims that Washington law, like Delaware’s, provides illegal action is a violation of fiduciary duty, and for the purposes of this blog post, I’ll assume the laws are similar.  In Delaware, shareholders may bring derivative claims alleging that corporate boards violated their duty of loyalty by allowing the company to violate the law.  This principle was articulated in In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), and further elaborated in In re Massey Energy Co., 2011 WL 2176479 (Del. Ch. May 31, 2011).

I previously explained in connection with the shareholder derivative claims against Fox Corp. that, under these precedents, corporate boards are prohibited from engaging in illegal conduct, even if they conclude it’s ex ante beneficial for the company.  That is, they are not permitted to make a calculation that, given the expected benefits and the likelihood of detection, it is in fact profit-maximizing to break the law.  This was actually something that VC Laster just recently articulated:

In one hypothetical scenario, the lawyers say: “Although there is some room for doubt and hence some risk that our regulator may disagree, we believe the company is complying with its legal obligations and will remain in compliance if you make the business decision to pursue this project.”

In the other hypothetical scenario, the lawyers say: “The company is not currently in compliance with its legal obligations and faces the risk of enforcement action, and if you make the business decision to pursue this project, the company is likely to remain out of compliance and to continue to face the risk of an enforcement action. But the regulators are so understaffed and overworked that the likelihood of an enforcement action is quite low, and we can probably settle anything that comes at minimal cost and with no admission of wrongdoing.”

In the former case, the directors can make a business judgment to pursue the project. In the latter case, the decision to pursue the project would constitute a conscious decision to violate the law, the business judgment rule would not apply, and the directors would be acting in bad faith.

So, as I said in my blog post, fiduciary prohibitions on illegal conduct represent the outer limits of shareholder primacy; directors must forego profit maximizing actions in order to benefit stakeholders who are protected by positive law.  Caremark/Massey claims are therefore an odd duck in corporate law, because they are brought by shareholders, but, strictly speaking, they do not vindicate shareholders’ interests.  Liability will be imposed even if the conduct was, in fact, ex ante beneficial for shareholders.

So, you see my question in the context of the Starbucks case.  I absolutely agree that the NCPPR does not represent the interests of Starbucks shareholders, and is, in fact, antagonistic to those interests.  But is that the right frame for a Caremark/Massey claim in the first place?

This post comes to us from Ann M. Lipton, the Michael M. Fleishman Associate Professor in Business Law and Entrepreneurship at Tulane University Law School. It is based on her post, “To Whom are Caremark Duties Owed,” on the Business Law Prof Blog, available here.