Alex Cooper, Cynthia Williams, Ellie Mulholland, Robert Eccles, and Sarah Barker argue that directors of Delaware corporations face Caremark liability for climate change risk management failures.
As discussed in detail in a new paper published in October 2021 by the Commonwealth Climate and Law Initiative (CCLI), climate change has therefore evolved from an “ethical, environmental” issue to one that presents foreseeable financial and systemic risks (and opportunities) over mainstream investment horizons. This evolution has substantially changed the relevance of climate change to the governance of corporations, which has implications for the fiduciary duties of directors and officers under Delaware law. ...
Climate change is likely to significantly increase the risks facing a corporation’s operations, and through government’s efforts to halt climate change and protect economies and communities from its impacts, increase its regulatory obligations. Therefore, in the context of climate-related risks, oversight liability may arise where directors and officers:
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- fail to consider or oversee the implementation of climate-related legal risk controls;
- fail to monitor mission-critical regulatory compliance, either specific climate change-related regulations or existing regulations which require consideration or disclosure of climate change risks. This latter category is likely to include a broad range of regulations, but may include: securities laws, which require listed companies to disclose material risks; environmental laws, as the physical effects of climate change catalyze infrastructure failure; and health and safety laws for companies with employees are exposed to increasingly hostile conditions; or
- fail to monitor climate-related mission-critical operational and business risks.
It's not entirely clear whether they think that's a good thing or not. But their descriptive analysis is spot on. The precautions they urge boards to take seem advisable. Those precautions might even help save the planet, which would be a good thing.
In sum, I agree that there is a risk here. But insofar as the ought questions are concerned, I think courts should not allow that risk to materialize. I elaborate in my paper Don’t Compound the Caremark Mistake by Extending it to ESG Oversight (September 2021), which is forthcoming in The Business Lawyer. In it, I argue that:
Since the foundational decision in In re Caremark Intern. Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996), 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.” Accordingly, there is no doctrinal reason that Caremark claims should not 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.
The question thus arises as to whether Caremark should be extended to board failures to exercise oversight with respect to environmental, social, and governance (ESG) factors. 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.
Many ESG issues are not yet the subject to legal requirements, however. The question addressed in this Article is whether the board’s Caremark obligations should be extended to encompass oversight of corporate performance with 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 in place to insure compliance with ESG-related legal requirements, but also to monitor ESG risks in areas where corporate compliance would be voluntary or aspirational.
As I explained in a summary version of article at CLS Blue Sky Blog, 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.” 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, there is substantial risk that changing perceptions of that risk induces directors to take excessive precautions.
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.] 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.”
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.
