I have observed before that Arch Oboler was an American entertainer perhaps best known for running the 1930s radio drama Lights Out. One of his most famous stories was The Chicken Heart. In brief, a mad scientist keeps a disembodied chicken heart alive and beating. Until one day the apparatus is overturned and smashed. And disaster followed:
That apparatus—robot-heart or whatever you want to call it—was accidentally smashed and over the week-end, in some miraculous manner, that little chicken heart no larger than my thumb-nail grew into a mass of pulsing flesh a thousand times its original size! ...
When those women knocked over the apparatus - it fell against that rack of chemicals! Is it not possible that some unknown combination of those reagents acting upon the tissue resulted in what you choose to call a "miracle"—the super-growth of this heart, this independent existence of an organ outside its own bodily environment?
And the chicken heart kept growing. And started moving:
With my own eyes I saw it! It moved out until it reached that case of white mice there and then it—it wrapped itself around one of the mice! ... Then—then the tentacle retracted itself and the mass of flesh engulfed the mouse!
And still it grew:
That little piece of flesh has grown until now it's jamming that building with flesh! All inside the space of an hour!
Until:
The end has come for humanity—not in the glory of interstellar combustion—not in the peace of white cold silence—but with that - creeping, grasping flesh below us! It is a joke, eh, Lewis? A great joke! The joke of the Cosmos! The end of mankind - because of a chicken's heart!
That tale of horror came to mind when I read Delaware Vice Chancellor Travis Laster's opinion in In re McDonald's Corp. Stockholder Deriv. Litig., in which the VC held that Caremark's oversight duty applies to officers as well as directors. McDonald's generated two posts:
In re McDonald's Corp. Stockholder Litig.: Caremark is the Chicken Heart
and
VC Laster Disposes of Shareholder Suit over McDonald's Corporate Culture
As I explained in the former, I have two longstanding concerns about Caremark.
First, Caremark was wrong from the outset. In the original Caremark decision, the unique procedural posture of the case, which was such that it would not be appealed, 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 that of 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.
All of which came to mind when I read a report from Bloomberg about a speech in which Delaware Chancellor Kathaleen St. Jude McCormick. Noting the "rising number of Caremark claims being filed in Chancery Court," McCormick called that increase “interesting but not alarming.”
The report continues:
Caremark claims historically are among the hardest cases for shareholders to win, but a series of Laster’s rulings over the past year—involving AmerisourceBergen Corp., McDonald’s, and Walmart Inc.—potentially have smoothed the path forward.
There’s also been a notable rise in the number of lawsuits seeking corporate books and records concerning board decisions for investigations that may lead to Caremark claims or M&A cases, she said.
Unlike the Chancellor, I find this trend alarming. Caremark should have been nipped in the bud. At the very least, it should have been constrained to its fact pattern. Instead, like the chicken heart of fable, it seems destined to swallow increasing swaths of corporate law.
UPDATE: Larry Cunningham was at the Institute and offers a take in which Caremark is not the chicken heart. As I note, however, I’d like to see Chancery draw some red lines beyond which Caremark will not be allowed to go
For more detailed critiques of Caremark, see:
Bainbridge, Stephen Mark, Caremark and Enterprise Risk Management (March, 18 2009). UCLA School of Law, Law-Econ Research Paper No. 09-08, Available at SSRN: https://ssrn.com/abstract=1364500 or http://dx.doi.org/10.2139/ssrn.1364500
The financial crisis of 2008 revealed serious and widespread risk management failures throughout the business community. Shareholder losses attributable to absent or poorly implemented risk management programs are enormous.
Efforts to hold corporate boards of directors accountable for these failures likely will focus on so-called Caremark claims. The Caremark decision asserted that a board of directors has a duty to ensure that appropriate "information and reporting systems" are in place to provide the board and top management with "timely and accurate information." Although post-Caremark opinions and commentary have focused on law compliance programs, risk management programs do not differ in kind from the types of conduct that traditionally have been at issue in Caremark-type litigation.
Risk management failures do differ in degree from law violations or accounting irregularities. In particular, risk taking and risk management are inextricably intertwined. Efforts to hold directors accountable for risk management failures thus threaten to morph into holding directors liable for bad business outcomes. Caremark claims premised on risk management failures thus uniquely implicate the concerns that animate the business judgment rule's prohibition of judicial review of business decisions. As Caremark is the most difficult theory of liability in corporate law, risk management is the most difficult variant of Caremark claims.
Bainbridge, Stephen Mark, Don’t Compound the Caremark Mistake by Extending it to ESG Oversight (September 2021). Business Lawyer (September 2021), UCLA School of Law, Law-Econ Research Paper No. 21-10, Available at SSRN: https://ssrn.com/abstract=3899528
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.
