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Delaware VC Travis Laster Responds to Trump AG William Barr's Critique of Woke Delaware Corporate Law

In a WSJ op-ed last week former Trump AG William Barr (and attorney Jonathan Berry) argue that Delaware courts' "flirtation with ESG is jeopardizing its status as a preferred destination for corporate headquarters." I commented on that article in an earlier post. Over the weekend, Delaware Vice Chancellor Travis Laster also critiqued Barr's article.

I'm a fan of VC Laster's writing style, which has a certain flair. So I was amused by the zinger with which he opened:

There are many legal topics where AG Barr has vast knowledge and experience. On those subjects, his opinion should carry weight. His column demonstrates that Delaware law is not one of them.

Turning to Laster's substantive argument, he opens by saying that:

First, Delaware is not a stakeholder state. It has a board-centric model in which fiduciary duties run to the corporation for the ultimate benefit of the stockholders. That’s why Robert T. Miller, an Iowa law professor with impeccable conservative bona fides, recently authored an article titled Delaware Law Requires Directors to Manage the Corporation for the Benefit of its Stockholders and the Absurdity of Denying It. It's a good place to start.

As a point of personal privilege, I would prefer to characterize Delaware corporate law as a system of director primacy but I concede that director primacy is board-centric, so let's move on.

I would also note in passing that Robert Miller's article is a must read on this topic. As another matter of personal privilege, however, I would also suggest checking out my book The Profit Motive: Defending Shareholder Value Maximization, which has an extensive treatment of the state of Delaware law on this point.

Back to VC Laster, Barr had complained that:

... former Delaware Supreme Court Justice Tamika Montgomery-Reeves, who in 2021 declared that state law allows directors “to consider interests of broader constituents,” such as “stakeholders other than stockholders.” President Biden named her to the federal appellate bench in 2022.

Laster responds:

Judge Montgomery-Reeves was right when she said in 2021 that Delaware law allows directors “to consider interests of broader constituents,” such as “stakeholders other than stockholders.” ... But when the board makes its decision, the directors must believe in good faith that the path chosen will promote the value of the corporation for the long-term benefit of its stockholders.

A quibble: There are two sets of cases in which directors who consider non-shareholder interests in making decisions face a serious risk of liability. First, confessional cases; i.e., those in which the board of directors basically says "we're putting stakeholder interests ahead of those of shareholders and our shareholders can lump it." As I discuss in The Profit Motive, the classic confessional case was the Michigan Supreme Court's decision in Dodge v. Ford Motor Co., which was embraced sub silentio by the Delaware Chancery Court in eBay Domestic Holdings, Inc. v. Newmark. In effect, confessional cases are those in which the board has effectively admitted that they are acting in bad faith.

Second, although Laster doesn't mention it, Delaware law is clear that there is one set of circumstances in which Delaware courts forbid directors from taking stakeholder interests into account. As I explain in The Profit Motive (at p. 60):

In the course of the [Revlon] opinion, the Delaware Supreme Court [held that] once the board enters Revlon-land [i.e., enters into a transaction that will result in a change of control], any “concern for non-stockholder interests is inappropriate.” In other words, getting the best possible deal for the shareholders—regardless of the potential impact on other corporate constituencies—must be the board’s sole focus.

Back to VC Laster. who minimizes concerns about Caremark:

All Caremark requires is that directors make a good faith judgment regarding an information system to make them aware of potential threats to the corporation, then respond in good faith to information about threats.

Here I must part ways with the Vice Chancellor, albeit with respect. As I have said many times, albeit to no avail, Caremark was wrong from the outset and its progeny have mostly made things worse. In particular, note VC Laster's reference to "threats to the corporation." Therein lies the nub of the problem: What kinds of threats? Although VC Laster suggests that Caremark is most relevant to decisions about law compliance, he acknowledges that "directors could breach their duties if they knowingly fail to respond to other types of risks," while positing that "it would be a much tougher case." As I explain in my article, Don’t Compound the Caremark Mistake by Extending it to ESG Oversight:

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 ensure compliance with ESG-related legal requirements, but also to monitor ESG risks in areas where corporate compliance would be voluntary or aspirational.

Admittedly, I have indulged in a fun bit of hyperbole by repeatedly comparing Caremark to The Chicken Heart, which was an episode of Arch Oboler's 1930s radio show Lights Out. The risk that Caremark will continue to expand into areas like ESG compliance, however, still strikes me as a very valid concern.

Having said that, however, I must note that Chancellor McCormick is not alarmed by recent developments suggesting that Caremark cases are becoming more frequent and easier to win. I also note Larry Cunningham's comments about a panel discussion on which he and Chancellor McCormick participated, which he thinks suggests concerns are the growth of Caremark are overstated. Larry concludes that "The real danger today is from Washington not Wilmington," a point with which I am fully in accord.

In sum, I agree with VC Laster's first two points. As for Barr's concern that "Caremark [is] a vector for “social-responsibility topics,” I tend to come down more on AG Barr's side. As I explained in my article, Don’t Compound the Caremark Mistake by Extending it to ESG Oversight , Caremark has the potential to convert aspirational goals into legal mandates. As such, extending Caremark to the ESG context would effectively create a legal mandate that directors try to balance profit against environmental and social issues. As such, it would work an important change in Delaware’s law of corporate purpose.

Former Trump AG William Barr thinks Delaware's Caremark Doctrine is a Serious Policy Error That's Going to Erode Delaware's Dominance. He's half right.

Former Trump Attorney General William Barr (and attorney Jonathan Berry) are now trying to save Delaware from itself. From the WSJ:

Delaware is falling in line with other blue states in embracing ESG, which rejects shareholder value as corporate law’s lodestar. Meanwhile, red states are developing potentially attractive alternatives. …

The watchword is Delaware’s Caremark doctrine, which makes executives liable for failures in risk management. Once reserved for outright corporate crime, this notable exception to Delaware’s signature deference to executives has demonstrated expansive potential. Two former Delaware Supreme Court justices have stated that, under the doctrine, ESG issues should become more than optional social-responsibility topics. They should be “risks” that boards are required to oversee. The influential former Delaware Supreme Court Chief Justice Leo Strine has coauthored several papers—including one titled “Caremark and ESG: Perfect Together”—addressing how the doctrine invites companies to undertake ESG initiatives.

… Delaware’s weakness presents an opportunity for red states that oppose ESG. This year Texas elected to set up its own designated business court. Georgia, Utah and Wyoming recently did the same.

At this point, I pause to ask readers unfamiliar with Caremark to skip over to an earlier post: After Boeing, Caremark is no longer "the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment". It will provide necessary background on Caremark's growth.  I also refer the reader to my post summarizing my recent writing on corporate purpose, ESG, corporate social responsibility, and stakeholder theory.

I want to come at this issue from three perspectives. First, will the Delaware courts expand Caremark to encompass ESG issues? I confess to a certain amount of concern on this score; so much so that I wrote a law review article, Don’t Compound the Caremark Mistake by Extending it to ESG Oversight, arguing that Caremark should not be extended to board failures to exercise oversight with respect to environmental, social, and governance (ESG) factors. What follows briefly summarizes the main arguments in that article.

In Caremark and its progeny, Delaware courts mandated that company boards establish effective legal compliance systems. Originally, Caremark was largely focused on legal and accounting compliance, but it also considered overseeing a company's overall business performance. Thus, Caremark-related claims could potentially arise not only from legal non-compliance but also from inadequate risk management.

Several experts have suggested that Caremark's scope should include board oversight failures in environmental, social, and governance (ESG) matters. Prominent legal figures, including former Delaware Chief Justice Norman Veasey and former Justice Randy Holland, have suggested that board responsibilities should cover monitoring programs in areas like ESG. SEC Commissioner Allison Herren Lee also argues that directors’ fiduciary duties encompass ESG risk oversight.

Caremark is already applicable in areas where ESG-related compliance is legally required, such as human resources, environmental protection, and worker safety. However, many ESG issues are not legally mandated yet. The debate, as discussed in my article, centers on whether Caremark duties should also cover voluntary or aspirational ESG performance oversight.

Extending Caremark in this way would be highly problematic. First, the original Caremark ruling was a serious error whose premise rested on the case’s procedural uniqueness and the resulting leeway it gave Chancellor Allen to misinterpret (deliberately) Delaware Supreme Court precedents. Second, subsequent decisions have altered the foundational fiduciary duty from care to loyalty, leading to an unwarranted expansion of Caremark liability. Although actual liability risk remains low, the perceived risk might prompt directors to take excessive measures.

Furthermore, applying Caremark to ESG matters risks distorting Delaware's established corporate purpose laws by pushing director duties into areas of social responsibility not directly tied to corporate profits. This extension might inadvertently encourage companies to adopt socially responsible practices not mandated by political processes, effectively blurring the lines between corporate and governmental roles.

In sum, the combined issues – the original Caremark decision's flaws, the shift in fiduciary duty from care to loyalty, and its potential extension to non-mandatory areas – could undermine the protections provided by the business judgment rule. Expanding Caremark to ESG matters threatens Delaware's board-centric corporate governance model and could lead to a scenario where adherence to externally set “best practices” becomes the primary defense against loyalty duty lawsuits.

In sum, I share Barr and Berry’s concern that Delaware courts are expanding Caremark far beyond its original boundaries and that doing so is a serious policy error.

Second, I note in passing Carr and Berry’s comment on my friend former Delaware Supreme Court Chief Justice Leo Strine. It is true that Strine’s recent scholarship has been pro-ESG (or, as he renamed it, EESG by adding Employees to the list). Yet, one of the many reasons I respect Strine is his ability to draw a sharp difference between what he thinks the law ought to be and what he knows the law is. In a 2015 article, Strine more broadly addressed claims by Stout and numerous progressive corporate law scholars “that directors may subordinate what they believe is best for stockholder welfare to other interests, such as those of the company’s workers or society generally.” In assessing that claim, the Chief Justice minced no words; to the contrary, he hurled multiple verbal grenades into the debate:

• “These well-meaning commentators, of course, ignore certain structural features of corporation law . . ..”
• “Indeed, these commentators essentially argue that Delaware judges do not understand the very law they are applying, and the Delaware General Assembly does not understand the law it has created.”
• “It is not only hollow but also injurious to social welfare to declare that directors can and should do the right thing by promoting interests other than stockholder interests.”

Perhaps most damningly, however Strine essentially accused the commentators – whom he called out by name in lengthy string cites – of misrepresenting the law, arguing that they “pretend that directors do not have to make stockholder welfare the sole end of corporate governance, within the limits of their legal discretion, under the law of the most important American jurisdiction – Delaware.” It is about as damning a dismissal of academic arguments as one encounters.

Third, where I part ways with Barr and Berry is in their theory that the Caremark error will lead to Delaware losing incorporations to red states (or, for that matter, any state). So many states have tried to knock Delaware off its throne. None have succeeded.

I explored the reasons for Delaware’s success in Why the North Dakota Publicly Traded Corporations Act Will Fail. In that short essay, I commented on the North Dakota Publicly Traded Corporations Act. North Dakota hoped that the Act will empower it to compete with Delaware in the market for corporate charters. In my view, North Dakota was doomed to failure. If state chartering competition is a race to the bottom, managers will prefer Delaware to North Dakota because the former facilitates the extraction of private rents. If state competition is a race to the top, investors will prefer the director primacy approach taken by Delaware to the shareholder primacy one adopted by North Dakota. Either way, North Dakota was bound to lose. And it has.

Obviously, Delaware makes mistakes. But for the most part Delaware manages to retain pride of place. On major reason is that Delaware's legislature acts quickly to adopt developments in other states that prove successful. "The Delaware legislature pays close attention to keeping the GCL [i.e., the Delaware General Corporation Law]up-to-date and efficient. It has a longstanding relationship with the Corporate Law Section of the Delaware Bar Association, which frequently recommends, reviews, and drafts revisions to the GCL. William F. Griffin, The Delaware Alternative, CLHBU MA-CLE 10-1 (2015).

As Wilmington attorney Black noted, … Delaware's system is not easily emulated. “There are elements unique to Delaware that would be very hard to replicate, particularly in big states,” he says. Delaware benefits from having a unique combination of an enabling corporation statute, a legislature that keeps the statute up to date and that has developed a long and trusting relationship with the corporate bar, and judges who come from among the best and brightest attorneys in the state, he says. “

Donald F. Parsons Jr. & Joseph R. Slights III, The History of Delaware's Business Courts: Their Rise to Preeminence, 17 Bus. L. Today 21, 25 (March/April 2008).

In sum, if a state starts to make gains, the Delaware legislature will just copy that state’s approach--probably with improvements--and remain dominant by virtue of the unique combination of identified by Parsons and Slights.

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"Is Undisclosed Jiu-Jitusu Securities Fraud?"

Today's Money Stuff email from Matt Levine informs us that:

1. Every bad thing that happens to a public company is also securities fraud.
2. Getting beaten up is bad.
3. Mark Zuckerberg getting beat up is probably bad for Meta Platforms Inc. “If Mr. Zuckerberg were to become unavailable for any reason,” says Meta in its securities filings, “there could be a material adverse impact on our operations.” For instance if he got beat up real bad.
4. Therefore Mark Zuckerberg getting beaten up is securities fraud.

He notes that a Bloomberg reporter wrote that:

Meta’s Mark Zuckerberg has become increasingly obsessed with formal mixed martial arts fighting, and is training for a competitive fight next year. But the chief executive officer faced a major setback: He tore his ACL in training and underwent surgery to repair it. ...

there is a serious consideration here about whether Meta Platforms Inc.’s co-founder, CEO and controlling shareholder has a duty to disclose his MMA activities to investors, particularly if formal contests are in his future. What if it’s worse next time? Zuckerberg posted about his surgery on Instagram, and there was no filing or company statement.

“It’s a question of materiality,” said Bryan Westhoff, an attorney at Polsinelli PC. “Is it material to a reasonable investor to know what the executives are doing? Is there danger and uniqueness to it? MMA is something that most of us don’t do."

Really? "A serious consideration"? Seriously?

Back to Levine:

The corollary to “everything is securities fraud” is that everything is also insider trading, and there are obvious applications here. What if you show up at a Brazilian jiu-jitsu tournament to find that you are fighting Mark Zuckerberg? If you knock him out, can you run to your Robinhood account and short Meta stock before the ambulance gets there? (Can you short the stock before the match if you just know that you’re huge and will knock him out? Do you then fight dirty?) Brazilian jiu-jitsu tournaments now have a unique ability to create material nonpublic information about Meta stock; what if someone uses it?

There is noting new under the sun, of course. To the contrary, there has been occasional academic speculation about when a CEO's health becomes a matter for discloure to investors. Before diving into that topic, however, let us pause to recall that a Friends episode presciently deal with this precise topic:

Back to the law. My friend Joan Heminway wrote about this back in 2007. Joan MacLeod Heminway, Personal Facts About Executive Officers: A Proposal for Tailored Disclosures to Encourage Reasonable Investor Behavior, 42 Wake Forest L. Rev. 749 (2007).

Joan argued that:

Personal facts about an executive may be important to a reasonable investor or have a significant impact on available public information because they may indicate the possibility that the corporation will be without the executive's services either temporarily or permanently. ... Investors may find an executive's unavailability especially important in making an investment decision as to a corporation's securities if the executive has a unique expertise or specialized skill critical to the corporation's successful operations.

Joan further argued that executives and companies are likely to err on the side of non-disclosure, not least because of privacy concerns.

She made two proposals: 

First, the SEC should establish baseline mandatory corporate disclosures of executives' personal facts in the 1933 Act registration statements and the 1934 Act periodic reports (Form 10-K or Form 10-Q). These mandatory disclosures would establish, at the outset of public company status or an individual's service as an executive and on a periodic basis during the executive's term of office,186 the corporate significance of the executive's service and other attributes (e.g., name-as-the-brand or other elements of iconic status)--importance to operations, financial condition or results of operations, or other aspects of firm value.

My problem with this proposal is that no CEO is going to want the company to disclose that s/he is not essential. 

Next, the SEC should provide specific guidance on event-based and transaction-triggered corporate disclosures of executives' personal facts in current reports (on Form 8-K) under the 1934 Act. These disclosures would be prompted only when a personal fact impacts a specific executive's articulated importance to the company, as identified in the corporation's baseline disclosures about the executive (as the same are updated from time to time) and could be simply implemented as an addition to the items required to be reported on Form 8-K.

My problem with this proposal is how one defines "impacts." Should Zuckerberg have to disclose his MMA involvement even before he loses time to an injury? Should a CEO have to disclose their chronically high cholesterol? That s/he bought a McLaren and take it on high speed track meets every weekend? After all, a disclosure mandate that only kicks in after the CEO dies by slamming the McLaren into a flaming crash at 200 mph is too little too late.

I would also recommend Tom C. W. Lin, Undressing the Ceo: Disclosing Private, Material Matters of Public Company Executives, 11 U. Pa. J. Bus. L. 383 (2009), to the interested reader.  Tom proposed:

a model approach that would first require principle-based disclosure by senior executives of material private information to their board of directors or appropriate committee. Second, the approach requires that such disclosure be made available to the investing public within the current federal securities framework after the board independent of the disclosing executive determines that such disclosure is material and should be disclosed. ...

Examples of the type of information that should be disclosed about senior executives are diagnoses of a fatal illness, certain threatened criminal investigations, and certain meaningful outside investments.

But there remains a serious line drawing problem.

Personally, I have long been rather dubious of requiring disclosure of matters relating to a CEO's personal life. Between privacy concerns and the difficulty of drawing lines between what should and should not be disclosed, the game is not worth the candle.