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.
