It is a difficult time to be a director on a corporate board. They must steer through a morass of unprecedented exogenous events: aftershocks of a once-a-century pandemic, exorbitant energy prices, staggering inflation environment, crippling supply chain shortages and the most dangerous geopolitical constellation since the end of the Cold War. Against that backdrop, environmental, social and governance (ESG) considerations are also front of mind for directors. ESG considerations have been central to the business community dialogue in the UK for quite some time. Recently, a debate about directors’ obligation to pursue ESG considerations under the revitalized Caremark standard has raised the stakes for directors of Delaware corporations, and gives us reason to compare the role of a Delaware board with that of a UK board with respect to ESG considerations.
The locomotive of the ESG movement has been asset managers and ESG-focused funds: as of December 2021, a record $357 billion poured into ESG-focused funds in the United States, up 51% from the end of 2020, and so-called sustainable funds in Europe, where the industry is more developed, reached $2,231 billion in assets. This swell of purpose-driven capital, hunting for purpose-driven deployment, has put pressure on corporate boards to address ESG issues. For instance, in the United States, new trends appeared across the 286 ESG-focused shareholder proposals during the first half of the 2022 proxy season, including enhanced attention to Scope 3 emission disclosures in the context of greenhouse gas emissions reduction efforts. In the UK and Europe, the 2022 AGM season saw an increase in both ESG-focused shareholder proposals and board-sponsored “Say on Climate” resolutions. Notably, five climate-related resolutions attracted more than 20% dissent in the UK (generally considered a victory for activists even if the resolution is successful, as it requires boards of certain listed companies to engage with shareholders).
In the UK and Europe, ESG-related policies and regulations have grown exponentially in number and scope over the last few years and are increasingly driving companies’ strategic decision-making. For instance, in the UK, all listed companies, certain large private companies, asset managers, life insurers and pension providers are required to make public disclosures aligned with the recommendations by the Task Force on Climate-related Financial Disclosures (TCFD). Further, the UK Listing Rules require listed companies to disclose whether they have met specific board diversity targets. In Europe, the forthcoming Directive on Corporate Sustainability Due Diligence (Diligence Directive) will require companies with turnover of over EUR 150 million and more than 500 employees (and smaller companies in certain sectors) to address and prevent human rights and environmental issues in their value chains, with public disclosure.
Focus by U.S. regulators on ESG issues has reached a new level. U.S. antitrust regulators have stated publicly that certain ESG issues, such as labor markets, are within their enforcement purview. Last year, the U.S. Securities Exchange Commission (SEC) formed the Climate and ESG Task Force within its Enforcement Division. Earlier this year, the SEC issued its much-anticipated proposed rule on climate change disclosure. At the time of writing, we await issuance of the final SEC rule.
There is an active debate in Delaware corporate law circles about directors’ liability under recent Caremark progeny for failing to pursue ESG considerations beyond what is expressly required by law. This is a weighty question, as a successful shareholder derivative claim under Caremark may mean personal liability for directors.
Under Delaware law, fiduciary duty imposes affirmative obligations on boards to promote the best interests of the corporation. Such obligations include, as set out in the Caremark case, an obligation to make a good faith effort to oversee the company’s operations and compliance with law. While decisions of Delaware director are generally afforded substantial deference under the business judgment rule, this deference does not apply for breach of duty of loyalty claims, such as under Caremark. Under this standard, boards have been scrutinized for their oversight responsibilities and liability arises where directors utterly fail to implement any reporting or information controls, or consciously fail to monitor operations. Historically, though, Caremark claims were limited to oversight of financial-related risks and rarely survived the motion to dismiss: plaintiffs were required to show the directors had acted in bad faith, but in the pre-discovery stage, they had no access to information that would support this claim.
However, in the recent Caremark claim cases, the courts granted Section 220 demands for books and records (consistent with another recent trend of loosening the Section 220 demand requirements in Delaware), allowing plaintiffs access to discovery, and demonstrated an increased willingness to apply enhanced scrutiny via a “mission critical” designation (not yet defined but currently encompassing ESG issues such as safety, regulatory compliance and cybersecurity). This opens the door to director liability with respect to a particular issue, notwithstanding technical compliance with law on that issue.
In the UK, directors’ long-standing common law duties were codified in the Companies Act 2006. The fundamental duty expressly requires directors to promote the success of the company for the benefit of its shareholders as a whole. Importantly, the Act adopts the “enlightened shareholder value” approach and specifically requires directors to exercise reasonable care, skill and diligence taking into account all relevant factors, including “the interests of the company’s employees,” “the impact of the company’s operations on the community and environment” and “the likely consequences of any decision in the long term.” As in the United States, directors have some latitude to define “success” and may consider the interests of all relevant stakeholders in making business decisions. Ultimately, however, any decision-making should be intended to provide at least some long-term benefit to shareholders. Recently, the Better Business Act campaign has sought to change the statute so that directors would be required to “advance the purpose” of the company by equally weighing its impact on wider society and the environment alongside shareholder interests. While it is yet unclear if this campaign will succeed, given ESG considerations have become central to the UK corporate ecosystem, there is little doubt that boards should carefully consider ESG factors when fulfilling their duties.
On the U.S. front, given the recent Caremark case law trends and the American predilection for using litigation as an enforcement tool of business standards, we, like many others, expect to see more Caremark claims as a means of pursuing ESG norms. More importantly, we think that this increase, coupled with the general ESG zeitgeist we find ourselves in, will cause boards to re-evaluate pressing issues (including ESG ones) that are “mission critical” to their business—with the end result being further convergence with the UK (and Europe) on the importance of ESG matters. Whereas compliance with ESG norms will likely be implemented by plaintiffs’ attorneys in the United States (unheard of in the UK), we expect to see more enforcement actions brought by UK regulators. The UK Competition and Markets Authority is already investigating certain retailers over greenwashing claims, while the Financial Conduct Authority has said that ESG matters are high on the regulatory agenda and that there is a clear rationale for regulatory oversight of ESG data and rating providers.
An even more macro trend is one that began in the United States and migrated across the Atlantic: “anti-wokeism” and those who oppose the tenets of ESG. Unsurprisingly, this has taken hold most strongly in the United States. Florida passed the Stop WOKE Act, becoming the first state to restrict diversity, equity and inclusion-focused conversation in the workplace. Texas has also joined the war against ESG and banned ten financial firms from doing business within the state, including BlackRock, a global leader in ESG initiatives. In a letter to Larry Fink, the Attorney General of the State of Texas (joined by his counterparts from several states) challenged BlackRock’s pursuit of an “ESG agenda” at the expense of the state pension funds BlackRock manages. While the UK is yet to see a similar backlash in corporate governance, it remains to be seen if the new Liz Truss government will re-assess the extent of ESG regulation as it pursues a “small-state” ideology.
More difficult to predict, however, is how these cross-Atlantic dynamics interplay within an organization. How will a UK-incorporated and -headquartered company with a NASDAQ listing approach these issues? What about a UK topco with a U.S. subsidiary, or vice versa? Those organizations must have a nuanced approach to board duties and local law compliance already, but ESG-driven policies and reporting often must be implemented at the organization-wide level to be meaningful (e.g., a supplier code of conduct or carbon tracking). As boards and compliance departments consider these issues and the moving target of requirements, it is likely an efficient and conservative approach to implement one set of policies targeted at the lowest (or highest) common denominator—creating a race to the top on ESG issues and causing these transatlantic organizations to comply with a higher bar than may otherwise be required. This threshold, however, is evolving, particularly in the wake of anti-wokeism. In both jurisdictions, board consideration of ESG issues results in increased cost, as boards hire advisors to support and defend them on these matters (on top of already peaking D&O insurance costs in the United States)—costs which are ultimately borne by stockholders—and the challenge of being a director has intensified.
Authored by Megan-Ridley Kaye, Patrick Sarch, Tina Guo, and Vinura Ladduwahetty.
