Climate Change and Caremark in the Context of Fossil-Fuel Companies

Pursuant to the Paris Agreement signed in 2015, hundreds of countries have committed to battle climate change and adopt measures aimed at mitigating the adverse effects of such a phenomenon. This treaty sets forth goals to mitigate further global warming (the “GW Goals”), including the worldwide reduction of emissions of greenhouse gases to net-zero by 2050 by undertaking a transition from fossil-fuel energies (e.g., coal, oil and natural gas) to renewable energies (e.g., solar and wind energy).

Governments have failed to enact the laws and regulations required to achieve the GW Goals. At least in the U.S., there are no laws or regulations imposing mandatory reductions of greenhouse gas emissions required to be “Paris-compliant”. Many voices are attempting to fill said regulatory gap via the fiduciary duties imposed on directors and officers of corporations. In my previous article, I discussed whether the managers of the so-called carbon-major or fossil-fuel companies (e.g., oil, gas and carbon companies) may voluntarily align their business model with the GW Goals without breaching their fiduciary duties.

In this article, I will discuss whether boards of directors of fossil-fuel companies are obligated to comply with or, at least, take into account the GW Goals. Particularly, I will focus on whether, under the so-called Caremark duties, boards are required to consider the GW Goals.

Caremark In a Nutshell

In the 1996 Caremark decision, the Delaware Court of Chancery recognized an oversight duty pursuant to which the board is required to implement a reporting system adequate to monitor the company’s “business performance”. Later, in the Stone v. Ritter decision, the Delaware Supreme Court adopted the Caremark duties, and held that a board breaches said duties if it (a) “utterly failed to implement any reporting or information system”, or (b) “consciously failed to monitor and oversee such system.”

Since Stone, the Caremark duties have been characterized as part of the duty of loyalty, meaning that any liability arising from the breach of such duties is not covered by the DGCL 102(b)(7) exculpatory provisions. Moreover, in the Citigroup decision, the Court of Chancery held that liability under Caremark (exclusively?) arises upon failing to oversee legal risks and not business risks, the latter being protected by the business judgment rule. Therefore, while boards must implement a monitoring system adequate to oversee the company’s legal and regulatory compliance, it is not necessary for such system to encompass any business risks (regardless of their materiality).

Does Caremark Apply to Climate-Change Risks?

As anticipated above, in the U.S. there are no legal or regulatory mandates to pursue the GW Goals and be Paris-compliant. This lack of regulation has led many commentators, such as Professors Stephen M. Bainbridge and Brett McDonnel, to conclude that the Caremark duties apply neither to the GW Goals nor climate change. To put it differently, boards are not required to integrate in their monitoring system risks related to climate change, since such risks are of a business (rather than a legal) nature.

While these conclusions have been widely accepted and align with existing case law, other authors, such as Professors Cynthia A. Williams and Lisa Benjamin, have suggested that the failure to adequately assess climate change risks may indirectly result in the violation of legal or regulatory mandates. For example, Williams identifies the following legal risks that climate change currently poses on fossil-fuel companies and that may trigger a Caremark claim:

• Securities Law Disclosure: Companies listed in a U.S. stock exchange have heavy disclosure requirements, including the obligation to disclose material financial and business risks. In the case of fossil-fuel companies, it is clear that climate change is having (and will have) a material impact on their business model (e.g., fossil fuels will eventually be displaced by renewable energies). Thus, listed fossil-fuel companies are currently obliged to disclose such climate-change-related business risks and the failure to do so may trigger legal and regulatory violations which, in turn, may result in a breach of the Caremark duties. Reflecting this position, in the 2018 Ramirez v. ExxonMobil case, the U.S. District Court of Northern District of Texas found that ExxonMobil could have violated its disclosure obligations by failing to disclose certain climate-change business risks and to declare once-proved oil reserves as stranded assets (i.e. oil reserves that can no longer be exploited due, among others, to the GW Goals).

• International Human Rights: Companies are legally required to respect and protect international human rights, as recognized under the U.N. Guiding Principles on Business and Human Rights. Williams suggests that any violations of human rights caused by the failure to tackle climate change, may also result in Caremark liability. In fact, in Netherlands, a court ruled that Royal Dutch Shell violated international human rights by failing to reduce their greenhouse emissions in accordance with the Paris Agreement. While no similar precedent exists in the U.S., one could arise in the near future.

Therefore, even though there is no direct legal obligation to pursue the GW Goals and comply with the Paris Agreement, the failure to do so may indirectly run afoul of currently existing laws and regulations, which could trigger a breach of the Caremark duties.

Should Caremark Apply to Climate-Change Risks?

The doctrinal discussion aside, a separate debate is whether, from a public policy perspective, it is convenient to extend the Caremark duties to climate change risks. Two prominent figures have defended opposite positions of this debate.

On one side of the debate, Professor Bainbridge has warned of the inconvenience of extending the Caremark duties to Environmental, Social and Governance matters (ESG), including climate change issues. He argues that, since it is not always the case that ESG factors are profit maximizers, requiring boards to take into account such factors, conflicts with the longstanding shareholder primacy theory followed by Delaware law. Additionally, the argument follows, while regulatory compliance can be objectively measured, ESG metrics are often subjective and difficult to be measured objectively. This subjectivity would add additional complexities to the board’s oversight. Lastly, mandating boards to monitor and consider what are aspirational norms (rather than legal requirements), is shifting to unelected corporate officers, powers and responsibilities currently allocated to the government and Congress.

On the other side of the debate, former Vice Chancellor Strine (and others) propose that boards should integrate with, and incorporate to their current monitoring systems, the monitoring and oversight of ESG factors. To support this proposal, they assert that (a) a significant part of the ESG monitoring overlaps with the current compliance monitoring under Caremark, and (b) pursuing ESG factors reduces the risk of violating current regulations which, in turn, would reduce the risk of Caremark liability.

This debate, which is far from being settled, may have a significant role in potential future Caremark claims related to climate change and the GW Goals.

Pedro Arango graduated as a Corporations LLM at NYU in May, 2022 and serves as Graduate Editor at the NYU Journal of Law & Business. Pedro is currently working at the New York law firm Cleary Gottlieb Steen & Hamilton as an International Lawyer. He is licensed to practice law in Colombia and, before attending NYU, he practiced for almost six years at two prestigious law firms in Colombia. His practice is focused on Banking & Finance, Mergers & Acquisitions and Corporate Law.