Caremark’s Politics

How and why do corporate rules evolve? Delaware is the unquestioned jurisdiction of choice for most publicly traded US corporations. And since the decision of where to incorporate belongs to corporate insiders, one might attribute Delaware’s market dominance to a corporate law that caters to their needs. According to this view, Delaware corporate law habitually relaxes the restraints that hamper insider expropriation of gains that would otherwise be distributed to outside investors. Conversely, because insiders anticipate the need to tap the capital markets for future funding, Delaware’s supremacy might be due to the lower cost of capital enjoyed by Delaware-incorporated companies. Subscribers of this view highlight Delaware’s robust legal constraints that deter self-dealing and other harmful actions by powerful insiders.

These two views, commonly known as the “race to the bottom” and the “race to the top,” share a point of commonality regarding Delaware’s apprehension of being displaced by a competing state as the trigger for corporate law evolution. In practice, no other state comes close to Delaware’s market share of publicly traded corporations. If not the fear of competition from other jurisdictions, what external forces influence the trajectory of Delaware corporate law? Professor Mark Roe provided a compelling answer to this question: State corporate law is not the only game in town. If displeased with the level of investor protection provided at the state level, Congress will enact corrective federal legislation. Congressional intervention, however, only occurs for issues that reach national prominence. Delaware’s concern for the value of its corporate brand incentivizes it to nip public debate about those issues in the bud. In practical terms, the Delaware courts – as arbiters of Delaware law – will appear to be sufficiently vigilant in protecting outside investors lest Congress assume that task.

The ebb and flow of Delaware’s Caremark doctrine fits Roe’s depiction to a T. The seminal Chancery Court decision established a proactive monitoring obligation for the board of directors. As initially perceived, however, this requirement was largely ceremonial. Caremark situated a director’s obligation to monitor as part of the exculpable duty of care. Such classification means that even credible allegations of suspect monitoring cannot overcome the impregnable liability shield that exculpation provides. A few years after Caremark was handed down, a succession of economic scandals shocked the US economy, and public fervor spurred Congress into action. The specter of Congressional intervention catalyzed Delaware law. The stated desire to promote more vigorous board oversight led to a recasting of the Caremark duty to monitor as a subset of the non-exculpable duty of loyalty. The newly invigorated Caremark era did not last long. Before long, Wall Street scandals no longer commanded the general public’s attention, and judicial clarifications of the doctrine made it nearly impossible for a plaintiff to succeed in a Caremark claim.

Until now. Caremark has recently experienced another doctrinal evolution, significantly increasing the monitoring obligation that the duty entails. In Marchand v. Barnhill, the Delaware Supreme Court proclaimed that directors must exercise a higher degree of attentiveness when overseeing “mission critical” aspects of the business. Failure to do so implies a culpable mental state, which remains a prerequisite to liability. Marchand’s impact on Delaware corporate law was immediate and significant. While it is tempting to explain this doctrinal development under Roe’s framework, the lack of impending federal legislation calls its validity into question. Surely, there is room for a complimentary theory to make sense of this development.

My Article, Caremark’s Politics (forthcoming, Cardozo Law Review) argues that Marchand reflects Delaware’s response to a new challenge to its legitimacy as the leading authority in U.S. corporate law – one that arises not from external political pressure but from a shifting shareholder base. Central to this contention is the relationship between board oversight and the foundational social contract. Due to their vast influence on society, corporations are expected to adhere to social norms and obey the law. Indeed, Delaware courts have traditionally interpreted Caremark as an obligation to oversee legal compliance, and nothing else.

That bare minimum is no longer enough. As Baby Boomers gradually pass away, a significant intergenerational wealth transfer is taking place. Generation X and Millennials stand to inherit their vast share holdings and corporate influence. Unlike Baby Boomers, who approached their equity investment purely in terms of dollars and cents, the younger generations place significant weight on a corporation’s broader societal and environmental impact. A surprising number are even willing to sacrifice returns if a corresponding benefit accrues to a cause they believe in. In short, the emerging shareholder base envisions a social contract that demands not only compliance with the law but also proactive engagement in fostering a more equitable society.

Marchand responds to that demand. The Delaware Supreme Court’s hesitation to delineate the boundaries of mission criticality has propelled Caremark to the center of corporate law’s most contentious policy debates. And extra-judicial proclamations by members of the Delaware judiciary hint at an even larger role for director oversight, far removed from the traditional mandate of overseeing legal compliance. This Article contends that these rulings and proclamations are directed not at Congress, but at the incoming shareholder class. Marchand signals Delaware’s recognition of the values espoused by this new generation of investors, thereby preempting potential challenges to its legitimacy as the most powerful jurisdiction in US corporate law.

The Article is available for download here.