Director Oversight of Corporate ESG Issues in the USA

With the increasing politicisation of environmental, social and governance (ESG) issues in the USA, companies are facing pressure to publicly comment on ESG-related topics and impacts. Both Republican and Democratic politicians have publicly criticised corporate action in relation to a wide range of ESG issues, including fossil fuels, greenhouse gas (GHG) emissions, and workplace diversity and safety. Criticisms from both sides often focus on the board of director’s discharge of fiduciary duties owed to the company’s stockholders. Unsurprisingly, stockholders are vocalising concerns and demands about ESG-related corporate policies or actions too.

This year, the Delaware Court of Chancery issued two noteworthy decisions addressing ESG-related issues. The court’s rulings serve as helpful reminders that, when the legal issues are stripped of the “weighty public policy questions surround[ing] the margins” (Simeone v The Walt Disney Company (2023), the traditional pillars of strong corporate governance – namely, effective monitoring systems that ensure careful oversight and informed and conflict-free decision-making – can help boards fend off legal challenges to corporate decision-making involving ESG issues.

In McDonald’s, plaintiff stockholders of McDonald’s Corporation asserted claims for breach of fiduciary duty against McDonald’s, its board, and certain officers relating to an alleged “corporate culture” that “condoned sexual harassment and misconduct”. The court denied a motion to dismiss filed by one of the company’s officer defendants, who served as the Global Chief People Officer with responsibility for “ensuring” that McDonald’s “provided its employees with a safe and respectful workplace”.

The officer had argued that plaintiffs failed to state a claim against him because, among other reasons, the duty of oversight – an aspect of the duty of loyalty articulated in In re Caremark Int’l Derivative Litigation (1996) – applies only to directors and not officers. Caremark established potential liability for directors for oversight failures where they did not implement (or monitor and take action based on information obtained from) internal control systems. In McDonald’s, the court expressly recognised that officers likewise have oversight duties.

Despite the fact that a Caremark claim is “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment”, the court found plaintiffs sufficiently pled a Caremark violation against the former officer. This was because the complaint alleged that the officer knew about but consciously chose to ignore red flags “indicating that sexual harassment occurred at the Company” and personally “engage[d] in acts of sexual harassment”, thereby making it reasonable to infer that “the officer consciously ignored red flags about similar behaviour by others”.   

In a separate decision, the court dismissed plaintiffs’ Caremark claims against the McDonald’s board of directors, finding that the plaintiffs’ own allegations did not support a “pleading-stage inference that the director defendants acted in bad faith”. The court reasoned that, according to the complaint, the board “engaged with the problem of sexual harassment and misconduct at the company” by hiring outside consultants, amending relevant policies, implementing new training programmes, providing additional support to franchisees and taking other steps to “establish a renewed commitment to a safe and respectful workplace”. The court explained that fiduciaries are not required to “guarantee success” but, rather, must “make a good faith effort”.

In Simeone, the court denied a stockholder’s demand pursuant to Section 220 of the General Corporation Law of Delaware to inspect the books and records of The Walt Disney Company in order to investigate potential wrongdoing concerning Disney’s response to Florida House Bill 1557 (“HB 1557”, the so-called “Don’t Say Gay” bill), which “limits instruction on sexual orientation or gender identity in Florida classrooms”. The plaintiff claimed that Disney’s board breached its fiduciary duties in publicly opposing HB 1557 because it “either put their own beliefs ahead of their obligations to stockholders or flouted the risk of losing rights associated with the special district”.

After conducting trial on a paper record, the court held that the plaintiff failed to establish the requisite proper purpose to inspect the requested documents because there was no credible basis supporting potential mismanagement (eg, a conflict of interest, gross negligence, or bad faith). It found the plaintiff’s complaints amounted to “critiquing a business decision”.

The court stated: “The plaintiff and his counsel may disagree with Disney’s position on HB 1557[,] but their disagreement is not evidence of wrongdoing.” It further recognised that “stockholders invest with the understanding that the board is empowered to direct the corporation’s affairs”.

Here, the court found that the board’s response to HB 1557 was within the purview of its powers to direct Disney’s affairs. In so finding, the court recognised that the board “actively engaged in setting the tone for Disney’s response to HB 1557”, “did not abdicate its duties or allow management’s personal views to dictate Disney’s response to the legislation”, and “held the sort of deliberations that a board should undertake when the corporation’s voice is used on matters of social significance”. Accordingly, the court denied the plaintiff additional access to Disney’s books and records.

These decisions serve as an important reminder to officers and directors of the importance of implementing internal controls and reporting systems – and taking action in response to “red flags” generated from those systems – so as to enable companies to adequately address material issues facing the company in a timely manner. McDonald’s underscores that boards may avoid liability if they make a good faith effort to establish board-level monitoring systems and take prompt remedial action in response to relevant information, even if those actions ultimately prove insufficient to cure the problem.

Relatedly, Simeone reinforces the well-established corporate principle that boards alone are responsible for setting corporate policies and that the decision to speak on public policy issues is an ordinary business decision that rests with the board, “even if the decision turned out poorly in hindsight”. As ESG-related scrutiny from politicians, regulators, stockholders, and other stakeholders continues, boards should remain diligent in creating internal policies and systems that enable them to identify, monitor and – where necessary – address corporate risks and opportunities.