Caremark as Soft Law

Compliance is a stunningly hot topic, with companies spending significant resources on it, and probably literally, dozens of conferences on the subject each week.^[1] One curious feature of the compliance landscape is the role of ‘Caremark’ and Caremark duties.’  The 1996 Caremark case in Delaware^[2] is arguably what thrust compliance into the consciousness of corporate law scholars—and arguably, corporate lawyers as well, as ‘Caremark duties,’ oversight and monitoring duties regarding a company’s operations, notably its compliance with law, joined the litany of fiduciary duties boards owed to their companies and the companies’ shareholders.  But Caremark itself was a settlement of a case that the judge, Chancellor Allen, acknowledged the plaintiffs would almost certainly have lost, characterizing the plaintiffs’ claims as ‘extremely weak.’  Indeed, Chancellor Allen characterized the theory advanced in the case as ‘possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment,’^[3] a characterization commonly cited in subsequent Caremark cases, and borne out by the bad results for plaintiffs in those cases.

Yet Caremark duties, albeit not constituting the whole compliance landscape, are still a very prominent part of it, at least rhetorically.  Caremark duties are characterized as ‘duties’, although what they actually require, in the sense of there being a legal consequence for not abiding by them, is not at all clear, or perhaps it is clear: very little.  Caremark’s prominence, my essay argues, is in its status as soft law.  That proposition in its more limited form is unremarkable, but I go further: Caremark has a considerable penumbra that extends far further than could ever be enforced through legal sanctions in any area of law, and that ultimately contributes to a convergence of profit maximization with corporate social responsibility broadly construed.

The aggregate cost/benefit assessment for directors favors doing more than Caremark duties require in any event, given that the costs of Caremark compliance are not incurred by directors themselves, and the types of issues that do or could lead to Caremark claims may affect their compensation (if they receive stock options) and yield reputational costs, as well as yield financial and reputational costs for officers, who choose many of the directors.  Moreover, as importantly, the types of issues that do or could lead to Caremark claims also carry other penalties and costs to the firm as well as, potentially, its officers and directors. A broader penumbra is thus advisable, especially given reputational costs and costs associated with regulatory disfavor.  Being detected calculating how close to the line one could get or how much one could bargain on weak enforcement is not a good look.  Indeed, there is a significant economy of scope in companies’ Caremark compliance programs, their attempts to avoid breaking the law, and their ability to demonstrate to regulators their efforts in both these regards.

Beyond that, there is also an economy of scope in selecting for empathy and moderation in risk-taking in hiring and promotion, and encouraging a corporate culture promoting those traits; admittedly, there may be some cost to profits in doing so, but there are associated benefits as well, not just in avoiding law-breaking but also for reasons of reputation and regulatory favor.   Finally, there is now enormous pressure, not just from the usual suspects but also from institutional investors, towards some form of corporate social responsibility.  Firms seem to be competing for CSR plaudits, some touting not just their good intentions and also their good results, presented in the same sorts of ways, and with the same level of rigor, as results from traditional profit-making endeavors are presented.  In sum, what companies do to ‘comply’ with their Caremark duties, and more broadly, the compliance programs they are developing and following, now as a matter of best, if not simply good, practices, recognize an expansive penumbra, well beyond illegality and near-illegality, that encompasses evolving societal notions of corporate good citizenship.

The essay, Caremark as Soft Law, is available here.

Claire A. Hill is Professor and James L. Krusemark Chair in Law at the University of Minnesota Law School