Corporate lobbyists cheered when the Ninth Circuit Court of Appeals granted an injunction temporarily blocking enforcement of a California law requiring most companies doing business there to disclose climate-related “financial risks.” But the real threat may lie 5,000 miles to the east, where bureaucrats in Brussels are gearing up to enforce something called the Corporate Sustainability Due Diligence Directive, or CS3D.
That law will place demands on companies that California activists could only dream of. Starting in 2027, companies doing more than 1.5 billion euros a year in business within the European Union will have to start monitoring a broad menu of concerns, from human rights to the environmental impact of their suppliers’ operations, and issue yearly public reports on their progress. And here’s the kicker: Delaware courts may provide the enforcement muscle.
A 1996 decision by the Delaware Supreme Court known as Caremark imposes liability on corporate directors if they fail to implement or monitor internal compliance systems necessary to prevent catastrophic shareholder losses. The quintessential Caremark case in 2019 allowed shareholders to sue directors over a fatal listeria outbreak in Blue Bell ice cream.
CAREMARK COMPLIANCE
Since then, Delaware courts have made it clear that ignorance is no excuse under Caremark. Managers and directors must do their own digging to make sure employees are playing by the rules.
Legal scholars and corporate law firms are warning that this means the combination of Caremark and CS3D will effectively impose broad oversight and reporting requirements on U.S. companies if they want to keep doing business
CS3D, putting the penalties well within the realm of Caremark liability under Delaware law.
One perverse outcome may be U.S. companies wind up with a heavier compliance burden than EU competitors, say legal scholars Luca Enriques, Matteo Gatti and Roy Shapira in an influential article released last August. In it, they note EU companies may make a superficial attempt to comply with CS3D, while U.S. firms face potentially crippling Caremark litigation if they don’t strictly follow the law and heed every warning from external regulators and stakeholders.
“This imbalance raises concerns that the CS3D could inadvertently place a heavier compliance burden on U.S. corporations operating in the EU,” the authors say.
THE BUSINESS BURDEN
What are those compliance burdens?
Take a seat, they are hefty. By 2029, thousands of U.S. companies will have to identify and assess potential human rights and environmental risks across not only their own operations but those of suppliers and business partners. They will have to invest in programs to mitigate those adverse effects and provide remediation where they can’t prevent them entirely. They’ll have to engage in “meaningful engagement with stakeholders,” including employees and the surrounding community, and establish systems for trade unions, human rights organizations and others to submit complaints directly to the company. And every year they must report how the whole effort is going on the company website.
Finally, companies will have to file a “climate transition plan” identifying how they will decarbonize operations by 2050 to comply with the Paris Agreement climate accord.
California legislators seem fully committed to enforcing similar rules on companies that want to do business in what is the world’s fourth-largest economy. Corporate lawyers and business associations are doing their best to try and blunt that effort with lawsuits to block the measures. Meanwhile, thousands of miles away, EU regulators and Delaware courts are quietly assembling the building blocks of a much more onerous regime.
