ESG, Externalities, and the Limits of the Business Judgment Rule - TEPCO Derivative Suit on Fukushima Nuclear Accident and the Expansion of Caremark –

On March 11, 2011, an enormous tsunami caused by the Eastern Japan Great Earthquake struck the Fukushima 1st Nuclear Power Plant of Tokyo Electric Power Company (TEPCO). The tsunami went over the seawalls and flooded the vital facilities of the power plant, causing the loss of electricity necessary for cooling nuclear reactors. This resulted in the meltdown of the reactors and the emission of radioactive materials on a massive scale. A group of TEPCO’s shareholders filed a derivative suit against its former directors, who were at the time of the incident the chairman of the board of directors, the president, and the directors in charge of the nuclear power branch, for damages suffered by TEPCO because of the Fukushima incident. 

On July 13, 2022, the 8th Civil Division of the Tokyo District Court held that four of the five defendants had breached their duty of care for not taking appropriate preventive measures against the occurrence of a huge tsunami (TEPCO Decision). A primary basis for the TEPCO Decision was that the directors disregarded a report by a scientific government council noting the possibility that a huge tsunami may occur at some point that would impact the power plant. As a result of the breach, the Court ordered the four directors to jointly pay TEPCO 13.321 trillion Japanese Yen (approximately $85 billion USD). 

This was a landmark decision as the quantum of damages awarded against the directors dwarfed any previous award in Japanese history. Equally as important as the quantum of damages was the court’s rationale for its decision relating to how it applied the duty of care in this case: 

“if the defendants who were directors of TEPCO had recognized or had been able to recognize the possibility of the occurrence of a severe incident at the Fukushima 1st Power Plant due to a huge tsunami that can be predicted by current scientific knowledge, but had failed to order taking measures necessary to avoid such an incident, such directors shall be deemed to have violated their duty of care against TEPCO regardless of whether such failure constitutes a violation of a particular law or regulation applicable to the corporation.” (emphasis by the author)

When viewed through a comparative lens, it appears that the TEPCO Decision dovetails with recent developments in the Delaware courts with respect to the duty of oversight. Specifically, recent Delaware decisions, such as Marchand v. Barnhill (Del. 2019) and In re Boeing Company Derivative Litigation (Del. Ch. 2021) have expanded the scope of the so-called Caremark duty of oversight in cases where there was no specific violation of laws or regulations (for the development of Delaware case law, see Shapira 2022). 

This expansion of the duty of oversight in Japan and the United States might be welcomed by some as a step toward a more sustainable society – one in which directors can more easily be held liable in cases where companies are involved in incidents that produce enormous negative externalities. However, it must be noted that the expansion of the duty of oversight may collide with the business judgment rule – a foundational corporate law principle that is seen as essential to incentivize optimal risk-taking, maximize corporate value, and promote economic growth. The combined impact of limiting the business judgment rule, with the imposition of an unimaginable quantum of personal liability which is exempt from D&O liability insurance, is likely to have a significant chilling effect on risk-taking by directors. From this perspective, the TEPCO Decision may discourage directors from engaging in an optimal level of risk-taking, which would be detrimental to corporations, their shareholders, and the economy.

To avoid such a chilling effect, my recent working paper, “ESG, Externalities, and the Limits of the Business Judgment Rule: TEPCO Derivative Suit on Fukushima Nuclear Accident and the Expansion of Caremark”, seeks to clarify when and why the business judgment rule should be limited when corporations are involved in businesses which may produce large negative externalities. The working paper analyzes the TEPCO Decision and recent discussions regarding the expansion of the Caremark duty of oversight. It analyzes multiple perspectives supporting the expansion of the duty of oversight to illuminate possible justifications for the expansion and depicts how the differences in these perspectives affect their scope of application.

Ultimately, my working paper suggests that the directors’ duty of oversight is highly contextual and is contingent on the type and the nature of the risks and externalities in question. It is well-known that “ESG” is a broad concept encompassing a variety of issues, ranging from climate change to local environmental pollution, and from human rights in supply chains to consumer protection from company’s products. As such, to avoid the deleterious consequences of an over-expansion of the duty of oversight, while still addressing the need to mitigate serious negative externalities, the concept of “ESG” must be unpacked to ensure that it is applied appropriately based on the specific characteristics of the externality in question. Such an approach does not provide an elegant, one-size-fits all, rule for applying the oversight duty. But, we do not live in a one-size fits all world. 

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By Gen Goto (Graduate Schools for Law and Politics, The University of Tokyo)

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