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

The recent focus on ESG has led to extensive discussions about whether directors of stock corporations are permitted to take stakeholders’ interests into consideration when making business decisions. Many different views have been presented to date, but it might not be so wrong to say that they tend to answer the above question positively in some way or another. 

The focus of recent discussions is shifting to another related question, whether such directors are obliged to take stakeholders’ interests into consideration beyond the requirements of laws and regulations and should be held liable against their corporations for failure to do so. Unlike the previous question, there are two opposing approaches to this question. On the one hand, there is a traditional approach that denies such obligation and liability of directors emphasizing that directors owe their responsibility to the company and its shareholders, and that they are granted wide discretion in deciding how to improve the firm value. 

On the other hand, there are new developments in case law in Japan and the United States that limit the discretion of directors to a certain extent. In Japan, Tokyo District Court held in a shareholders’ derivative suit concerning the meltdown of Fukushima 1st Nuclear Power Plant that former directors of Tokyo Electric Power Company were in breach of their duty of care for not taking preventive measures against the occurrence of a huge tsunami and ordered the defendants to pay 13.3 trillion Japanese Yen. Also in the United States, recent decisions by Delaware courts denied motions to dismiss by defendant directors for their breach of the so-called Caremark duty of oversight, seemingly expanding its scope to cases where there was no specific violations of laws or regulations.

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, it must be noted that the expansion of the duty of oversight may collide with the business judgment rule, which is arguably one of the fundamental principles of corporate law 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 would exceed the limit of 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, this article 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 article analyzes the Tokyo District Court decision on the TEPCO derivative suit 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.

The article also suggests that a directors’ duty of oversight is highly contextual and is contingent on the types and the nature of the risks and externalities in question. “ESG” is a broad concept encompassing 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.