Directors in the firing line: derivative climate change actions

In February this year, environmental charity ClientEarth issued a claim in the English High Court against all of the individual directors of Shell plc alleging that they have failed to take steps to protect the company against climate change related risks.  The claim was asserted in a letter of claim a year before, in March 2022.

ClientEarth is alleging that Shell's directors have breached their legal duties under sections 172 and 174 of the Companies Act (duties to promote the success of the company and to exercise reasonable care, skill and diligence) by failing to:

• manage material risks to the company posed by climate change;
  
  
• adopt an energy transition strategy that aligns with the Paris Agreement; and
  
  
• be ready to deliver a 45% reduction in group-wide emissions by the end of the decade, as was ordered by a Dutch Court in May 2021.

ClientEarth alleges that Shell's directors have failed to act in a way that promotes Shell's success for the benefit of its shareholders as a whole and are putting Shell's long-term commercial viability at risk. 

It is asking the High Court to make: (i) a declaration that the directors are in breach of their duties; and (ii) an order that the Board adopts a strategy to manage climate risk in line with its duties under the Companies Act, and in compliance with the Dutch Court's judgment mentioned above. (Shell is appealing that judgment.)

A group of institutional investors collectively holding more than 12 million shares in Shell have written public letters in support of the claim.

Shell is also facing pressure from shareholders on other fronts. Earlier this month, investor activist Follow This filed shareholder resolutions against Shell, BP, Chevron and Exxon Mobil urging them to take swifter action to cut greenhouse gas emissions and to set more robust climate targets for 2030. 

The Shell claim is a derivative action, brought by ClientEarth as a small shareholder on behalf of and for the benefit of the company. Derivative claims allow a company's shareholders to seek redress against the directors for certain types of wrong committed against the company, including negligence and breach of duty. They are called "derivative" because the shareholder's right to sue is not personal to them but instead derives from a right of the company which the company, via its directors, has failed to exercise.

The court's permission is not required to file a derivative claim, but permission must be obtained following filing in order for the claim to proceed.  This involves a relatively complex multi-stage procedure, with the court first determining "on the papers" (i.e. on the permission application form and evidence submitted by the claimant) whether there is a prima facie case, followed by an oral hearing if the court rejects the application on the papers. If the court rejects the application again at this hearing, the action cannot proceed. However, if it finds that a prima facie case exists (either on the papers or at an oral hearing), there will be a full hearing of the permission application, where the court will follow a two-stage process namely:

1. It must refuse permission if it is satisfied of one or both of the following preconditions:

•  a person acting in accordance with the statutory duty to promote the success of the company would not seek to continue the claim;
  
  
•  the proposed or past act or omission in respect of which the shareholder wishes to bring the derivative action has been authorised or ratified by the company before or after it occurred.

2. If neither of those preconditions applies, the court has a discretion whether to grant permission. That discretion must be exercised having regard to all relevant matters including whether the shareholder is acting in good faith and the views of shareholders who have no personal interest in the matter.

These stringent procedural hurdles make derivative claims difficult to get off the ground. The evidential difficulties are demonstrated by the High Court's judgment refusing permission in the USS derivative claim discussed below. However, the initial (public) acts of threatening, issuing and seeking permission to continue such claims are nevertheless steps that well-funded activists and other claimants can use to interrupt or try to influence a Board's strategy and decision-making, and to gain publicity for their cause.  

The Shell claim is not the first derivative action to be brought in the climate change sphere in the UK.  In 2021, two academics issued a derivative claim against the directors of the corporate trustee of the USS, the largest private pension scheme in the UK, for, inter alia, failing to create a credible disinvestment plan for its fossil fuel investments. The claimant academics are members of the pension scheme and their self-stated purpose in bringing the claim is to "save the university pension and save the planet"[1]. Because the corporate trustee is a company limited by guarantee and therefore does not have shareholders, the claimants are one step removed from it, and brought what is known as a "multiple-derivative claim" which is governed by common law rules rather than the statutory regime under the Companies Act described above. However, similar rules with regard to permission to continue the claim apply.

The fossil fuels claim was one of four claims asserted by the claimants in the proceedings.  They alleged that the scheme continued to invest directly and indirectly in fossil fuels and that although it announced on 4 May 2021 that its ambition was to be carbon neutral by 2050, the directors had failed to form an adequate plan to deal with the financial risks involved in such investments. The claimants' primary case was that this continued investment in fossil fuels without an adequate plan for divestment constituted a breach of the directors' duty to act for proper purposes, including making investments that avoid significant risk of financial detriment to the scheme, the beneficiaries and the company, and to promote the success of the company having regard to its long-term interests.  In the alternative, the claimants alleged that the directors had failed to take into account a number of relevant considerations in failing to have a plan and that, in the light of those considerations (which included the Paris Agreement and the results of an ethical investment survey), the directors were in breach of sections 171 and 172 of the Companies Act 2006 by failing to make an immediate plan.

In May 2022, the High Court refused to grant permission for the claim to continue. It rejected the fossil fuels claim on the basis that the claimants had not been able to make out a prima facie case that the Company had suffered or would suffer an immediate financial loss as a consequence of the directors' failure to adopt an adequate plan for long-term divestment.  Even if they had been able to show an immediate financial loss, the court found that their claim would also have foundered because they did not suggest that the company's loss was reflective of financial losses that they themselves had suffered (a prerequisite for a common law derivative claim). This meant that the claimants did not have sufficient standing to continue the fossil fuels claims.

The court noted the lack of particularisation of the claimants' case on loss: they did not specify which investments the company should have sold or when, or what the consequences would have been. Nor did they plead why the company would have avoided those consequences if it had adopted an immediate plan for divestment or specify the plan which the company should have adopted.  The principal evidence supporting the claimants' case on loss was given by one of the individual claimants, Dr McGaughey, that investment in fossil fuels "has caused significant financial detriment to the interests of beneficiaries in recent years". He did not claim to have any expertise to express this view and his evidence was based on a selection of Financial Times articles.

By contrast, the company adduced detailed evidence explaining: (i) that, although the directors had responsibility for overall investment strategy, the scheme rules provided for an investment committee, with day-to-day investment management decision-making delegated to a sub-company; and (ii) how the company had considered it best to exercise its investment powers over the past 20 years, including publishing a discussion paper on climate change, taking legal advice and publishing it on the scheme website so members would understand the framework for investment decisions, conducting a survey of members, and adopting an ambition of net zero by 2050 as well as policies for working with the companies in which it invested in the meantime.  

The judge's analysis of and conclusions on the evidence in this case shows two things:

• claimants will be expected to adduce detailed evidence supporting their claims in order to establish a prima facie case and obtain permission to proceed; and
  
  
• those defending the claim will also have to adduce substantive evidence, which is likely to involve disclosure, and resulting public scrutiny, of board strategy and decision-making. This public scrutiny is likely to be viewed by some activist claimants as a victory in itself, regardless of the outcome of the permission hearing.

This was the first climate change-related claim in the UK brought under sections 170 – 177 of the Companies Act 2006 (directors' duties).  It was a bold move to try to use the procedural route of a derivative claim in the context of a pension scheme trust. The lengthy and detailed judgement demonstrates the significant procedural and evidential hurdles that claimants will have to clear to obtain permission to continue such claims, with the court applying the rules in a systematic and exacting manner, even though they are only conducting an initial assessment of the merits. However, that is unlikely to deter claimants from trying to challenge directors' conduct on environmental matters by reference to statutory duties, and we are likely to see further such attempts by claimants in the future. Although the claim against the USS was brought by two individual academics, they claimed to have wide support from scheme members and had met their legal fees with crowd funding from over 5,500 donors.

The claimants are appealing the High Court's decision, with a hearing scheduled for June 2023 in the Court of Appeal.

These two claims illustrate the ongoing innovation and evolution in private law climate change litigation, and highlight the importance of boards' assessment, review and communication of climate risks and targets. The introduction in the UK last year of mandatory climate risk disclosure for listed companies and other large businesses in line with the recommendations of the TaskForce on Climate-related Financial Disclosure (TCFD) will provide shareholders and other stakeholders with access to new information on, and therefore opportunities to scrutinise and challenge, companies' strategies and actions with regard to climate-related risks and opportunities.

Although energy companies and any other emitters of greenhouse gases are obvious targets for claims of this type of claim, the USS claim demonstrates how institutional investors and financial institutions are also at risk.