ENGLISH HIGH COURT REJECTS CLIMATE CASE AGAINST ENERGY COMPANY BOARD

In our insight “Personal Liability of Directors for Climate Strategy: Landmark Case against Energy Company Board,” we analyzed the claim filed in the English High Court by non-profit organization ClientEarth against the directors of Shell. The claim was one of the first known attempts to bring a derivative action—an action brought by a shareholder of a company in the shareholder’s own name, but on behalf of the company—seeking to hold directors personally liable for alleged harm to the company arising from purported mismanagement of climate risk.

On May 12, 2023, the application by ClientEarth for permission to bring the claim on behalf of Shell was dismissed.^[1] ClientEarth is challenging that decision.

Key Takeaways

• The claim alleged breaches of the U.K. Companies Act 2006, including of the directors’ duty to promote the success of the company, as well as the related duty to exercise reasonable care, skill and diligence.

• The High Court held that ClientEarth had failed to establish a prima facie case, which was fatal to the application.

• The reasoning of the High Court reinforces the English courts’ longstanding reticence to interfere in company management, including on climate change matters. The Court emphasized the array of risks a large and complex global business such as Shell faces, requiring the directors to balance a range of competing considerations in their decision making, in respect of which the courts were ill-equipped to intervene.

• The High Court rejected attempts to formulate specific directors’ duties in respect of climate change. In this regard, the Court confirmed that approaches to managing climate risk fell to be assessed within the existing statutory framework, which affords company managers considerable latitude in the performance of their duties.

• The High Court moreover stressed the relevance of a shareholder’s motivation in bringing a derivative claim, finding that ClientEarth’s de minimis shareholding gave rise to a clear inference that the claim had been brought for a purpose other than promoting the success of the company for the benefit of its members as a whole.

Background

The Parties

To recall, the applicant before the High Court was ClientEarth, which has a token shareholding (27 shares) in Shell. ClientEarth was supported in bringing the claim by company members collectively holding 12.2 million shares (an ownership interest of approximately 0.17%).

The claim was brought against Shell Plc, along with the eleven members of Shell’s board in their personal capacity.

The Claim

Further details of the claim have emerged with the publication of the High Court’s judgment.

The claim was brought under Part 11 of the U.K. Companies Act 2006 (the “Act”), which permits derivative claims seeking relief on behalf of a company in relation to a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company (Section 260(3)).

Breaches were alleged of the following provisions of the Act:

• Section 172, requiring directors to act in the way they consider, in good faith, is “most likely to promote the success of the company for the benefit of its members as a whole.” In discharging this duty, directors must consider a non-exhaustive list of factors, including “the impact of the company’s operations on the community and environment” (Section 172(1)(d)).

• Section 174, obliging directors to exercise reasonable care, skill and diligence in the discharge of their duties.

It was asserted that the Board had breached these duties in three respects:

• First, by allegedly failing to adopt a measurable and realistic pathway to meeting the absolute net zero (NZ) emissions reduction target by 2050 set out in Shell’s energy transition strategy. In particular, it was alleged that Shell had failed to implement any interim reduction targets for its Scope 3 (end-user) emissions, and that its Scope 1 (direct emissions) and Scope 2 (indirect emissions from energy generated in carrying out Shell’s operations) reduction targets relied on carbon intensity targets which did not result in demonstrable absolute emission reductions.

• Second, by allegedly failing to properly manage climate risk—including commercial, regulatory and stranded-asset risk. In particular, it was alleged that Shell intended “only a modest decline in its oil production and an active growth in its gas business,”^[2] and that the company’s energy transition strategy placed too much reliance on carbon capture and storage, along with the use of carbon credits.

• Third, by allegedly failing to comply with the May 2021 ruling of a Dutch court ordering Shell to reduce its worldwide aggregate CO2 emissions by net 45% compared to 2019 levels by the end of 2030. For an analysis of this ruling (which Shell is appealing), see our insight “Milieudefensie v. Shell – A Landmark Court Decision for Energy and Energy-Intensive Companies.”

Relief Sought

ClientEarth sought a mandatory injunction requiring Shell to:

• adopt and implement a strategy to manage climate risk in keeping with the company’s statutory duties; and

• comply immediately with the Dutch court’s ruling.

Additionally, ClientEarth sought a declaration that the directors had breached their statutory duties in the manner described.

The Test for Granting Permission to Continue a Derivative Claim

Under Part 11 of the Act, a member of a company bringing a derivative claim must apply to the court for permission to continue it (Section 261(1)). If it appears to the court that the application and supporting evidence do not disclose a prima facie case for permission, the court must dismiss the application (Section 261(2)).

Permission must, moreover, be refused if the court is satisfied that:

• a person acting in accordance with the duty to promote the success of the company would not seek to continue the claim (Section 263(2)(a)); or

• the relevant act or omission has been authorized or ratified by the company (Section 263(2)(b)–(c)).

The Act further lists several discretionary factors that the court must consider in deciding whether to grant the application, including:

• whether the applicant is acting in good faith in seeking to continue the claim (Section 263(3)(a));

• the importance that a person acting in accordance with the duty to promote the success of the company would attach to continuing the claim (Section 263(3)(b)); and

• the existence or likelihood of authorization or ratification by the company of the relevant act or omission (Section 263(3)(c)–(d)).

The court must additionally have regard to any evidence before it as to the views of members of the company who have no personal interest in the matter (Section 263(4)).

In accordance with Part 19 of the Civil Procedure Rules, the company is not made a respondent to the permission application (CPR 19.15(3)). However, the company may volunteer a written submission (Practice Direction 19A, para. 2). In the present case, Shell presented a “lengthy”^[3] written submission to which the Court had regard in reaching its decision.

The Decision of the High Court

In his May 12, 2023, judgment, Trower J explained that the reason for requiring permission to continue a derivative claim is that such a claim is an exception to the fundamental principle that it is a matter for the company, acting through its constitutional organs, to determine whether or not to pursue a cause of action available to the company. As such, permission will be granted only in “limited and restricted circumstances.”^[4]

No Prima Facie Case

The Court concluded that notwithstanding the “voluminous”^[5] evidence submitted in support of ClientEarth’s application, ClientEarth had failed to present a prima facie case. Pursuant to Section 261(2) of the Act, this was fatal to the application for permission to continue the claim.

Specifically, the Court held that:

• In respect of the first alleged breach (failure to align Shell’s business with an absolute NZ target by 2050), while ClientEarth’s views were “genuinely held,”^[6] they did not constitute reliable expert evidence. Further, in the absence of any universally accepted methodology for Shell to achieve its NZ target, it was not possible to conclude that the approach adopted by the board was unreasonable.

• With respect to the second alleged breach (failure to properly manage climate risk), a “fundamental defect”^[7] of ClientEarth’s case was that it ignored the multitude of risks a business of Shell’s size and complexity faced, requiring the board “to take into account a range of competing considerations, the proper balancing of which is [a] classic management decision with which the court is ill-equipped to interfere.”^[8]

• Concerning the third alleged breach (failure to comply with the Dutch ruling), there was no recognized duty under English law, separate and distinct from the general duties imposed under the Act, to ensure compliance with the orders of a foreign court. Moreover, the Dutch court had given Shell total freedom to achieve its reduction obligation as the company saw fit. Further, as regards Scope 3 emissions, the Dutch court had imposed an obligation of “best-efforts” only, and it had not been shown that the board had no intention of procuring Shell to comply with this obligation.

Next, the Court reasoned that in deciding whether ClientEarth had established a prima facie case, it was necessary to consider not only the breaches alleged, but also the relief requested. In this regard, the Court found that:

• The orders sought by way of mandatory injunctive relief were insufficiently precise and fell foul of the principle that a court will not grant such relief if constant judicial supervision will be required. Disputes about compliance with the relevant orders would, moreover, have a disruptive impact on Shell’s business, contrary to the ultimate objective of promoting the success of the company.

• The declaratory relief sought lacked utility, and it was not the Court’s function to express views on the directors’ conduct “which have no substantive effect and which fulfil no legally relevant purpose.”^[9] The proper forum for expressing such views was the general shareholders meeting.

The Court therefore concluded that ClientEarth had not made out a prima facie case either on the basis that the directors were in breach of their duties, or on the basis that the Court should grant the requested relief. It followed that the Court was obliged to dismiss the application pursuant to Section 261(2) of the Act.

Other Considerations

The Court was moreover satisfied that, in circumstances where there was no prima facie case on the merits, a person acting in accordance with the duty to promote the success of the company would not seek to continue the claim. This further mandated the rejection of the application under Section 263(2)(a) of the Act.

While not technically necessary, the Court decided that it was nonetheless appropriate to have regard to the other discretionary factors referred to in the Act. These reinforced the Court’s decision to reject the application, as follows:

• As to the first factor, namely, whether ClientEarth was acting in good faith in seeking to continue the claim (Section 263(3)(a)), it was not sufficient that ClientEarth honestly believed the claim to be in Shell’s long-term best interests. Rather, it was necessary to assess ClientEarth’s primary motivation in bringing the claim. In this regard, ClientEarth’s de minimis shareholding coupled with its asserted entitlement to seek relief on behalf of the company “in a claim which on any view is of very considerable size, complexity and importance (and will be exceptionally expensive and time-consuming to pursue)” gave rise to a “very clear inference” that ClientEarth’s ultimate objective was not to promote the success of the company.^[10] Instead, it was clear to the Court that the dominant purpose of the claim was “the imposition of [ClientEarth’s] views and those of its supporters as to the right strategy for dealing with climate change risk.”^[11] In those circumstances, it could not be said that the claim had been brought in good faith. According to the Court, this conclusion further counted against a finding that ClientEarth had established a prima facie case.

• As to the second factor, namely, the importance that a person acting in accordance with the duty to promote the success of the company would attach to continuing the claim (Section 263(3)(b)), it followed from the Court’s conclusion under Section 263(2)(a) that a person acting consistently with this duty “would attach little if any importance to continuing the claim.”^[12]

• As to the third factor, namely, the existence or likelihood of authorization or ratification by the company (Section 263(3)(c)–(d)), there was no basis for any such finding in this case. There was, however, evidence as to the views of other members of the company, to which the Court was required to have regard under Section 263(4). In particular, the majority of shareholders had voted in favor of Shell’s energy transition strategy at the 2021 and 2022 AGMs (notwithstanding material minority support for climate resolutions proposed at those meetings by another activist shareholder group). As for the other members who had expressed their support for ClientEarth,^[13] they represented “a very small proportion of the total shareholder constituency, and it is that constituency as a whole whose views should carry very considerable weight when determining how Shell can best manage the climate change risk with [which] these proceedings are concerned.”^[14]

No ‘Incidental’ Climate-Related Duties

In pleading its claim, ClientEarth argued that the directors’ statutory general duties incorporated several “incidental”^[15] climate-related duties, including:

• to accord appropriate weight to climate risk and to make judgments regarding climate risk based on a reasonable consensus of scientific opinion;

• to implement reasonable measures to mitigate climate risk so as to ensure the long-term financial profitability and resilience of the company in a NZ future; and

• to adopt strategies which were reasonably likely to meet Shell’s climate-related targets.

The Court rejected these arguments, which revealed “an underlying misapprehension of what Shell would have to prove (and what ClientEarth therefore seeks to prove on its behalf) if the claim were to proceed.”^[16]

In particular, the Court found that the proposed duties sought to impose specific obligations on the directors concerning the management of the company, “notwithstanding the well-established principle that it is for directors themselves to determine (acting in good faith) how best to promote the success of a company for the benefit of its members as a whole.”^[17] This principle was long established under the common law and in the Court’s view remained unchanged by codification of the duty in Section 172 of the Act.

Further, the Court refused to superimpose on the general duty to exercise reasonable care, skill and diligence under Section 174 of the Act any “more specific obligations as to what is and is not reasonable in every circumstance.”^[18] Rather, the question was whether the directors’ approach fell outside the range of approaches reasonably available to them at the time.^[19]

Thus, the Court concluded that while the impact of Shell’s operations on the community and the environment was a matter to which the directors were required to have regard under Section 172(1)(d) of the Act, the directors’ response to climate risk was “part of the decision-making process by which [they] manage Shell’s business.”^[20] As such, it was subject to the well-established principle that:

“There is no appeal on merits from management decisions to courts of law: nor will courts of law assume to act as a kind of supervisory board over decisions within the powers of management honestly arrived at.”^[21]

Next Steps

ClientEarth has exercised its right in accordance with CPR 19.15(10) to ask for an oral hearing to reconsider the decision to dismiss the permission application.^[22] Directions for that hearing (which remains a hearing before the High Court and is not an appeal) will be given in due course.

Meanwhile, a hearing is fixed for June 13, 2023, on an appeal from another High Court decision refusing to allow a claim alleging climate-related breaches of directors’ duties.^[23] In that case (Ewan McGaughey v. Universities Superannuation Scheme Limited), the claimants argued that the directors’ conduct in investing in fossil fuels without an adequate plan for divestment was prejudicial to the company’s success. In May 2022, the High Court dismissed the claim on the grounds, inter alia, that the claimants had not established a prima facie case on the merits.^[24] In October 2022, Lewison LJ in the Court of Appeal granted the claimants permission to appeal, noting that “the grounds of appeal raise important issues (some of which are novel) and have sufficient merit to warrant consideration by the full court.”^[25]

As the company in Ewan McGaughey v. Universities Superannuation Scheme Limited (a corporate trustee of a pension scheme) is a company limited by guarantee with no shareholders, the claim in that case is not a derivative action for the purposes of the Act. Rather, it is governed by common law rules—which are, however, largely analogous to the statutory rules, including as to the need to obtain permission to continue the claim.^[26] Accordingly, the judgment can be expected to shed some light on whether the Court of Appeal shares the same misgivings as Trower J with regard to holding directors personally to account for alleged climate-related breaches of duty.

Comment

Although the final outcome of the process is not yet known, the May 2023 decision of the High Court in ClientEarth v. Shell is likely to disappoint shareholder activists while being welcomed by company boards everywhere.

The decision shows that the English courts, at least, will be very reluctant to allow activist shareholders—particularly those with de minimis shareholdings—to use the derivative claim procedure to challenge management decisions on climate risk that are made in good faith. The fundamental principle underlying the High Court’s reasoning is that the courts will not interfere with good-faith business decisions (especially those involving complex matters of commercial judgment), and that the appropriate forum for shareholders to challenge directors’ strategy and decision making on climate matters is in general meeting. This principle is one of general application, and will make it difficult to bring claims similar to the one attempted by ClientEarth.

The decision moreover confirms that the directors’ general duties under the Act do not also include standalone duties relating specifically to climate risk. Rather, company board approaches to managing such risk fall to be examined within the general framework of directors’ duties, including the duty to consider a company’s environmental impact under Section 172(1)(d) of the Act.

Further, the decision makes clear that, to establish a breach of directors’ statutory duties in this context, it must be shown that the directors’ approach to managing climate risk has caused harm to the company, contrary either to:

• the duty to promote the company’s success under Section 172 of the Act—subject, however, to the well-established principle that it is for the directors themselves to determine, acting in good faith, how best to accomplish that objective (and, indeed, to decide what is meant by “success,” which typically is measured largely against the yardstick of financial performance); or

• the duty to exercise reasonable care, skill and diligence under Section 174 of the Act—requiring a demonstration that the directors’ approach fell outside the range of reasonable responses to climate risk.

Additionally, the decision indicates that even if a derivative claim is permitted to proceed, the English courts will refuse to order mandatory injunctive relief where constant judicial supervision will be required to enforce compliance with the relevant orders. Given the different pathways to NZ, it may well prove difficult to formulate orders with sufficient precision to overcome this hurdle.

Less than two weeks after the High Court’s decision was handed down, Shell held its 2023 AGM, at which a majority of the company’s members again rejected a climate resolution organized by a shareholder activist group.^[27] Regardless of the ultimate fate of ClientEarth’s application before the High Court, it is clear that shareholder activists will continue to use all means at their disposal to agitate on climate matters. Whether the derivative claim procedure is a viable tool for activists to challenge companies’ action on climate change, however, is now seriously open to question.

Further Information

Shearman & Sterling’s Environmental, Social & Governance (ESG) team provides advice and advocacy to companies across multiple impact areas. The firm’s Mergers & Acquisitions practice also regularly advises companies, boards, senior management and shareholders on a broad range of governance matters, including directors’ duties, shareholder proposals, and shareholder and stakeholder engagement. We would be pleased to answer any questions or to provide further analysis.

This note provides a general overview of recent legal developments in the United Kingdom. The position is likely to be different in other jurisdictions.