February 27, 2023
In a potentially precedent-setting case, 11 directors of global energy company Shell Plc (formerly Royal Dutch Shell Plc) are being sued in their personal capacity over the company’s energy transition strategy. The claim, which has been filed in the English High Court, alleges that the strategy is “fundamentally flawed” and puts the global energy company at risk as the world transitions toward net zero, in breach of the directors’ fiduciary duties to the company.
The claim is brought by non-profit organization ClientEarth, and is supported by a group of institutional investors collectively holding more than 12 million Shell shares (representing an ownership proportion of approximately 0.17%). It follows the May 2021 ruling of the District Court of The Hague in Milieudefensie et al. v. Shell (analyzed in our June 2021 perspective), granting a claim brought by a group of Dutch NGOs and ordering Shell to reduce its worldwide aggregate CO2 emissions by net 45% compared to 2019 levels by the end of 2030. Shell is appealing, but has said that it “aim[s] to rise to the challenge.”
The current claim before the English High Court is the first known attempt to hold a company’s directors personally liable for allegedly failing to properly manage climate risk and to prepare the company for the energy transition. As such, we expect it will be closely watched.
The claim against the Shell Board follows a string of recent environmental legal challenges against the company.
As noted above, in May 2021 the District Court of The Hague issued its ruling in Milieudefensie et al. v. Shell. The ruling applies both to:
The court took the view that the company’s 2020 energy transition strategy—which envisaged net zero for group-wide Scope 1 and 2 emissions by 2050, and a 30% reduction for Scope 3 emissions by 2035 uplifted to 65% by 2050—was misaligned with the goals of the 2015 Paris Agreement. Following the ruling, Shell announced it had set a new target, reflected in its 2022 operating plan, to reduce by 2030 its Scope 1 and 2 emissions by net 50% compared to 2016 levels.
In addition to the Milieudefensie case, a complaint against Shell was submitted earlier this month to the U.S. Securities and Exchange Commission by non-profit organization Global Witness, accusing the company of allegedly misleading investors about the amount of investment the company is directing toward renewable energy. Shell is also facing claims in the U.K. courts for alleged environmental damage in connection with the group’s operations in the Niger Delta.
The most recent case against the Shell Board takes place against the backdrop of a wider movement of shareholder activism on climate and environmental matters. Shareholders are, for example, voting in increasing numbers for climate-related proposals and for the appointment of “climate competent” nominee directors as a means of intensifying pressure on companies to take action on climate change.
Companies are also having to keep pace with rapidly evolving government policies—such as carbon pricing regimes and economic incentives for investment in renewable energies—designed to compel businesses to curb emissions and to help States achieve increasingly ambitious climate targets.
In 2021, a report by the International Energy Agency called for an immediate halt to new fossil fuel projects in order to reach net zero by 2050. A number of States—including Belize, Denmark, France, Greenland, Ireland and Spain—have already taken steps to ban future fossil fuel exploration and/or extraction.
At the same time, companies and company directors are navigating an increasingly stringent global web of climate-related disclosure regulations. In the U.K., for example, directors of publicly traded companies like Shell are required to prepare a strategic report containing information about “environmental matters (including the impact of the company’s business on the environment)” and “social, community and human rights issues.” Since April 2022, the strategic report for such companies must include a Non-Financial and Sustainability Information Statement. The Statement must contain the climate-related financial disclosures of the company, including a description of how the company identifies, assesses and manages climate-related risks and opportunities, and how such risks are identified and integrated into the company’s risk management process.
In parallel with the above developments, litigation challenging companies’ actions and inaction with respect to climate change is on the rise. The cases against Shell are not isolated instances, but rather illustrations of this global trend. According to a 2022 report, the number of climate change-related cases against companies and governments worldwide has more than doubled since 2015, bringing the total number to over 2,000. Around one-quarter of these are said to have been filed between 2020 and 2022.
We are already seeing claims against directors asserting breaches of duties for allegedly failing to comply with disclosure regulations, or making allegedly unsubstantiated or misleading statements regarding the company’s environmental or social performance. The case against the Shell Board stands out, however, for being the first known case focused on the personal responsibility of company directors to manage climate risks and opportunities on behalf of the company.
ClientEarth, which has a token shareholding in Shell, filed the claim in the High Court of England and Wales as a derivative action under Part 11 of the U.K. Companies Act 2006. A derivative action is brought by a shareholder in their own name but on behalf of the company, seeking compensation for alleged harm or loss to the company in circumstances where those who control the company are unable or unwilling to cause the company to bring the claim directly. Such actions are commonly brought against company directors alleging breach of fiduciary duty, or negligence.
ClientEarth first notified the Shell Board of the claim in a pre-action letter (which has not been made public) in March 2022.
We understand from the limited information available in ClientEarth’s press release and FAQs about the litigation that the claim makes allegations that:
These alleged failures are claimed to be breaches by the Shell directors of their duties to the company.
The claim appears to rely on the following provisions of the Companies Act 2006:
The requirement to exercise reasonable care, skill and diligence under Section 174 applies to directors when carrying out their obligation to consider the factors listed in Section 172. That is, the two duties are linked.
It is well accepted that it is not sufficient to pay “mere lip service” to the factors listed in Section 172, and that directors must “take action to comply.”
For the purpose of Section 172, the decision as to what will promote the success of the company, and indeed what constitutes “success,” is one for the director’s good faith judgment. Absent any indication to the contrary (for example, in the company’s constitution), the “success” of a company in this context typically has been taken to mean an increase in financial value for shareholders.
The High Court will now decide whether to permit the claim to continue.
Under the Companies Act 2006, a derivative claim will not be permitted to continue if the court is satisfied that:
In considering whether to give permission, the court must have “particular regard to any evidence before it as to the views of members of the company who have no personal interest, direct or indirect, in the matter.”
Notably, in Ewan McGaughey v. Universities Superannuation Scheme Limited, the High Court refused to allow a derivative claim alleging similar climate-related breaches of duty by directors of a pension scheme. In that case, the claimants argued that the directors’ conduct in causing the scheme to continue to invest in fossil fuels without an adequate plan for divestment was prejudicial to the success of the company. In his ruling of May 24, 2022, Leech J dismissed the claim on the grounds, inter alia, that the claimants had not established a prima facie case that the scheme had suffered any loss as a result of the directors’ actions.
We understand that on October 21, 2022, Lewison LJ in the English Court of Appeal granted the Ewan McGaughey claimants permission to appeal, reportedly 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.”
While not yet finally resolved, the Ewan McGaughey case highlights the procedural hurdles facing derivative claims against company directors for alleged climate-related failures.
As the Ewan McGaughey case and the claim against the Shell Board suggest, directors of U.K. companies who fail to duly consider climate risks and opportunities in discharging their duties to the company may expose not only the company but also themselves to the threat of litigation.
As noted above, Section 172 of the Companies Act 2006 stipulates that, in fulfilling their duty to promote the success of the company, directors must take into account “the impact of the company’s operations on the community and environment” and “the likely consequences of any decision in the long term.”
While we are not aware of English law precedent interpreting directors’ duties specifically to require consideration of climate-related impacts, in a 2019 speech, Lord Sales of the English Supreme Court stated the view that “the challenges raised by climate change . . . are primarily accommodated within the general framework of wide and open-textured directors’ duties, with certain statutory overlays.” According to Lord Sales, such overlays include the duty to consider a company’s environmental impact under Section 172, as well as statutory disclosure and reporting requirements.
By requiring directors to consider wider stakeholder interests in promoting the success of the company, the Companies Act 2006 adopts a so-called “enlightened shareholder value” approach. As noted above, however, the “success” of a company continues to be measured largely against the yardstick of financial performance. To establish a breach of the Act, it is necessary to demonstrate not only that insufficient consideration was given to environmental and social factors, but also that this failure has caused financial harm to the company. There is presently no specific actionable duty in the U.K. requiring company directors to consider environmental or social impacts at large.
With these considerations in mind, it remains to be seen whether using directors’ duties litigation as a vehicle for climate action will generally be successful and therefore become more widespread. There is also a question mark over just how effective such litigation can be in effecting broad-based action to reduce or ameliorate the impact of climate change, beyond any one company—if that is the driver for this type of litigation.
Most directors’ service contracts with the company contain provisions indemnifying directors against certain kinds of liability. In the U.K., as in other jurisdictions, however, companies are not permitted to indemnify directors in connection with breaches of fiduciary duty or negligence, and any provision purporting to offer such protection from liability will be void. Companies may pay a director’s legal costs of defending any civil claim, but if final judgment is rendered against the director, these sums must be repaid.
To fill these gaps, companies may purchase D&O insurance, the coverage of which typically extends to actions against directors for breaches of their fiduciary and statutory duties. Increasingly, moreover, D&O policies include bespoke cover for claims in relation to environmental harm and climate change. In each case, it is necessary to scrutinize the policy wording (including any exclusions from cover) to determine whether it protects against climate-related litigation risk. It is also important to identify any monetary limits on coverage. This is particularly relevant where, as in the case against the Shell Board, a claim targets numerous directors.
A final consideration is whether, in defending climate-related claims for breach of duty, directors can rely on the so-called “business judgment rule.” This is a (rebuttable) presumption that, in making a business decision, directors are acting on an informed basis and in the honest belief that the decision was in the best interests of the company and its shareholders.
The business judgment rule may be used as a defense in certain common law jurisdictions such as Australia and the U.S. but has not been recognized in the English courts. Nonetheless, the duty under Section 172 of the Companies Act 2006 is broad, and it is for the directors to balance the listed factors (including environmental impacts) in determining how to promote the “success” of the company—with the definition of “success” also being, as noted above, a matter for the directors’ judgment. As such, good-faith business decisions generally are not subject to judicial interference.
Importantly, the business judgment rule does not apply if directors have made an unreasonable or uninformed judgment. As climate risks increase, and the acceptance that action needs to be taken to mitigate them becomes increasingly widespread, there is a heightened expectation that directors will inform themselves on climate-related matters and integrate into their decision-making the impacts (both immediate and long-term) of climate change on the company’s business operations. This extends to both existing and still emerging risks.
To encourage directors to incorporate climate risks as a routine part of their decision-making, companies could consider introducing specific drafting into board minute precedents, where appropriate. Specimen language has been published for this purpose by the Chancery Lane Project, whose aim is to create climate-aligned contractual clauses and other precedents ready for adoption by companies and other actors.
Interestingly, the news of the claim against the Shell Board came just one week after the company announced a record $40 billion profit for 2022, a year which saw energy prices soar after Russia’s invasion of Ukraine. Whether the U.K. courts will require company directors to look beyond short-term profits and focus on the long-term viability of the company in a net-zero future—a so-called ‘triple bottom line’ of profit, planet and people—remains to be seen.
Shearman & Sterling’s Environmental, Social & Governance (ESG) team provides advice and advocacy to companies across multiple impact areas. We would be pleased to answer any questions or to provide further analysis.
This note provides a general overview of recent legal developments primarily in the United Kingdom. The position is likely to be different in other jurisdictions.