Derivative claims… ClientEarth v Shell Plc

You may very well have heard about ClientEarth v Shell Plc because it’s had rather a lot of attention in the news. ClientEarth is a climate action group and holds a small number of shares in Shell. It brought a derivative claim against the directors of Shell to object to the directors’ policies on climate change. A derivative claim is one where shareholders bring a claim against a company’s directors on behalf of the company itself.

The question of whether a derivative claim like this one can succeed is an important one in an age of activism. So, what is ClientEarth v Shell all about? The Companies Act 2006 includes a section which directors will be familiar with, section 172, which requires each director to promote the success of the company for the benefit of its members as a whole. Crucially, the requirement is to do so ‘in good faith’. Section 172 sets out a non-exhaustive list of factors for directors to take into account, including the impact of their decisions on the community and the environment. Section 174, meanwhile, imposes a duty of care on directors i.e., a duty to exercise reasonable care, skill and diligence in the performance of their duties.

ClientEarth wanted to bring the claim in order to demonstrate that Shell’s directors had failed in their duty to promote the success of the Company for the benefit of the shareholders as a whole, taking into account the impact of their decisions on the community and the environment when setting their climate change risk management strategy (‘ETS’) as described in corporate documentation and in their duty to exercise reasonable care, skill and diligence in respect of the ETS. It also alleged breaches relating to the directors’ response to an order made by the Hague District Court on 26 May 2021 in Milieudefensie v Royal Dutch Shell plc but I wont get into that second point here.

There are strict procedural rules around bringing a derivative claim. You need the Court’s permission to proceed and ClientEarth fell at this first hurdle. Their claim was initially rejected in May but ClientEarth requested an oral hearing. That hearing was held on 12 July (with judgment on 24 July) and, once again, the Judge refused permission. ClientEarth requested permission to appeal but on 31 August 2023 Mr Justice Trower decided that the appeal had no prospect of success and ordered ClientEarth to pay Shell’s costs (which reportedly run to seven figures).

For a derivative claim to succeed, there must be ‘an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by one or more of the Directors’ (CA 2006 s.260(3)). It’s for the claimant at the initial, permission stage to show that their claim has sufficient merit (that it has a ‘prima facie’ case, a case on the face of it) to justify giving permission to proceed. Basically, if it went to trial and Shell and its directors gave no evidence in defence, would ClientEarth’s claim succeed?

ClientEarth argued that the duties owed by the directors of Shell included specific factors the directors should weigh ‘when considering climate risk for a company such as Shell’, namely:

• a duty to make judgements regarding climate risk that are based upon a reasonable consensus of scientific opinion;
• a duty to accord appropriate weight to climate risk;
• a duty to implement reasonable measures to mitigate the risks to the long-term financial profitability and resilience of Shell in the transition to a global energy system and economy aligned with the global temperature objective of 1.5°c under the Paris Agreement on Climate Change 2015;
• a duty to adopt strategies which are reasonably likely to meet Shell’s targets to mitigate climate risk;
• a duty to ensure that the strategies adopted to manage climate risk are reasonably in the control of both existing and future directors; and
  a duty to ensure that Shell takes reasonable steps to comply with applicable legal obligations.

ClientEarth changed their approach to these issues between the initial, written, stage and the oral hearing. Initially, ClientEarth argued that the above obligations are ones to which all companies like Shell are subject. It then shifted its argument and said that, as Shell had accepted ‘that climate risk is a serious risk to Shell’s business,’ the new, detailed duties above flowed from that acceptance. So, by doing anything at all, Shell’s directors were taking on a higher burden of responsibility than if they had simply refused to acknowledge climate risk at all, or so the argument seemed to go.

So, what of Trower J’s conclusions? He refused permission on a number of grounds:

• the ‘duties’ were inherently vague and incapable of constituting enforceable personal legal duties;
• the ‘duties’ cut across the basic principle of company law that it is for the directors themselves to determine the weight to be attached to the non-exhaustive list of factors referred to in s.172;
• the ‘duties’ were incompatible with the subjective nature of the duty under s.172, which: ‘requires proof of conduct other than in good faith… there will be cases in which an absence of good faith can be inferred from the irrational nature of the conduct in issue, but it remains the case that the state of mind of the director concerned is what matters. For these purposes, good faith, not irrationality, is the cornerstone and an honest but unreasonable and mistaken belief that a particular course of action is in the company’s best interests is not sufficient to amount to a breach of s.172.’ He cited a previous judgment by Lewison J that said ‘the weighing of all these considerations is essentially a commercial decision, which the court is ill-equipped to take, except in a clear case’;
• the ‘duties’ amounted to an unnecessary and inappropriate elaboration of the statutory duty of care referred to in s.174;
• the Court wouldn’t grant an injunction where ‘constant supervision is required, which will be particularly acute as a factor if the relief sought is insufficiently precise. This would be the case if the order sought necessarily contemplated that the court may be required to adjudicate on disputes over whether or not a business is being run in accordance with [the injunction’s] terms’.

Indeed, Trower J noted that ‘it is difficult to see how the court could be satisfied that the disruptive impact which disputes over compliance [with the injunction] would have on the conduct of Shell’s business would not of itself have the serious adverse impact on the success of Shell for the benefit of its members as a whole, which ClientEarth contends that these proceedings are designed to avoid’;

• there was no evidence that the derivative claim had support among other shareholders as a whole, except for a relatively small number of other shareholders who wrote in support (the Judge complained about the template letters used to do so). Indeed, the votes at successive general meetings were overwhelmingly supportive of the ETS; and
• the derivative claim was motivated not by promoting the success of the Company for the benefit of the shareholders as a whole but by imposing ClientEarth’s preferred managerial strategy on the directors.

Interestingly, the Judge also scolded ClientEarth over its failure to introduce expert evidence at this early stage, in support of its allegations against the Shell directors. His tone is as noteworthy as the content. He said:

‘ClientEarth submits that it is unreasonable to require or expect it to adduce expert evidence at the prima facie stage. I disagree. The case it has chosen to advance relies on a breach of s.174 and attacks eleven individuals on the basis that they acted irrationally or so unreasonably that the decision making of all of them falls outside the range of decisions reasonably available to the Directors at the time. If it is not possible for ClientEarth to establish a prima facie case to the effect that the Directors’ approach to climate risk falls outside the range of reasonable responses open to the board of a company such as Shell without properly admissible expert evidence, that is simply a reflection of the very serious nature of the case it wishes to advance and the attendant difficulties which its pursuit entails. It is no reason to conclude that the normal rules on the admissibility of opinion evidence should not apply.’

The judiciary is always wary of ‘opening the floodgates’ and I’m not at all surprised that the High Court was unwilling to do so. I agree that an injunction is a blunt instrument, not a scalpel and that this kind of claim could give the judiciary an unpalatable (and unlooked for) level of control over companies.

There’s a great deal of polarisation on companies’ ESG policies, with people on both the left and the right criticising directors’ decisions. Whether you have sympathies with ClientEarth’s purpose or not, is it right to clog up corporate decision-making (and the High Court) with a parade of lawsuits by bringing derivative claims? Crowdfunded legal fees could see that this happens (ClientEarth’s solicitors acted pro bono), although the recent costs decision and the scale of Shell’s costs are as much of an inhibition against bringing a derivative claim as the original decision itself. The risk of a seven figure costs bill is an enormous one to take. In my opinion, though, directors do need to be able to take good faith business decisions without the threat of legal action.

Business continuity is important and, although it can result in decisions that we sometimes disagree with, it’s important that the ability of directors to run companies as they see fit should be maintained without micromanagement from the Courts. In most cases (although not always where there is a monopoly), the public have the option of choosing to take their business elsewhere and they frequently do these days. It’s then for the directors to decide whether to stand their ground or change course.

And has ClientEarth actually achieved anything? Publicity, perhaps? It claims that

‘Institutional investors with over 12 million shares in the company came out in support of the claim, including Nest, the UK’s largest workplace pension fund,’

and the Church of England pension fund announced recently it would be selling its Shell (and BP) shares but, really, the majority of people probably just shrugged at the allegations made against Shell’s directors, thinking ‘of course they weren’t doing enough. It’s a global oil giant, after all’.

Meanwhile, ClientEarth also says that:

‘The Board [of Shell] has since doubled down on fossil fuels, dropping its plan to reduce oil production by between one and two percent each year until 2030.’

It will be interesting to see what the shareholders who were so supportive of the ETS make of that.