ClientEarth Derivative Action Against Shell

In ClientEarth's recent attempt to bring derivative action against Shell's Board of Directors, Mr Justice Trower said: ''[I]t 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.''

Introduction/Background

In February 2023, ClientEarth (an environmental organisation with a minority shareholding in Shell) sought permission to bring a derivative claim against the board of directors of Shell for alleged breaches of their duties under the Companies Act 2006 (the "CA 2006"). The High Court dismissed ClientEarth's application in May 2023, whereupon ClientEarth exercised its right to ask the Court to reconsider its decision at an oral hearing. In July 2023, the High Court dismissed ClientEarth’s application for a second time. In November 2023, the Court of Appeal rejected ClientEarth's application to appeal the High Court's decision.

Taken together, the decisions provide valuable guidance on what the parties must establish in this type of claim. Furthermore, given that it is one of the first UK shareholder derivative claims concerning climate change issues, the judgments shed light on the nature of directors' duties as they relate to ESG considerations. In an update to our previous blog, we consider the consolidated judgment and its potential impact on directors' duties.

Directors' Duties

ClientEarth asserted that Shell's directors had not established an energy transition plan in line with the Paris Agreement, thus raising Shell's vulnerability to climate-related risks and impeding its future financial sustainability. According to ClientEarth, this is in contravention of the Shell directors’ statutory duties to act with care, skill and diligence (s.174 CA 2006) and to promote the company’s success (s.172 CA 2006).

Furthermore, ClientEarth identified six 'necessary incidents' arising from the consideration of climate risk that, according to their submission, the directors must be subject to. These included, for example, a duty to accord appropriate weight to climate risk and a duty to adopt strategies which are reasonably likely to meet Shell's targets to mitigate climate risk. At first, ClientEarth asserted that these duties applied to the directors whenever they made business decisions. At the later oral hearing, they argued that these obligations naturally emerged once the directors recognised that their climate strategy was a commercial goal supporting Shell's success and, therefore, the court should have the authority to provide guidance on how the board should execute this climate strategy.

The High Court disagreed with ClientEarth's submission in this regard for three main reasons:

1. the incidental duties were found to be ‘inherently vague’ and therefore could not form legally enforceable personal obligations;
2. they 'cut across' the fundamental principle of company law which authorises directors to decide which factors, among competing considerations, are prioritised when fulfilling their duty to promote the company's success; and
3. the High Court considered the incidental duties to be unnecessary as they represented an unsuitable expansion of the statutory duty outlined in s.174 CA 2006.

Sections 172 and 174 CA 2006

The High Court made it clear that directors are responsible for deciding, in good faith, how to promote a company's success for the benefit of its members. A key question for the court was therefore whether a lack of good faith could be inferred from the nature of the decisions of Shell's directors. ClientEarth submitted that, in implementing a climate strategy that couldn't achieve their net-zero energy goal, the decisions of Shell's directors were irrational and could not have been made in good faith. At the oral hearing, however, the High Court outlined that the test for breach of the s.172 CA 2006 duty was subjective in nature and necessitates evidence showing a director's actions were not carried out in good faith. In certain instances, a lack of good faith may be implied from the irrationality of the behaviour in question but the director's state of mind remains the most crucial factor to consider. Provided a decision is honestly arrived at by a director, an unreasonable but mistaken belief that a particular course of action is in the company's best interests will not amount to a breach of s.172 CA 2006. The High Court therefore held that ClientEarth had mistakenly assumed that the concepts of good faith and irrationality were interchangeable, although it was evident that they were not.

When assessing a breach of duty under s. 174 CA 2006, the key consideration is whether the decision made by the directors was outside the range of decisions reasonably available to the directors at the time the decision was made. ClientEarth alleged that the directors approach fell "outside the range of reasonable responses to climate change risk." However, the High Court held that ClientEarth's position was not "reconcilable with the true nature of the duty to exercise reasonable care, skill and diligence to which the Directors are subject under s.174."

The High Court concluded that that it was required to deny the application on the basis that ClientEarth had not established that it had a prima facie case against the directors, noting that pursuant to s. 263(2)(a) CA 2006, an application for permission to pursue a derivative claim should be denied if the court is convinced that no individual, acting in accordance with their duty to promote the success of the company, would actively pursue the continuation of the claim.

Costs

Generally in litigation, an unsuccessful party is responsible for covering the legal costs of the successful party. However, this general rule is typically disapplied where, at the prima facie stage of an application for permission to commence a derivative claim, the defendant company volunteers a submission or attendance without invitation from the court. In such cases, the defendant company will not normally be allowed to recover its costs for that submission or attendance.

In this case, Shell provided written submissions and attended the July 2023 hearing without a direct court invitation. Shell argued that ClientEarth should have to bear all of Shell's expenses on the basis that ClientEarth's allegations against Shell's directors were 'unfounded' and 'very serious', leaving it with no option but to take steps to respond and oppose the application from the outset.

The High Court held in favour of Shell, requiring ClientEarth to cover Shell's legal costs, concluding that it was appropriate and proportionate for Shell to attend the oral hearing and making submissions at both parts of the prima facie stage.

Appeal

On 14 November 2023, the Court of Appeal refused ClientEarth the right to appeal the High Court's judgment, concluding that ClientEarth did not present a prima facie case and there was no compelling reason to hear the appeal.

Key Takeaways

• The court expressed disapproval of the remedies sought by ClientEarth, noting that they were attempting to influence the strategic management decisions of the Shell board.
• It is important to emphasise that the courts do not typically interfere with genuine, good-faith commercial decisions made by directors while fulfilling their duties. This reaffirms the discretion of directors in balancing various factors when making decisions.
• That said, directors should be aware of this case as derivate actions and shareholder activism may become more common in relation to companies' climate strategies.

If you require further advice on any of the issues raised in this article, please get in touch with your usual Brodies contact or one of the contacts listed below who will be happy to assist.