Clarifying directors’ duties in relation to climate risks

A High Court decision this week will bring relief to directors who face the challenge of balancing action on climate change risks with other business priorities.

The Court has rejected an application by an NGO, ClientEarth to bring a shareholder (derivative) action against Shell's directors, alleging that they had failed to fulfil their legal obligations to the company (ClientEarth v Shell Plc and others [2023] EWHC 1137 (Ch)).

ClientEarth had argued that Shell's directors had not fulfilled their duties owed to the company (set out in the Companies Act 2006), contending that they should:

• Base their judgments on climate risk on a reasonable consensus of scientific opinion.
• Give appropriate consideration to climate risk.
• Implement reasonable measures to mitigate risks to Shell's long-term financial profitability and resilience in the transition to a global energy system aligned with the 1.5°C global temperature objective of the Paris Agreement on Climate Change 2015.
• Adopt strategies that are reasonably likely to achieve Shell's climate risk mitigation targets.
• Ensure that both existing and future directors have control over the strategies employed to manage climate risk.
• Ensure that Shell takes reasonable steps to comply with applicable legal obligations, including the order of the Dutch Court in the Milledefensie v Shell case.

ClientEarth claimed that Shell’s directors had breached these duties by failing to:

• Establish a measurable and realistic pathway for Shell to achieve net-zero targets in line with market conditions consistent with the Paris Agreement.
• Provide a reasonable basis in their climate risk management strategy to achieve Shell's net-zero target aligned with the Paris Agreement.
• Develop a plan for timely compliance with the Dutch Court's order in the Milledefensie v Shell case.

However, the Court rejected ClientEarth's arguments based on established principles. It held that directors must act in good faith to determine the best way to promote the company's success for the benefit of its members, considering various competing factors. The Court would generally not question this unless there was evidence that the directors could not reasonably have concluded that their decision was in the best interest of the company as a whole. ClientEarth also faced evidentiary issues, including the failure to submit expert evidence according to the relevant procedural rules. The High Court's decision was based on the fact that as a shareholder, ClientEarth could only bring a derivative claim if there were actual or proposed breaches of duty by one or more directors.

Permission from the court was necessary to proceed with the claim. The legislation imposes this requirement because such a claim is an exception to the basic principle of company law, which states that it is the responsibility of the company, through its proper constitutional organs, rather than individual shareholders, to decide whether to pursue a legal action. ClientEarth had to demonstrate that the limited circumstances justifying permission for its action against Shell's directors were present. Mr. Justice Trower, in a thorough judgment, concluded that ClientEarth did not meet that threshold based on the documents submitted. In particular, the Court held that:

1. ClientEarth did not sufficiently demonstrate that the primary purpose of the claim was to benefit the company. The fact that ClientEarth is a campaigning entity raised doubts in this regard. Moreover, the majority support from Shell's shareholders for the directors' climate plans weakened this argument.
2. The mandatory orders sought were not adequately defined to be enforceable.

ClientEarth has indicated that it will exercise its right to request an oral hearing to reconsider the court's decision.

Although this particular claim was dismissed, it serves as a reminder of the growing scrutiny placed on companies' climate performance and broader ESG (Environmental, Social, and Governance) credentials.ClientEarth and other NGOs are likely to continue to pursue this and other routes, so managing the risks posed to businesses by climate and wider ESG factors is key.  As observed by Mr. Justice Trower in this case, directors retain significant discretion in determining how to address business risks that they deem to be in the company's best interests. The Court will not intervene or substitute its own judgment if the directors' decisions are reasonable, well-informed, made in good faith, and serve the overall success of the company and its shareholders.

However, this broad discretion does not absolve directors of their responsibilities. Directors must remain diligent in evaluating, managing, and reviewing climate-related risks and targets to mitigate the potential for legal disputes. It is crucial for boards to ensure transparent communication of these risks and targets, aligning with relevant disclosure obligations.

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If you would like to discuss these issues further, please contact us at climatechangelitigationgroup@freeths.co.uk, or speak to Michael Hoskins on 0345 634 2584.