In a significant decision for boards seeking to grapple with how to respond to the impact of climate change on their company’s business, the High Court has refused permission for ClientEarth, a minority shareholder in Shell plc, to continue a derivative action on behalf of the company against its directors (the Directors) under s.261(1) of the Companies Act 2006 (CA 2006): ClientEarth v Shell plc & Ors  EWHC 1137 (Ch).
The underlying claim brought by ClientEarth alleged that the Directors had breached their statutory duties owed to Shell as a result of acts and omissions relating to: (i) Shell’s Energy Transition Strategy (ETS) published and updated between April 2021-2022; and (ii) the Directors’ response to an order made by the Hague District Court (Dutch Order) on 26 May 2021 in Milieudefensie v Royal Dutch Shell plc CLI:NL:RBDHA:2021:5339.
As a shareholder seeking to bring a derivative claim in the name of the company, ClientEarth was required to apply for permission to proceed with the action. However, the court ruled that ClientEarth failed to meet the initial threshold of establishing a prima facie case for granting permission, and so dismissed the application in accordance with s.261(2)(a) CA 2006.
The judgment provides comfort to boards that the court will be slow to allow shareholders with small or de minimis shareholdings to use the derivative claim procedure under CA 2006 as a way to challenge strategic or long-term decisions made in good faith in relation to addressing the risks posed by climate change. The top takeaways from the decision are as follows:
- The court is extremely reluctant to interfere in company management decisions. The decision suggests that it will be difficult for environmental or other campaign groups to challenge directors’ strategy and decision making via a derivative action, since the court will generally take the approach that it is for the directors themselves, and not the court, to determine how best to promote the success of the company. This underlying principle is woven into numerous aspects of the reasoning in this decision, including the stringent test for permission to bring a derivative action, which the court will only grant in “limited and restricted” circumstances. The court noted that the management of a business of the size and complexity of Shell will require the Directors to take into account a range of competing considerations, the proper balancing of which is a directors’ management decision, which the court is ill-equipped to interfere with. In the court’s clear view, the proper forum for ClientEarth to voice its concerns as to the Directors’ conduct, is by vote of the members in general meeting. However, it is important to remember that a technical breach of statutory duty by a director could satisfy the prima facie case threshold on other facts (for example, where a directive shareholder-requisitioned resolution has been passed, a breach of any part of that resolution could amount to a technical breach of directors’ duties).
- The court rejected attempts to formulate new and absolute duties in respect of climate change. The court was critical of the way in which ClientEarth put its case, by seeking to impose new and absolute duties on the Directors. These alleged new duties cut across the Directors’ general statutory duties under s.172 CA 2006, which require directors to have regard to many competing considerations in determining how best to promote the success of the company for the benefit of its members as a whole. The law does not superimpose on the general statutory duties more specific obligations as to what is and is not reasonable in every circumstance, and the question is whether the decision falls outside the range of decisions reasonably available to the Directors at the time (as per Sharp v Blank & Ors  EWHC 3096 (Ch)).
- Relevance of a shareholder’s motivation, good faith and the views of other shareholders. Although the court was considering whether a prima facie case for granting permission had been made out, it nevertheless reflected on the test to be applied at a substantive hearing of an application for permission to bring a derivative action. One of the discretionary factors that the court must take into account under s.263(3)(a) CA 2006, is whether the shareholder is acting in good faith in seeking to continue the claims. In considering this factor, the decision suggests that the court will look at the motivation behind the action and will be unlikely to grant permission if it takes the view there is an ulterior motive and/or the derivative mechanism is being used for a collateral purpose, such as to publicise and advance the shareholder’s own policy agenda, rather than to secure the directors’ compliance with their duties for the benefit of members as a whole. The test for the substantive application for permission also requires the court to consider the views of other members of the company with no personal interest in the matter (s.263(4) CA 2006, a provision which was incorporated into the legislation during the parliamentary drafting process, as a result of efforts led by Herbert Smith Freehills and other concerned parties). Interestingly, the court quoted support for the ETS in votes cast by members at Shell’s AGMs in 2021 (88.4%) and 2022 (80%) as evidence of the strength of the members’ support of the Directors’ strategic approach to climate change risk.
- The court is unlikely to grant mandatory injunctive relief in such cases (even if the claim is successful). It is trite law that the court will not grant mandatory injunctive relief if constant supervision is required to enforce the relevant order. In the court’s judgment, the mandatory orders sought by ClientEarth in this case were too imprecise and would require constant court supervision and adjudication on whether the business was being run in accordance with their terms. This is likely to be a sticking point for any campaign group seeking to compel a company to adopt a different strategy.
It is important to note that the present judgment may not bring an immediate end to these proceedings. The application was considered on the papers, and ClientEarth is entitled to ask for an oral hearing to reconsider the decision, provided that it makes a request in writing within seven days of the judgment.
We discuss the decision in more detail below.
ClientEarth is a non-profit environmental law charity and minority shareholder in Shell plc (currently holding 27 shares). It sought to bring a derivative claim on behalf of Shell against the Directors under s.260(1) CA 2006, arising out of certain alleged acts and omissions by one or more of the Directors. The alleged acts and omissions by the Directors related to:
- Shell’s climate change risk management strategy (i.e. the ETS), published and updated between April 2021-2022.
- Breaches relating to the Directors’ response to the Dutch Order.
ClientEarth sought a declaration that the Directors had breached their duties (as discussed further below) and a mandatory injunction requiring the Directors to (a) adopt and implement a strategy to manage climate risk in compliance with their statutory duties, and (b) comply immediately with the Dutch Order, with which it said that Shell had failed to comply.
Under s.261(1) CA 2006, a shareholder must obtain the court’s permission to bring a derivative claim and the present judgment considered ClientEarth’s application for permission to continue the claim.
The High Court (Trower J) refused ClientEarth permission to continue the derivative claim and dismissed the application in accordance with s.261(2)(a) CA 2006. The principal reasons for the court’s decision are discussed below.
Procedure to seek permission to bring a derivative action under CA 2006
The court explained that s.260(3) CA 2006 imposes an obligation on a shareholder to obtain the court’s permission to bring a derivative claim, because such claims are an exception to the principle of company law that the company itself, not its shareholders, must determine whether or not to pursue a cause of action that may be available to the company. ClientEarth was therefore required to show that the “limited and restricted circumstances” in which it is appropriate for the court to authorise it (as a shareholder of Shell) to continue a derivative action against the Directors on behalf of Shell for breach of duty, were present.
The court confirmed that the procedure to seek permission to continue a derivative action differs, depending on whether the claim has been brought at common law or under the statutory regime. The procedure under the CA 2006 involves a two-stage process:
- Prima facie case. The first stage requires the court to dismiss the application, if the application itself and the evidence filed in support of it do not disclose a prima facie case for giving permission (s.261(2)(a) CA 2006). The purpose of this stage of the process has been said to provide a filter for “unmeritorious” or “clearly undeserving” cases and it imposes an evidential burden on the applicant at the outset. In accordance with CPR 19.15, the court considers the matter on the papers in the first instance, and the defendant parties are not made respondents to the application at this stage. If the application is dismissed, the shareholders have a 7-day window in which to request an oral hearing to reconsider the decision (CPR 19.15(10)).
- Substantive application for permission. Provided the court concludes that a prima facie case for giving permission has been established, the court will then order the defendant parties to be made respondents to the permission application, and give directions for a substantive hearing of that application (CPR 19.15(12)).
The present judgment is concerned with the first stage of this process, namely, whether ClientEarth established a prima facie case for giving permission to continue the derivative claim.
The court confirmed that the approach to what amounts to a prima facie case under CA 2006 is similar to the common law position, which was articulated in Abouraya v Sigmund  EWHC 277 (Ch) to be “a higher test than a seriously arguable case”. Having formulated the threshold for the application, the court proceeded to consider the duties relied on by ClientEarth, as discussed further below.
It is interesting to note that, although the company will not normally be entitled to its cost of making a submission at this first stage, Shell nevertheless chose to put in a lengthy written submission to the court. It is apparent from the judgment that the court was persuaded by many of the arguments advanced in this submission.
Duties owed by the Directors
In the view of the court, the evidence established a prima facie case that each of the Directors was subject to the following duties during the period in which the acts and omissions complained of occurred:
- Duty to promote the success of the company (s.172 CA 2006): Duty to act in the way the director concerned considers in good faith would be most likely to promote the success of the company for the benefit of its members as a whole, having regard, amongst other matters, to an identified list of considerations, such as the likely consequences of any decision in the long term, and the impact of the company’s operations on the community and the environment. It is well established that this is a subjective test.
- Duty to exercise reasonable care, skill and diligence (s.174 CA 2006): Requires a director to exercise the care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions they carry out, and the general skill and experience that director actually has. This therefore includes both subjective and objective elements.
The “incidental duties”
In addition to the statutory duties under the CA 2006, ClientEarth argued that the Directors were subject to six “necessary incidents” of the statutory duties, which applied “when considering climate risk for a company such as Shell”. These were said to include specific duties to:
- Make judgements regarding climate risk that are based upon a reasonable consensus of scientific opinion;
- Accord appropriate weight to climate risk;
- 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;
- Adopt strategies which are reasonably likely to meet Shell’s targets to mitigate climate risk;
- Ensure that the strategies adopted to manage climate risk are reasonably in the control of both existing and future directors; and
- Ensure that Shell takes reasonable steps to comply with applicable legal obligations.
The court agreed with Shell that these incidental duties were misconceived, in particular because they sought to impose specific obligations on the Directors as to how the management of Shell’s business should be conducted. In the court’s view, this was contrary to 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, not the court (confirmed by Re Smith & Fawcett Limited  Ch 304 and Iesini v Westrip Holdings Limited  EWHC 2526 (Ch)).
Further, the court did not think that the “incidental duties” pleaded were reconcilable with the true nature of the duty to exercise reasonable care, skill and diligence, to which the Directors were subject under s.174 CA 2006. In the court’s view, the law does not superimpose more specific obligations as to what is and is not reasonable in every circumstance. Rather, the question is whether the decision falls outside the range of decisions reasonably available to the Directors at the time, as per Sharp v Blank & Ors  EWHC 3096 (Ch) (this question is considered further in the context of the case below).
The “further obligations”
The “further obligations” pleaded by ClientEarth were that, pursuant to the common law of England and Dutch law respectively, a director who is aware of a court order is under a duty to take reasonable steps to ensure that the order is obeyed. This was pleaded as a precursor to ClientEarth’s allegation that Shell has failed to comply with the Dutch Order.
The court agreed with Shell that there is no recognised duty owed by directors to a company in which they hold office, to ensure that they comply with the orders of a foreign court. It confirmed that the nature and extent of the Directors’ duties to Shell were governed by English law as the law of Shell’s incorporation, and that there was no separate established English law duty, separate from the general duties owed to the company under CA 2006, which required them to take steps to ensure that the order of a foreign court was obeyed.
The court’s concluding comments on duties owed by the Directors
The court commented that ClientEarth’s approach to the formulation of the “incidental duties” and “further obligations” demonstrated insufficient regard to the way in which the legislature has formulated the general duties under CA 2006.
The court was critical of the way in which ClientEarth put its case, by seeking to impose absolute duties on the Directors which cut across their general duty to have regard to the many competing considerations as to how best to promote the success of Shell for the benefit of its members as a whole. The court underlined that the impact of Shell’s operations on the community and the environment is a matter which the Directors are required to weigh in the balance in that context (s.172(1)(d)), but, their response to the business risks for Shell associated with climate change is part of the decision making process by which the Directors manage Shell’s business, and is subject to the well-established principle explained by Lord Wilberforce in Howard Smith Ltd v Ampol Ltd  UKPC 3:
“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.”
Alleged breach of duties owed by the Directors
The court said that ClientEarth would have to show a prima facie case that there was no basis on which the Directors could reasonably have come to the conclusion that the actions they had taken were in the interests of Shell (as per TMO Renewables v Yeo and others  EWHC 2033 (Ch) at 391)). The alleged breaches of the Directors’ duties relied upon by ClientEarth fell into the following three categories:
- Failure to set an appropriate emissions target.
- Strategy as regards to the management of climate risk does not establish a reasonable basis for achieving the Board’s net zero (NZ) target by 2050; and is not aligned with the global temperature objective of 1.5°C under the Paris Agreement on Climate Change 2015.
- Failure to comply with the Dutch Order.
(1) & (2) Alleged breaches relating to emissions target and strategy
ClientEarth’s central allegation under the first two categories of alleged breach was that, by adopting and pursuing an inadequate energy transition strategy, the Directors were mismanaging the material and foreseeable risk that climate change presents to Shell.
For the purpose of the application, the court concluded that ClientEarth had established a prima facie case that Shell faces material and foreseeable risks as a result of climate change which have or could have a material effect on it. Shell did not disagree with that proposition in broad terms, although it did not accept the way in which some of the risks were explained and characterised in the evidence.
However, the court was clear that this did not demonstrate a prima facie case for the grant of permission. It said the more important question was the nature of Shell’s response to those risks and the extent to which ClientEarth had demonstrated a prima facie case of actionable breach of duty by the Directors in their management of those risks.
The Directors’ management of climate risk was addressed in the witness evidence of Mr Benson, a senior lawyer at ClientEarth. The court noted that this evidence contained an analysis of the alleged inadequacies/deficiencies in the Directors’ management of climate change risk and the basis on which those inadequacies/deficiencies were alleged to give rise to breaches of duty.
In the court’s judgment, there were a number of fundamental reasons why ClientEarth’s allegations did not establish a prima facie case:
- Evidential weight. The court could place very little weight on the opinions expressed by Mr Benson. While the court accepted that the criticisms he made reflected ClientEarth’s opinions which were genuinely held, the court emphasised that this was “plainly insufficient”. Mr Benson’s evidence did not establish a case that the Directors were managing Shell’s business risks in a manner which was not open to a board of directors acting reasonably. More importantly, as a lawyer focusing on policy relating to climate change, he was not able to give expert evidence on which the court could properly rely.
- No universally accepted methodology. The court found that the evidence did not support a prima facie case that there is a universally accepted methodology as to the means by which Shell might be able to achieve its climate risk management and emission reduction targets, set out in its ETS. It was therefore very difficult to treat what was said by Mr Benson as providing a proper evidential basis for alleging that no reasonable board of directors could properly conclude that the pathway to achievement was the one they had adopted.
- Competing considerations / balancing act by the Directors. In the court’s view, a fundamental defect in ClientEarth’s case was that the evidence did not engage with how the Directors allegedly struck the wrong balance when weighing up the various factors relating to climate risk and other business risks, so that no reasonable director could properly have adopted the same approach. The evidence completely ignored the fact that the management of a business of the size and complexity of that of Shell will require the Directors 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.
(3) Alleged breach relating to the Dutch Order
The court reviewed the wording of the judgment in Milieudefensie, which gave rise to the Dutch Order. It noted the Dutch Court’s acceptance that Shell is not currently acting in an unlawful manner, and recognised that it is a matter for Shell as to how it exercises its discretion to comply with emissions reduction obligations imposed by Dutch law. In fact, the Dutch Court had refused to interfere with the means by which the Directors may choose to ensure that Shell complies with its obligations.
This cut across the suggestion that the Dutch Court regards the Directors as being under any duty to Shell to take steps towards compliance with the Dutch Order in any manner other than through compliance with their duties under s.172 CA 2006 (i.e. to do that which they consider in good faith would be most likely promote the success of Shell for the benefit of its members as a whole).
Nature of relief sought
The court confirmed that it was required to consider at this stage in the process the precise nature of the relief sought and the prospects of the court granting such relief if the proceedings continued.
As to the injunction, it noted that a court will not grant mandatory injunctive relief if constant supervision is required, such as having to adjudicate on disputes over whether or not a business is being run in accordance with its terms. In the court’s judgment, the mandatory orders sought by ClientEarth would be too imprecise to be suitable for enforcement.
As to the declaratory relief sought, it was difficult for the court to see what legitimate purpose this would fulfil. The court said that it must look at the utility of the substantive relief sought, and it was not the court’s function to express views as to the Directors’ conduct which have no substantive effect and which fulfil no legally relevant purpose. It concluded as follows:
“The proper forum for generating those types of views as to the Directors’ conduct is by vote of the members in general meeting, a remedy which ClientEarth is entitled to take steps to procure in its capacity as a shareholder.”
Refusal of permission
Accordingly, the court ruled that ClientEarth failed to make out a prima facie case for the relief sought either on the basis that the Directors were in breach of their duties in the respects alleged, or on the basis that the court should grant the relief sought. The court was therefore required to dismiss the application in accordance with s.261(2)(a) CA 2006.
Notwithstanding its conclusion on the failure to make out a prima facie case, the court reflected on the test for the substantive application (the second part of the two-stage test discussed above), concluding that the court would be bound to refuse ClientEarth permission to continue the derivative action come what may. In the court’s opinion, a person acting in accordance with the duty to promote the success of the company would not seek to continue the claim (s.263(2)(a) CA 2006).
The court also considered other elements of the applicable test, if the case had proceeded to a substantive application for permission. Of particular interest are the court’s comments on (a) whether the member is acting in good faith in seeking to continue the claim; and (b) any evidence as to the views of other shareholders of the company with no interest in the matter:
Section 263(3)(a) CA 2006 makes provision for the court to take into account whether the member concerned is acting in good faith in seeking to continue the claim.
Shell submitted that there was good reason to conclude that the application was an attempt by ClientEarth to “publicise and advance its own policy agenda, which is clearly a misuse of the derivative claim procedure and supports the conclusion that the application is not brought in good faith”.
The court accepted that “where the primary purpose of bringing the claim is an ulterior motive in the form of advancing ClientEarth’s own policy agenda with the consequence that, but for that purpose, the claim would not have been brought at all, it will not have been brought in good faith”.
Further, ClientEarth had adopted “a single-minded focus on the imposition of its views and those of its supporters as to the right strategy for dealing with climate change risk”, which pointed strongly towards a conclusion that its motivation in bringing the claim was ulterior to the purpose for which a claim could properly be continued.
Views of other shareholders
Section 263(4) requires the court to 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.
The court noted that, at Shell’s AGM held on 18 May 2021, the support for its ETS was 88.4% of the votes cast by members. This fell to 80% support at the AGM held on 24 May 2022, when a progress report on the ETS was under consideration.
The court concluded that “the level of member support for the ETS and its progress would count strongly against the grant of permission, notwithstanding the support of 30.47% and 20.29% of votes cast in favour of resolutions proposed at the 2021 and 2022 AGMs by the activist shareholder group ‘Follow This’. While the voting in favour of these resolutions demonstrated material minority support for more information to be provided by Shell to its shareholders on the ETS and underlying policies for reaching their targets, they would fall well short of demonstrating any member support for action of the type contemplated by this application”.
The court noted the support which ClientEarth has received for its claim from members holding 12.2 million shares amounting to approximately 0.17% of Shell’s shares, with letters from another 12.5 million shares who have stated that their position is aligned with the arguments made by ClientEarth. However, the letters of support were largely common template in form and were “in any event, a very small proportion of the total shareholder constituency”.
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ClientEarth has today announced that it has been granted an oral hearing to reconsider the decision, under the relevant procedural rules referred to in our blog post above. We will report further once the result of that hearing is known.