Identifying your greenwashing litigation risk – Activist shareholders

Potential cause 2: Derivative claims under the Companies Act 2006 ("CA 2006")

ClientEarth brought its recent and well-publicised claim against Shell pursuant to section 260(3) of the CA 2006. Our article, "ESG and directors' duties – where are we now? ClientEarth v Shell" analyses in depth the arguments and merits (or otherwise) of what has become a seminal case in the ESG space.

The law: derivative claims

Derivative claims under section 260(3) must:

1. be brought by a shareholder; and
    
2. relate to an actual or proposed act or omission by a director (including a shadow director) involving:
   
   a) negligence;
   b) default;
   c) breach of duty; and/or
   d) breach of trust.

Under section 261 CA 2006, a member of a company must apply to the court for permission to bring a derivative claim. The application will first be considered "on paper" to determine whether a prima facie case has been established. If successful, the court will then proceed to order a substantive hearing of the application.

The court must refuse permission if a person acting in accordance with the duty to promote the success of the company (section 172 CA 2006) would not continue the claim. However, if the relevant act or omission was authorised or subsequently ratified by the company, the court retains a wide discretion at the substantive hearing to allow the claim to continue. The court has the power to consider all "relevant matters", including those set out at 263(3) to (4) of CA 2006, which include acting in good faith, the views of other shareholders that have no direct or indirect personal interest in the claim, and the importance a person acting in accordance with their s172 duty would place on continuing the claim.

The ClientEarth case

ClientEarth contended that Shell's directors had failed to meet their duties under s172 and s174 CA 2006 because they had allegedly failed to consider what ClientEarth framed as "incidents" of the statutory duties "when considering climate risk for a company such as Shell". The incidents included duties to:

• "make judgements regarding climate risk that are based upon a reasonable consensus of scientific opinion";
• "adopt strategies which are reasonably likely to meet Shell's targets to mitigate climate risk"; and
• "ensure that Shell takes reasonable steps to comply with applicable legal obligations".

The court held in its judgment ([2023] EWHC 1897 (Ch)) that Shell's directors were not subject to these incidental duties on the basis that they were (i) inherently vague and incapable of constituting enforceable personal legal duties; (ii) they cut across the basic principle of company law that the directors determine company strategy; and (iii) they are incompatible with the subjective nature of a director's duty to take reasonable care and skill in managing the business. The court concluded that the law required Shell's directors to manage the competing considerations of its business, the "proper balancing" of which the court was "ill-equipped to interfere":

"The impact of Shell's operations on the community and the environment is a matter which the Directors are required to way in the balance…, but [the Directors'] responses to the business risks for Shell associated with climate change, whether they be the adoption of a strategy or its implementation, are part of the decision-making process by which the Directors manage Shell's business."

However, in a recent speech at LSE facilitated by the Grantham Institute, former Justice of the Supreme Court, Lord Carnwath, has indicated his dissent to both the conclusions of the judge at first instance, and the decision of a single Lord Justice to deny ClientEarth's application for permission to appeal. Lord Carnwath considers that the basis on which the judge concluded that he could not intervene in the "balance" of commercial considerations was flawed: the point in issue was not the existence of this balance, but rather whether Shell's directors had considered a "credible methodology" for achieving its climate targets. Further, Lord Carnwath considered that a declaratory remedy, i.e. a court declaration that the Shell Board was in breach of its legal duties under section 174 in failing to adopt credible policies to achieve its climate strategy, would have had a "very powerful effect".

What does this mean for greenwashing risk?

In order to be successful, the ClientEarth judgment indicates that claims brought by shareholders alleging breach of duty in relation to environmental concerns need to transcend the discretion of a company's directors to balance competing business concerns.  As legal and regulatory frameworks strengthen in the greenwashing space, and if further case law extends the remit of the court to examine directors' decisions in such cases, we consider that derivative claims on the basis of negligence, default, breach of duty or breach of trust may well become easier for dissatisfied and activist shareholders to prove.

At Stephenson Harwood, we have expertise in all aspects of greenwashing risk: regulatory compliance, civil fraud, commercial and corporate litigation, competition and consumer protection. We are well placed to advise in every major industry and sector, ranging from multinational corporations, financial institutions, large and medium sized companies, and professionals.

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