Shareholder litigation and corporate ESG policy: ClientEarth v the directors of Shell plc

 
The application for permission to pursue the proposed derivative claim has been dismissed by the UK court on the basis that it did not meet a threshold standard of disclosing a prima facie case for giving permission for the litigation to continue. The plaintiff has indicated it is exercising its right to seek a reconsideration of that dismissal.

Background

ClientEarth, an environmental activist with a nominal shareholding in Shell plc, has initiated a derivative action in the United Kingdom against the directors of Shell, alleging that the directors have breached their duties by failing to pursue more aggressive climate transition plans. In the words of ClientEarth, it is “taking legal action to compel Shell’s Board to strengthen its climate transition plans, in the best interests of the company in the long-term”¹. The litigation identifies climate change as a corporate risk the board of Shell is responsible for managing, and it deploys the derivative action as the mechanism for achieving a remedy for what is alleged to be harm to the company and, indirectly, to ClientEarth and Shell’s other shareholders. The litigation goal is not the recovery of damages already caused to Shell by the board’s management of climate change risk, but rather forcing the board to adopt what ClientEarth believes are better climate transition plans. In substance if not in form, ClientEarth’s derivative action uses shareholder litigation putatively aimed at remedying harm to the corporation’s private interests to address public, ESG-focused goals.

Will ClientEarth’s claim succeed?

As shareholder litigation focused on corporate ESG policy, ClientEarth’s claim faces a number of potential obstacles:

• Absence of any actual harm to be remedied. Typically, the derivative action pursues a remedy for corporate harm that is financial in nature; here, the outcome sought is to force a change to corporate policy, albeit as a way to avoid what is said to be potential harm in the future. Avoiding potential harm to the company from looming climate change risks may not be a strong basis for shareholder litigation.
• Business judgment protection and responsibility for managing risks. Managing ESG risks is a board responsibility, one it shares with senior management. Mismanagement of any risk to the corporation—i.e., the failure to monitor and act on risks known or knowable to the board or senior management—is actionable using the derivative action mechanism where that mismanagement leads to corporate harm (e.g., Caremark claims as developed in Delaware)². However, choosing how to manage a risk in a case like the one against Shell’s directors engages business judgment protection. At a trial, the court in ClientEarth’s litigation will inevitably be invited to second-guess the way that the board has elected to manage climate change risk in favour of the point of view of ClientEarth on that issue.
• The views of and effects on shareholders as a whole. In the context of a derivative action, a court can consider the views of shareholders and the effect on shareholders as a whole. Here, the proponents of the litigation are small in number relative to support for Shell’s climate transition plans. ClientEarth and its supporters represent 0.17% of Shell’s shares while 80% of Shell’s shareholders voted in 2022 in favour of the company’s climate transition plans in an advisory vote³.

If these obstacles mean the derivative action turns out to be an ineffective mechanism to change Shell’s climate change policy, that may simply reflect the inaptness of shareholder litigation as such a change mechanism. Ultimately, shareholder litigation is focused on the affairs of the corporation, albeit in ESG matters, in a way that also engage areas of public concern, including very important issues such as climate change. Shareholder litigation is one mechanism for holding directors accountable for the way they manage the corporation’s affairs—along with shareholder voting—having regard to the performance of the corporation and its lawful profit-seeking activities. But shareholder litigation may not be an effective or apt mechanism for changing the way a corporation is managed by directors having regard to areas of public concern.

Will ESG claims effect change?

It may be tempting to look to shareholder litigation to link corporate affairs and areas of public concern, but the link is evasive, highlighting longstanding debate about the role of directors in managing corporate affairs that engage areas of public concern. In his classic article on the shareholders derivative action published almost 40 years ago, Stanley Beck starts his analysis with comments on the role of the corporation more generally in economic life and society:

The large corporation, as the dominant economic institution of our time, is particularly being redefined. No longer is it seen as a private institution operating solely for profit of and answerable only to its one true constituency, its shareholders. It is realized that it is a public institution in the sense that its major decisions have as significant impact on the economy as do those of government and that its constituency, like government’s, is the entre citizenry whether in the guise of shareholder, worker, consumer supplier or simply user of clean air and water. And so a debate has ensued … as to how the large corporation should be governed and by whom, how it is to be made answerable to broader public concerns while ensuring a reasonable return to investors …⁴

Despite those provocative opening comments, Beck does not find in the derivative action a link between areas of public concern and the management of corporate affairs. The ClientEarth derivative action may find such a link, and if it does, it will have significant implications for the role of directors, corporations and ESG risks.

The Court’s dismissal of ClientEarth’s case

ClientEarth’s application for permission to pursue the proposed derivative claim was dismissed because it failed to disclose a prima facie case. At its core, the reasons of the UK court expose a fundamental problem with the theory of the case and the roles for directors and shareholders posited by ClientEarth for corporate decision-making.

It is the responsibility of the board, not shareholders, to set corporate policy and its approach to managing climate-change related risk, a responsibility the board carries out in accordance with the directors’ duties and the obligation to consider different stakeholder interests and act in the best interests of shareholders as a whole. Litigation by a shareholder is not an apt tool for questioning that decision-making exercise. Moreover, the small size of ClientEarth’s shareholdings exposed further problems with using derivative litigation for the purposes of changing corporate policy. First, as noted above, a majority of Shell’s shareholders had approved the board’s approach to managing climate-change related risk and there is something incongruous in a small shareholder challenging that through derivative litigation. Second, the small size of ClientEarth’s shareholdings indicates, as the court noted, that the litigation was being advanced for a purpose other than remedying a wrong suffered by Shell, the intended function of derivative claims. As the court held, “the fact that ClientEarth is the holder of only 27 shares in Shell, but is proposing that it should be entitled to seek relief in behalf of Shell … gives rise to a very clear inference that its real interest is not in how best to promote the success of Shell for the benefit of its members as a whole.”