Introduction

In ClientEarth v Shell Plc & Others (2023) EWHC 1137, which is a recent decision by the English High Court, the Court declined an application by ClientEarth- a non-profit environmental law organisation and minority shareholder of Shell Plc (Shell), to bring a derivative action on behalf of Shell against its directors, arising out of alleged acts and omissions of the said directors relating to the company’s climate change risk strategy.

A derivative action is a means through which a shareholder can liti- gate on behalf of a company against a third party – usually a director or other shareholder – whose action has injured or threatens to in- jure the company. It is therefore a tool of accountability to obtain re- dress against wrongdoers, in the form of a representative suit filed by a shareholder on behalf of the company. However, it should be noted that a shareholder must first obtain permission from the Court to commence a derivative action (the Permission Stage).

The Permission Stage is necessary since claims of this nature are an exception to the rule that it is a company acting through its proper constitutional organs, and not one of its shareholders, which should determine whether to pursue a cause of action that may be available to the company. The Permission Stage further provides a filter for what may be termed as “unmeritorious” or “clearly undeserving” cases.

Claims made in ClientEarth v Shell Plc

As stated above, ClientEarth sought permission to continue a derivative action against Shell on the basis that Shell’s directors had refused to act on ClientEarth’s climate change risk strategy, as well as failed to comply with an order made by the Hague District Court on 26th May 2023 in Milieudefensie v Royal Dutch Shell Plc, which imposed a forty-five per cent (45%) emissions reduction order on Shell to be achieved by 2030 (the Dutch Order).

At the Permission Stage, ClientEarth sought to establish that Shell’s directors were in breach of their statutory duties to promote the success of the company, as well as their statutory duty to exercise reasonable care, skill, and diligence in adopting and pursuing an ap- propriate energy transition strategy so as to manage the numerous risks that climate change presents for Shell. The specific breaches alleged by ClientEarth against Shell’s directors fell into three (3) categories, namely – (i) failure to set an appropriate emissions target (ClientEarth claimed that Shell’s existing Carbon Intensity Target was inadequate); (ii) failure to have a climate risk strategy which establishes a reasonable basis for reaching the net zero target and which is aligned with the Paris Agreement; and (iii) failure to comply with the Dutch Order.

ClientEarth’s central allegation was that by adopting and pursuing an inadequate energy transition strategy, Shell’s directors were mismanaging the material and foreseeable financial risk that climate change presents for Shell, which primarily operates in the fossil fuel sector. ClientEarth also alleged that Shell’s directors were not adequately preparing Shell to overcome commercial and regulatory risks, such as lower demand and lower margins for oil and gas products, as well as the ever-increasing threat that governments worldwide would in the near-future set regulatory frameworks to restrict further exploration, production and use of hydrocarbons and their products.

Within the underlying derivative claim, the reliefs sought by ClientEarth were a mandatory injunction requiring Shell’s directors to – (i) adopt and implement a strategy to manage climate risk in compliance with their statutory duties; and (ii) immediately comply with the Dutch Order.

Shell, on the other hand, argued that the duties which ClientEarth was trying to impose on its directors were misconceived for reasons that – (i) they were inherently vague and incapable of constituting enforceable personal legal duties; (ii) it was for Shell’s directors themselves to determine the weight to be attached to the various factors which they considered to promote the success of the company; and (iii) the duties created by ClientEarth amounted to an unnecessary and inappropriate elaboration of the statutory duty of care.

Indeed, while Shell agreed with ClientEarth that the company faces material and foreseeable risks as a result of the impact of climate change, which could or would have a material effect on its operations in the future, this point did not in and of itself demonstrate a prima facie case, warranting permission to continue with the derivative claim. The more important question, according to Shell’s directors, was the nature of Shell’s response to those risks and the extent to which ClientEarth had demonstrated a case of actionable breach of duty by the directors in their management of those risks.

Shell also contended that there was good reason to conclude that the application for permission to continue the derivative action was an attempt by ClientEarth to publicise and advance its own policy agenda, which was a misuse of the derivative claim procedure, and supported the proposition that the application had not been brought in good faith.

The High Court’s Decision

The Court agreed with Shell’s arguments to the effect that the duties which ClientEarth sought to impose on the directors were an indirect attempt to impose specific obligations on the company’s directors as to how to manage and conduct Shell’s business and affairs, and that such a directive would go against 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.

The Court further held that through the derivative action, ClientEarth was seeking to impose absolute duties on Shell’s 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. In particular, the Court found that a business of the size and complexity as that of Shell required its directors to take into account a large range of competing considerations, the proper balancing of which is a classic management decision that the court was ill-equipped to interfere with. As such, the directors were in the best position to weigh the impact of Shell’s operations on the community and the environment against the business risks for Shell which are associated with climate change.

In this respect, the Court reiterated the principle in Howard Smith Limited v Ampol Limited (1974) AC 821, where it was held that Courts of law will not sit on appeal on a company’s management decisions as Courts should not act as a supervisory board over decisions within the powers of the management of a company, which decisions were arrived at honestly.

This decision brings to the spotlight the inherent difficulties of enforcing environmental, social, and governance (ESG) compliance guidelines in circumstances where a company has other competing interests.

Notably, the Court held that the need to establish a prima facie case at the Permission Stage involves a rigorous test and entails establishing that there is no basis upon which the directors could reasonably have come to the conclusion that the actions that they had taken were in the best interests of Shell. In this respect, the Court found that there were a number of fundamental reasons why ClientEarth’s allegations did not establish a prima facie case for permission to continue, namely:–

• ClientEarth had failed to establish that the directors were managing Shell’s business risks in a manner that was not open to a board of directors acting reasonably.
• ClientEarth had failed to establish that there is a universally accepted methodology as to the means by which Shell might be able to achieve the targeted reductions in
• In principle, the law respects the directors’ autonomy in decision-making on commercial issues, and their judgement as to how best to achieve results which are in the best interests of the
• ClientEarth had failed to establish how the directors had gone wrong in balancing the factors for their consideration on how to deal with climate risk, and that no reasonable director could have properly adopted the approach that they did.
• The Court applied the principle of de minimis shareholding to hold that the fact that ClientEarth, together with the parties supporting it, whilst holding only a small fraction of Shell’s shares, was proposing that it should be entitled to seek relief on behalf of Shell in a claim of a considerable size, complexity and importance, which gave rise to an inference that ClientEarth’s real interest was not in how best to promote the success of Shell, but an attempt to impose upon Shell its views and those of its supporters as to the right strategy for dealing with climate change risk.

Importance of the Decision

The Court’s decision appears to have taken a “reasonableness” approach to hold that directors who are applying their best efforts to balance all considerations impacting a company cannot be deemed to have breached their statutory duties to the company for failing to elevate climate-change-related risks above other considerations, be they commercial, societal, or physical. Indeed, the Court found that attempting to bring a derivative action with the sole objective of pushing a climate-change agenda was an abuse of this very special and limited procedure provided for under the Companies Act.

This decision brings to the spotlight the inherent difficulties of enforcing environmental, social, and governance (ESG) compliance guidelines in circumstances where a company has other competing interests. Whereas there may be in place ESG guidelines in an organisation or legislation geared towards ESG compliance, ensuring compliance and enforcement of the same might not be as straightforward.

In a world where ESG compliance is headlining the news every day and resulting in corporations implementing vast policy changes, this decision may, at first glance, seem like a step in the wrong direction. However, it is a perfect example of the delicate balance that most corporations will struggle to attain when trying to push the ESG agenda while ensuring that their strategies and actions are in the best interest of their shareholders.

It will also be interesting to watch the Kenyan jurisprudential space to see how our Courts will handle ESG compliance-related claims, especially in light of the various policy changes being effected in our markets, including the introduction of the Nairobi Securities Exchange ESG Disclosures Guidance Manual and the Central Bank of Kenya’s Guidance on Climate-Related Risk Management.