IN THE NEWS

The ClientEarth UK derivative claim against the Shell board fell at the first hurdle.

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It’s worth bearing in mind that under English law the first hurdle in these types of claim is a high one.  This is because they are an exception to the fundamental principle that only a majority of shareholders can or should be able to require the company to sue its directors for breach of duty.

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I was excited about this attempt because, even though likely to fail, it reminded us of how UK courts approach derivative claims (which unlike in the US are not very common here). More importantly, it was an intriguing first attempt to use the procedure to try to force companies to tackle climate change risks more proactively.  As such, the case has had a wider bearing on the whole ESG debate. 

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We were treated to two written judgments by the court by virtue of a quirky procedure that allowed ClientEarth two bites of the apple – an application on written evidence only and then an oral hearing (both ending in defeat). ClientEarth say they will appeal but at the time of going to press it is far from clear whether they will be able to, such was the resounding nature of this defeat. The main factor in their favour is those wider implications mentioned above.

 

In the US, the plaintiffs’ bar has succeeded in part by probing all potential legal theories until one sticks.  It is through this process that they have learned how to plead cases to avoid failing at motion to dismiss, and found the routes to liability, however narrow they may be.

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I’m not going to recite the arguments in the case here – there are many excellent law firm analyses out there to read. Instead, I am going to throw out a few observations about the case which might provide some clues as to whether it will deter future ones and if not how similar cases might fare in future.

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Observations

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• On a general level, it will always be difficult for any shareholder to get around the fact that courts will be reluctant to interfere with commercial decisions of directors unless there was a clear breach of duty.

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• The way the breach of duty case was put by ClientEarth, albeit in some ways ingenious, was more likely to fail because it relied on “incidental” and “additional” duties to the statutory duties (e.g. a duty to implement reasonable measures to mitigate risks to the financial health of Shell in its transition to an economy aligned to the goals of the 2015 Paris Agreement on Climate Change). The court found these were too vague to be useful. Further, without strong independent expert evidence on Shell’s “Energy Transition Strategy” (“ETS”) they lacked credibility. Cases brought solely on the statutory duties with expert evidence will have more “heft”. 

 

• In respect of the s172 Companies Act 2006 duty to promote the success of the company, whilst climate is one of the statutory factors the directors must consider, it cannot override everything else. The court found only the directors could be trusted to balance the factors in a way that overall promotes the success of the company unless there was no reasonable basis for that decision.

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• The claim also relied on the Dutch case against Shell in which a non-shareholder campaigning group successfully convinced a court to order Shell to reduce its carbon emissions by 45% by the end of 2030.  ClientEarth argued this order had not been complied with – another alleged breach of directors’ duties.  However, the Dutch decision is on appeal and the English court found there was no separate duty on the part of the English board to comply with it. This was a particular feature of this claim that will not be present in others.

 

• The court was swayed by a strong suspicion ClientEarth had an agenda that was to force Shell’s business, being heavily reliant on hydrocarbons, to have a less detrimental effect on the environment, over and above promoting the success of the company.  This was fatal to its chances.  ClientEarth is a campaigning group with legitimate aims, but an English judge is very unlikely to allow such a group to influence a company’s business strategy. Had the institutional investors who said they supported the action put their names on the Claim Form instead, this would have carried greater weight.

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• The court was also influenced by the fact ClientEarth held so few shares in Shell (27).  Had the supportive institutional investors thrown their 24.7m odd shares behind the action this would have made it less vulnerable, albeit it would still have represented less than 1% of the total shareholding.  To me, this would not have been a factor if the claim was stronger but here it just added weight to the other factors against allowing the claim to proceed. 

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• The nature of the remedy sought also made things more difficult – a declaration the directors were acting in breach of duty coupled with an injunction to change the board’s approach to climate risk. The court would be more ready to recognise a breach of duty in the past and award damages for that than seek to order the directors, going forward, to manage the company in a designated way.

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• Shell’s ETS had been approved by some 80% of its shareholders when considered only a year ago. The court strongly hinted the way minority shareholders should seek to influence the wider shareholder base – and therefore the board – is through general shareholder meetings, not the courts.

 

• In conclusion, it would be wrong to dismiss this attempt by ClientEarth out of hand.  It is out of failures like this that the law develops and is tested.  The outcome is undoubtedly a blow to any activist shareholder considering trying to change corporate strategy on climate change through the courts, but influential minority shareholders with no wider agenda may be able to bring stronger claims, based on the clues set out in these judgments.

 

• ClientEarth may yet have the last laugh.  The publicity generated by this case, even though unsuccessful, has probably assisted their cause and in the end may still indirectly have a bearing on Shell’s (and others’) energy transition strategy. 

 

I’ll end with some FAQs on how a derivative case may be treated under a D&O policy (I have no knowledge of the terms of Shell’s D&O policy and of course each case will depend on the particular factual circumstances and the precise terms of the relevant policy). 

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Side A or Side B?

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Whilst instigated by a shareholder, a derivative claim is in its essence a claim by and for the company. If a liability to the company on the part of the directors is established this will be non-indemnifiable loss and the claim will be dealt with under Side A.  However, up to that point the defence costs will under English law be indemnifiable and so dealt with under Side B if the company indemnifies.  If the company refuses to indemnify these costs will be paid under Side A but it’s likely insurers will require the company to pay the Side B retention, under the “presumptive indemnification” machinery in the policy.

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Is it a Securities Claim?

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A derivative claim is not a securities claim in the sense that the claim does not concern the shareholder’s shareholding itself. However, a derivative claim is often contained in the Securities Claim definition.  Why is this?  It wasn’t my idea but have rationalised this as being because until the action is given permission to proceed, the company is a defendant (Shell is a defendant in the present case, not a plaintiff – a situation that would only change if the action was allowed to proceed). The company is therefore known as a “nominal defendant” – no allegation is made against it, but it needs to be a party because the court’s order will have a direct bearing on it.

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As the Securities Claim definition is solely for the purpose of covering the company, it is convenient to cover the company for the costs it incurs in a derivative claim whilst a nominal defendant, under Side C.

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What other D&O provisions are potentially relevant?

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• The derivative claim may be preceded by a request by the shareholder that the company investigates a potential breach of duty by the directors.  This is common in the US. The costs of the company undertaking this investigation may be covered by a policy extension. Further, if required to attend an internal hearing as part of such an investigation, the director may be covered for the costs of being represented at that.

 

• If ClientEarth’s application had been successful then the court would likely order Shell indemnify ClientEarth’s costs of bringing the application because the company would have benefitted from it. Some policies provide cover for this to the company. It is debateable whether this is a good idea though – as for a time the policy will be eroded by all parties to the case – which will not benefit the directors if the limit of cover is under threat.