Round Two: ClientEarth’s second attempt to force Shell Directors to comply with climate change obligations dismissed by English High Court after oral hearing

Following the dismissal by the High Court of ClientEarth’s application on the papers to force Shell’s directors (the “Directors”) to comply with the Paris Agreement, it exercised its right to ask the court to reconsider that decision at an oral hearing. This application has now also been dismissed (ClientEarth v Shell [2023] EWHC 1897 (Ch)). Although the judgment repeats to a ‘significant extent’ the reasoning given in the first judgment (the ‘May Judgment’), it does provide further explanation as to why the application was dismissed on both occasions and is therefore instructive as to what the parties need to prove in a claim of this nature.

You can read the background to the application and our commentary on the May Judgment here. In this update we do not seek to repeat the content of our previous article but instead discuss additional matters raised in the judgment following the oral hearing and what can be learned as a result.

The judgment also provides a very helpful summary of how the application for permission to continue a statutory derivative action will operate. This requires that the Claimant satisfy the court that there is a prima facie case for giving permission before a substantive permission application can proceed.

ClientEarth asked the court to reconsider a number of its conclusions from the May Judgment at the oral hearing.

The Directors Duties relied on by ClientEarth – statutory and the ‘six necessary incidents’

ClientEarth originally claimed that the Directors had failed to comply with two statutory duties they owed to Shell pursuant to s.170 of Companies Act 2006 (CA 2006): the duty to promote the success of Shell (s.172 of CA 2006) and the duty to exercise reasonable care, skill and diligence (s.174 of CA 2006). In addition, there were six further “duties resulting from the consideration of climate risk which ClientEarth submitted that the Directors will necessarily be subject to”. ClientEarth referred to these as the ‘six necessary incidents’.

The Judge noted that at the oral hearing there was a change of emphasis by ClientEarth in relation to these six necessary incidents. ClientEarth submitted at the hearing that these duties arise as a matter of logic from the fact that the Directors saw its climate strategy as a commercial objective which was most likely to promote the success of Shell therefore, it did not need to establish these special incidental duties in order to succeed on its claim.

The court disagreed with this analysis, agreeing with Shell’s submissions on this aspect of the case:

1. The incidental duties were ‘inherently vague’ and ‘incapable of constituting enforceable personal legal duties’;
2. The incidental duties cut across the principle of company law that it is for the Directors to determine the weight to be attached to the non-exhaustive list of factors referred to in s.172; and
3. The incidental duties are unnecessary as they are an inappropriate elaboration on the statutory duty in s.174.

The court said that these incidental duties seek to impose specific obligations on the Directors as to how the management of Shell’s business should be conducted. This was inconsistent with the well-established principle that it was for the directors themselves, acting in good faith, to decide how best to promote the success of a company for the benefit of its members as a whole.

The Judge agreed with Shell that this position was illogical; ClientEarth argued that it would be wrong for the Court to intervene in the Directors commercial decision to adopt the Energy Transition Strategy (“ETS”) but if this was correct, then “the same principle of restraint should be applied to the means by which that strategy is to be implemented”.

Duty to promote the success of Shell (s.172)

At the oral hearing the Court considered this duty in more detail noting that the test for breach of the duty was a subjective test requiring proof of conduct which was not in good faith. The absence of good faith may be inferred in some cases from the irrational nature of the conduct in issue but the most important consideration is the state of mind of the director concerned. Good faith not irrationality is the cornerstone- an honest but unreasonable and mistaken belief that a particular course of action is in the company’s best interests is not sufficient to amount to a breach. The Court will not intervene in a decision honestly arrived at. The Court said that ClientEarth had mixed the concepts of good faith and irrationality and treated them as interchangeable, but this was clearly not the case.

Duty to exercise reasonable care, skill and diligence (s.174)

The Court took a similar position in relation to the duty under s.174. Other than the obligations set out within s.174, the law did not superimpose further specific requirements as to the reasonableness of a course of action. It was a requirement instead that Directors have an open mind about how to manage a company’s business and continue to have regard to a range of competing considerations.

Breaches of the duties

At the oral hearing ClientEarth had to show a prima facie case that there is no basis on which the Directors could reasonably have concluded that the actions they have taken have been in the interests of Shell. The parties broadly agreed that Shell faces material and foreseeable risks as a result of climate change, but the Court held that this did not demonstrate a prima facie case for the grant of permission. Instead, the question to answer was what is the nature of Shell’s response to those risks and therefore, the extent to which ClientEarth has demonstrated a prima facie cause of actionable breach of duty by the Directors in their management of those risks.

ClientEarth presented its evidence in a very long witness statement drafted by its in-house lawyer. This focused on a number of alleged breaches including: the inadequacy of Shell’s targets for Scope 1,2 and 3 omissions; a modest decline in its oil production running counter to its net zero targets, and that the company’s reliance on carbon capture and storage is unreasonable because it is ineffective. The Court agreed that it was “an accurate reflection of a consensus of opinions” relating to a very complex series of topics. However, these opinions were not fact and should have been the subject of expert evidence. ClientEarth submitted that it did not need to provide expert evidence at this prima facie stage, but the Court disagreed. It was important for ClientEarth to show that the Directors approach to climate risk fell outside the range of reasonable responses open to the board of a company such as Shell. Provision of expert evidence would show why the Directors erred in the balancing exercise they are required to perform so as to become actionable. If there is no evidence to show this, then there can be no breach of the s.174 duty of care. The Court concluded that ClientEarth had not managed to demonstrate a prima facie cause of actionable breach of duty because it failed to show that the responses by the Directors was outside the range of reasonable responses they could have arrived at. The Directors have numerous competing interests to consider and their response to the ETS fell within these.

Relief sought must be precise

Shell submitted that the court must also consider the nature of the relief sought by ClientEarth at this prima facie permission stage. The Court was dismissive of the nature of the relief sought by ClientEarth; a mandatory injunction and a declaration that the Directors have breached their duties.

The Court held that the relief sought must be precise and capable of supervision in the event of a breach. The Court was unconvinced that a mandatory injunction was appropriate in this situation as it was of the view that constant supervision would be required to adjudicate on disputes over whether or not the business was being run in accordance with the terms of the injunction. In this case the type of relief sought would also cut across the court’s normal reluctance to interfere with the Directors’ usual decision-making powers.

The declaratory order did not suffer from the same problem however, it would not fulfil a legally relevant purpose as the court would be in effect commenting on the Directors’ conduct which would have no substantive effect. In the Court’s view the proper forum to present this viewpoint on the Directors conduct was by vote of the members in a general meeting.

The judge also considered the discretionary factors in ss 263(3) and 263 (4) of the Companies Act. In particular they considered whether Client Earth would be acting in good faith in continuing the claim. Although the evidence from Client Earth was that it believed that the claim was in the long term best interests of Shell, this was not an answer to Shell’s argument that the claim was really brought to publicise and advance its own policy agenda. The court said that in assessing the question of good faith it was entitled to consider whether the claim was brought for an ulterior motive and this was particularly pertinent where Client Earth held only 27 shares. The judge’s view was that as it only held 27 shares but was proposing to pursue a claim on behalf of Shell which was of significant size, importance and complexity this gave rise to a clear inference that its real interest was not how best to promote the success of Shell for the benefit of the members as a whole. Its motivation in pursuing the claim was ulterior to the purpose for which a derivative claim could be properly continued.

In addition the Court considered whether the breaches relied on by Shell had been authorised or ratified by the shareholders. In doing so they took into account that there had been 80% shareholder support for the Company’s approach to climate change risk at the 2022 and 2023 AGM. This was balanced against the fact that only 0.17 % of Shell’s shareholder base had expressed support for the claim, with letters from a similar amount of further shareholders saying that they were aligned with the issues raised although it was noted that the latter were predominately members of the Climate Action 100 + initiative. The Court considered that the level of support for the Shell strategy would count strongly against the grant of permission.

The Court therefore considered that Client Earth had not made out a prima facie case for permission to continue the claim and application and the claim itself was dismissed by the Court.

Next Steps

ClientEarth have already said they will seek permission to appeal this decision. In the meantime, the judgment makes it clear that for shareholders to succeed in a derivative claim of this type, any evidence submitted to the court must demonstrate a prima facie case of actionable breach of duty by the Directors and the relief sought must be precise and capable of supervision in the event of a breach. It was important for ClientEarth to show that the Directors approach to climate risk fell outside the range of reasonable responses open to the board of a company such as Shell. Evidence from Shell itself and the views of other shareholders, convinced the Court that ClientEarth had not done so.

The judgment will make it extremely difficult for activist shareholders to pursue claims of this type in particular because they tend to subvert the established principle that the Court will respect the autonomy of directors when deciding on commercial issues save in circumstances where no reasonable director could have adopted the approach that is being challenged- the Court took into account that Client Earth had not explained how the Shell directors had gone wrong in balancing the competing commercial considerations that they were required to take into account. It will also be challenging for activists with very small shareholdings to show that their claim is brought in good faith rather than for a collateral purpose. No doubt activist shareholders will also use both judgments to help prepare future claims as the judgments set out not just the procedure but also where the judge considered the evidence fell short in this case. This is unlikely to be the last action by shareholders bringing a derivative claim of this nature.