Climate litigation turns personal as directors come under scrutiny

The recent shareholder claim against the Shell board will be a test case of how feasible it is for directors to be held responsible for the environmental and social impact of the companies they serve.

Board directors are finding themselves increasingly under scrutiny for their role as managers of their companies’ transition to a lower-carbon economy. Their responsibility will now also be tested in court, in a lawsuit filed by environmental non-profit ClientEarth against the board of oil major Shell.

ClientEarth has filed the case as a shareholder and received support from other institutional investors in Shell, such as UK pension fund Nest and Swedish national pension fund AP3. Shell’s 11 board directors are being sued in the High Court of England and Wales by investors holding over 12 million shares in the company, on the grounds that the directors have allegedly breached their legal duties under the UK Companies Act by failing to implement a transition strategy aligned with the Paris Agreement. 

Although climate litigation has been gaining momentum in UK courts and elsewhere, a derivative claim – a lawsuit brought by a shareholder on behalf of a company against a third party, such as the board – is relatively rare in this arena.

In the US, Starbucks’ board directors were sued last year by shareholders who claimed that the company’s diversity, equity and inclusion policies were unlawful as they benefited minorities only. Meanwhile, in the UK, the claim against Shell’s directors is seen as a first test case of how courts will respond to and interpret directors’ responsibility towards companies’ transition plans.

Nicola Pangbourne, a partner at law firm Kennedys, says: “While this case has the potential to lead to further climate related exposure for board directors, demonstrating that the directors’ conduct amounts to a breach of duty under the Companies Act is a high bar because the court could consider that strategy and management issues are matters of business judgment, with which it will not interfere.”

She adds that the claimant will also have to show that directors are the right people to litigate in an entity’s name, which is a matter for the court’s discretion.  

The recent record profits reported by oil and gas giants such as Shell might also make the case against directors more complex for shareholders who are cashing in large returns and dividends, says Roger Barker, director of policy and governance at the Institute of Directors.

“Regardless of the wider impact on the planet, right now shareholders are doing incredibly well. The key legal question will be whether the court decides to place the greatest emphasis on short-term shareholder interests or those much further into the future,” he adds.

Other legal routes

Although the success of this first derivative claim against directors in the UK is pending, experts agree the rise in environmental, social and governance claims is set to continue. David Greene, senior partner at law firm Edwin Coe, says: “Climate justice advocates will undoubtedly use any litigation method to push the message – so all companies that are involved in extraction or land exploitation, such as agriculture, are vulnerable.”  

Although most claims so far have been filed against companies, directors would also be wise to look at liability in other jurisdictions where the law may well be different, Greene suggests. He adds that companies may also decide to relocate to friendlier jurisdictions, referencing Shell recently moving its headquarters from the Netherlands to the UK.

While courts in the UK have also accepted climate litigation cases against Shell (including the company’s alleged responsibilities in causing environmental damage in Nigeria), the Dutch courts appear to have taken a tougher stance. In 2021 the Hague District court ruled that Shell had to reduce its emissions by 45 per cent by 2030 compared with 2019 levels – a decision the company is currently appealing against.

Elsewhere, Brazil’s supreme court has recognised the Paris Agreement as a human rights treaty, granting it “supralegal” status, meaning it prevails over other ordinary laws and regulations. In comparison, recent attempts by non-profits to consider emission-intensive projects funded by the UK government as unlawful, because they are incompatible with the Paris agreement, have not yet succeeded.

However, the UK Companies Act is just one legal avenue through which boards’ accountability for their companies’ climate footprint could be challenged in the future. 

Alexandra Nurse, partner at Kennedys, points to section 90 of the Financial Services and Markets Act as another example. This section deals with liability incurred for untrue and misleading statements that have been made on behalf of a company. Though these claims are historically difficult to pursue successfully, Nurse says, they do allow for collective shareholder action, which is something seen more often in the UK generally.

Regulatory pressure

Directors’ vulnerable legal position on sustainability issues is also enhanced by regulators imposing further disclosures on companies’ ESG credentials. 

EU legislation – especially the Sustainable Finance Disclosure Regulation and the Corporate Sustainability Reporting Directive – is seen as the most progressive in this field. Consequently, multinational corporations often build their global ESG frameworks on what their European offices are doing, says Simon Colvin, partner at UK law firm Weightmans.

An even more impactful piece of legislation would be the yet-to-be-finalised EU Corporate Sustainability Due Diligence Directive, where initial proposals by the European Commission expanded company directors’ liability by introducing additional duties to consider human rights and environmental factors in decision-making. However, this proposal was dropped by the European Council due to member states’ opposition. 

Still, board directors being forced to make greater disclosures on a range of sustainability issues in annual reports would still leave them at risk of potential litigation, says Kennedys’ Pangbourne: “The more an entity portrays itself or its products as having impressive environmental credentials, the more it will run the risk of falling foul of regulatory requirements and expose itself to regulatory investigations and litigation.”

Similar sustainability regulations to the EU’s are currently being tested in both the US (proposed climate disclosure rules by the Securities and Exchange Commission) and the UK (the Financial Conduct Authority’s sustainability disclosure requirements and investment labelling).

According to Pangbourne, shareholders could rely on a variety of arguments to target directors. They could allege that directors took specific decisions on behalf of the entity without considering the environmental impact of those decisions, and that this is a failure to promote the success of the company. Or that, for instance, inaccurate disclosures have led to a breach of directors’ duty of care to the company, thereby damaging the entity’s reputation and contributing to a potential fall in share price.  

Experts say that whether sustainability-related claims could also target single directors, instead of the collective board, is yet to be seen. Claims would usually be brought against the entire board who voted for a particular course of action, though in principle shareholders could select specific decision-makers, according to both Pangbourne and Greene.

Colvin points out that the UK’s current environmental laws allow regulators to prosecute directors where offences by a company are committed with their consent, connivance or neglect. He expects the law and regulation in relation to ESG and climate change to evolve in the coming years, to create similar offences for individual directors in this area.

Photo credit: Bloomberg