ClientEarth v Directors of Shell: Oral hearing takeaways

On 24 July 2023, following an oral hearing on 12 July 2023 at which ClientEarth asked Mr Justice Trower to reconsider several points made in his earlier judgment, the English High Court maintained its decision to refuse to give permission for ClientEarth (as a minority shareholder) to bring its ground-breaking application for a climate-related derivative action against the directors of Shell.

The July judgment records in a single document the Judge’s concluded views following his initial consideration of the matter (on the papers, as handed down on 12 May 2023) and his reconsideration at and after the oral hearing on 12 July 2023.

As the July judgment repeats to a significant extent the May judgment (our key takeaways from which are already summarised in our previous article) this article focusses on the additions the Judge made to his May judgment and what, in our view, those additions mean for ESG activism both in relation to litigation and wider activist strategies.

Court’s deference to directors’ management decisions

The Judge reiterated that he considered the English High Court "ill-equipped to interfere" with the decisions of company directors, in particular where the size and complexity of the company in question (in this case, Shell) is such that its directors must take account of a myriad of competing considerations, the proper balancing of which is a "classic management decision".

At the oral hearing, ClientEarth submitted that the May judgment failed to address the witness evidence provided by Mr Benson, a senior lawyer at ClientEarth, which sought to demonstrate that Shell’s directors had not put forward a realistic approach to achieving Shell’s Energy Transition Strategy (“ETS”). However, in the July judgment the Judge emphasised that even if he considered himself able to place any real weight on Mr Benson’s evidence, ClientEarth’s criticism "misses the fundamental point" that directors must take account of a myriad of competing considerations, not just climate-related risks.

Duty to promote the success of the company

It is well-established that the test for determining whether a director has breached their duty to promote the success of the company (s.172, Companies Act 2006 (“CA 2006”)) is a subjective one requiring proof of conduct other than good faith. The Judge considered that ClientEarth had failed to satisfy that test, in particular by conflating irrationality and good faith: “irrationality is part of the mix when the court is assessing the evidential question of whether or not the directors acted in good faith, but it cannot stand as a ground of breach on its own. There is no clear authority that it does and, anyway in the context of commercial decision-making, cuts across the well-established principle… that: "There is no appeal on merits from management decisions to courts of law: nor will courts of law assume to act as a kind of supervisory board over decisions within the powers of management honestly arrived at."”.

Duty to act with reasonable care, skill and diligence

The Judge reiterated that ClientEarth’s continued focus on the directors’ implementation of Shell’s ETS, and attempted imposition of other climate-related incidental duties (which we discuss in more detail below), was wholly inadequate to support ClientEarth��s allegation that Shell’s directors had breached their duty to act with reasonable care, skill and diligence (s.174, CA 2006). In the Judge’s view, ClientEarth had:

• only concentrated on "one aspect" of the directors’ decision making (i.e. their implementation of Shell’s ETS) and therefore ignored the fact that Shell’s directors, in managing a large and complex business, had to take into account a range of competing considerations; and
• failed to give any substantial recognition to the fact that Shell’s directors were permitted (and required) by the law to balance those considerations in the interests of the company, which was "a clear illustration of why" ClientEarth had failed to establish a prima facie case.

The alleged incidental climate-related duties: A subtle shift in emphasis

The Judge noted that there had been a subtle but important shift in the emphasis of ClientEarth’s arguments at the oral hearing with regards to the incidental climate-related duties that ClientEarth is seeking to apply to Shell’s directors. In his view, ClientEarth’s written submissions argued that Shell’s directors were necessarily subject to the alleged incidental duties by virtue of s.172 and s.174, CA 2006. In subtle contrast, at the subsequent oral hearing ClientEarth argued that those duties arise as a matter of logic once it was appreciated that Shell’s directors, by adopting the ETS, had identified climate strategy as a commercial objective that is most likely to promote the success of Shell for its shareholders. Further, ClientEarth argued that by adopting the ETS, Shell’s directors accepted that climate risk is a serious risk to Shell’s business, and the incidental duties flowed from that acceptance. The Judge considered that these arguments were predicated on the management of climate risk having "overriding status". However, he did not agree, and reiterated the requirement for directors to balance a myriad of considerations.

According to the Judge, ClientEarth’s case is that even if it is wrong for the Court to intervene regarding the directors’ decision to adopt the ETS, there is no reason why the Court could not intervene regarding the manner in which that strategy is implemented. However, the Judge considered this argument to be "illogical" and that the Court’s deference to directors’ decisions should be similarly applied to both adopting and implementing a particular strategy.

Ulterior motives

As mentioned in our previous article, when determining in the May judgment that ClientEarth had failed to establish the necessary prima facie case for permission to pursue a derivative action, the Judge relied (inter alia) on the fact that ClientEarth's intention in bringing such an action was to further its own wider objectives rather than promoting the success of Shell (i.e. an ulterior motive). In the July judgment, the Judge added that a "useful question" in this regard was to ask whether an independent director acting in accordance with their duty under s.172, CA 2006 (to promote the success of the company) would consider it appropriate to bring the action. According to the Judge, ClientEarth’s application and supporting evidence provided "only one answer: such a director would not do anything other than decline to continue the claim".

Further, in the May judgment, the Judge applied the "but for" test, concluding that but for ClientEarth’s intention to bring this action in pursuit of its own wider, ESG objectives, ClientEarth would not have made this application in good faith. At the oral hearing, ClientEarth submitted that the "but for" test should not be applied in such a rigid or simplistic manner; however, in the July judgment the Judge maintained that he had applied the test appropriately as a matter of policy in taking account of ClientEarth’s primary purpose of bringing the claim (i.e. for an ulterior motive).

Where do ESG activism derivative actions go from here?

For now, the Court appears stoically unwilling to entertain actions of this kind as, according to the Court, they are not in line with the legislative intention of the derivative action procedure (as contained in the CA 2006). According to the July judgment, it was the legislator’s intention that this procedure be employed only in "restricted circumstances". It is not intended to "encourage litigation against directors".

Perhaps as part of that intention, the July judgment sets out a heavy evidential burden for any potential claimant wishing to employ the derivative action procedure. According to the judgment, as the status of directors is similar to that of a "professional", the Court will strike out proceedings alleging breach of a director’s duty unless appropriate expert evidence is adduced at the prima facie stage: "If it is not possible for ClientEarth to establish a prima facie case to the effect that the Directors’ approach to climate risk falls outside the range of reasonable responses open to the board of a company such as Shell without properly admissible expert evidence, that is simply a reflection of the very serious nature of the case it wishes to advance and the attendant difficulties which its pursuit entails".

Further, the Judge’s application of the "but for" test with regards to the applicant’s motives in pursuing a derivative action would suggest that any shareholder with objectives beyond simply promoting the success of the company for its shareholders (ESG or otherwise) will face an almost irrebuttable presumption that they have an ulterior motive and will therefore fail that test and the necessary requirements for being granted permission to pursue a derivative action.

Next steps for ClientEarth’s action

This case is far from resolved: ClientEarth has already indicated its intention to appeal this decision to the Court of Appeal by making an application to Mr Justice Trower for permission to do so. We await the Judge’s decision. If permission is refused, it is open to ClientEarth to seek permission to appeal from the Court of Appeal.