Published on June 7, 2023
Court confirms derivative actions will only be permitted in limited circumstances

ClientEarth, an environmental charity, and a minority shareholder in Shell Plc, has been refused permission to bring a derivative action against Shell’s directors under section 2601(1) of the Companies Act 2006 (“CA 2006”) in regards to (i) the directors’ acts and omissions in relation to Shell’s climate change risk management strategy; and (ii) the directors’ response to an order of the Hague District Court from May 2021 in Milieudefensive v Royal Dutch Shell plc requiring a 45% emissions reduction by Shell by 2030 (the “Dutch Order”).

Derivative Actions: Court permission required

Under section 260 CA 2006, a minority shareholder is able to bring a claim arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by one or more of the directors of the company in which it holds shares. However, given such an action goes against one of the most basic principles of company law, i.e. it being a matter for a company, acting through its proper constitutional organs, not its shareholders, to determine whether or not to pursue a cause of action that may be available to it, court permission is required to bring that action.

The circumstances in which a court will grant permission for a derivative action against directors is limited. Section 263 CA 2006 sets out the test the court must apply for permission:

  1. Permission must be refused if (a) the applicant would not seek to continue the claim if they were acting in accordance with their duty to promote the success of the company or (b)/(c) the act or omission from which the cause of action arises has been authorised or ratified by the company before or since it occurred.
  2. There are a number of discretionary factors for the court to take into account:
    1. Whether the applicant is acting in good faith in seeking to continue the claim;
    2. The importance a person acting in accordance with his duty to promote the success of the company would attach to continuing it;
    3. Whether any act or omission from which the cause of action arises would likely be ratified by the company;
    4. Whether the company decided not to pursue the claim; and
    5. Whether the act or omission in respect of which the claim is brought gives rise to a cause of action that the member could pursue in his own right rather than on behalf of the company.

In making their assessment, the court must have regard to any evidence before it as to the views of members of the company who have no personal interest, direct or indirect, in the matter.

On this occasion, the court refused permission to allow ClientEarth’s action to continue.

ClientEarth refused permission to continue their claim

ClientEarth claimed that the directors had breached two of their statutory duties: (a) to promote the success of the company (section 172 CA 2006); and (b) to exercise reasonable care, skill and diligence (section 174 CA 2006). ClientEarth argued that the directors had incidental duties, inter alia, a duty to make judgments regarding climate risk that are based upon a reasonable consensus of scientific opinion, a duty to adopt strategies which are reasonably likely to meet Shell’s targets to mitigate climate risk, and a duty to accord appropriate weight to climate risk.

Shell argued, and the judge agreed, that the allegation the directors were subject to these incidental duties was misconceived. The law does not superimpose specific obligations on the directors in regards how they comply with their duty to display care, skill and diligence: “The formulation of these incidental duties make plain that [ClientEarth] seek to impose specific obligations on the Directors as to how the management of Shell’s business and affairs should be conducted, notwithstanding 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 members as a whole. This is a commercial decision which the court is ill-equipped to take.”

ClientEarth also claimed that the directors had a duty to take reasonable steps to ensure the Dutch Order was obeyed, and that they had failed to do so. The judge agreed with Shell that there is no recognised duty owed by directors to ensure they comply with the orders of a foreign court.

ClientEarth needed to establish a prima facie case that the directors’ approach fell outside the range of reasonable responses to climate change risk and would cause harm to Shell’s members. In this regard ClientEarth referred to the directors’ actions, including the failure to set an appropriate emissions target and their climate risk strategy, which included a proposal to make significant new investments in fossil fuel projects and opaque and insufficient proposed expenditure on renewable energy.

The court found that ClientEarth had not established a prima facie case. The law respects the autonomy of directors to make decision on commercial issues and their judgments as to how best to achieve results which are in the best interests of the members. The evidence produced by ClientEarth fell short of showing a prima facie case that the directors were managing Shell in a way that could be described as not in the best interests of the members.

Whilst this is unlikely to be the end for activist shareholders seeking to disrupt corporate management, this decision will provide comfort to directors that, notwithstanding social and political pressure in environmental matters, the court will not seek to dictate how they should comply with their duties save for in limited circumstances, and indicates a warning to shareholders who may attempt to bring derivative claims for an apparent ulterior motive, in particular those shareholders with minority shareholdings. The court will not take a decision to intervene in corporate decisions lightly. It remains the directors’ responsibility to make corporate decisions and how to promote the success of the company and permission for derivative actions will only be granted in limited and restricted circumstances.

Access a full copy of the judgment.

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