ENGLISH HIGH COURT BLOCKS DERIVATIVE ACTION AGAINST SHELL'S DIRECTORS FROM CLIMATE-CHANGE ACTIVIST SHAREHOLDER

Recently, we see a significant uptick in ESG litigations in different parts of the world. Together with this trend came activists' attempts to make use of judicial channel to hold companies accountable to their ESG-related management decisions.

In the recent English High Court case of ClientEarth v Shell plc & Ors [2023] EWHC 1137 (Ch) ClientEarth, as a minority shareholder holding 27 shares out of a total of over 7 billion shares in Shell, sought to bring a statutory derivative action against Shell's directors under the UK Companies Act 2006 (UK CA). ClientEarth alleged that Shell's directors had breached their statutory duties owed to Shell by failing, among others, to formulate a management strategy (Energy Transition Strategy) that sufficiently mitigates climate risk and to take steps to ensure that a former Dutch Court order made against Shell pursuant to Milieudefensie v Royal Dutch Shell plc ECLI:NL:RBDHA:2021:5339 would be complied with (Dutch Court Order).

As a matter of common law, it is generally the company – and not its shareholders – that has standing to pursue in Courts any cause of action available to it. Shareholder derivative actions therefore represent a departure from this norm and can only be pursued with the Court's permission in the UK. Similarly in Hong Kong, statutory derivative actions require leave of the Court, which will only be granted upon satisfying the Court, among others, that there is a serious question to be tried, and that the action appears to be in the interests of the company in question. The present decision arose from ClientEarth's application for such permission. The English High Court's reasons for refusing permission for ClientEarth's derivative action against Shell are summarised below.

While the ESG litigations stemming from shareholder activism have not been prevalent before Hong Kong Courts to date, the English decision is welcome news to the board and management of companies with a presence in Hong Kong. The decision, in particular, clarifies that Courts will be slow to usurp the role of directors by imposing absolute duties on them to make decisions in accordance with an ESG-friendly agenda. Given the obvious parallels between the Hong Kong and English regimes in respect of derivative actions and director's duties, we expect the Hong Kong Courts to give substantive weight to this English decision should similar issues arise.

ClientEarth had no prima facie case

Section 261(2) of the UK CA requires that ClientEarth must show that it has a prima facie case in bringing a statutory shareholder derivative action. In its application, ClientEarth argued that in addition to the statutory duties of directors to promote the success of the company, and to exercise reasonable care, skill and diligence as stipulated under the UK CA, Shell's directors further owed the company a number of "incidental duties".

Specifically, these "incidental duties", according to ClientEarth, included the obligation to accord appropriate weight to climate risk, implement strategies that reasonably mitigate climate risk and reasonably ensure that Shell could meet its promised emission targets and the Dutch Court Order.

The formulation of director's duties in Hong Kong bears much resemblance to that of the English regime, as directors in Hong Kong are also subject to duties to act in the interests of the Company, as well as owe a statutory duty to exercise reasonable care, skill and diligence in their discharge of responsibilities. The English Court's treatment of such alleged ESG-related "incidental duties" would therefore offer meaningful insight into how Hong Kong Courts would approach the same question.

In finding that ClientEarth's application disclosed no prima facie case, the English High Court criticised ClientEarth for seeking to impose absolute duties on directors which cut across the general duty to have regard to a myriad of complex and competing considerations. In particular, the English High Court reiterated that management decisions made by the board of a company could not be appealed to Courts of law. It was sufficient that the decision made by the board fell within the range of reasonable options which could be considered and taken by a reasonable board.

As such, the English Court was reluctant to adjudicate on and interfere with management decisions taken by Shell's board. The Court also held that the evidence put forth by ClientEarth was fundamentally lacking. ClientEarth failed to address whether, in balancing competing considerations and coming to the relevant resolutions, the decisions by Shell's board were so wrongly made that they could not have fallen within the range of decisions that could have been taken by a reasonable board.

Derivative action brought for an ulterior purpose

In reaching its decision, the English High Court made reference to section 263(3) of the UK CA, requiring courts to consider whether the minority shareholder was pursuing the derivative action in good faith. The English High Court opined that where the primary purpose of bringing the statutory derivative action was for an ulterior motive in form of advancing ClientEarth's own policy agenda, such claim would not be regarded as being brough in good faith.

Our views

This decision offers welcome reassurance to companies and their directors that Courts will be slow to allow activist shareholders with de minimis shareholdings to use derivative action as a vehicle to challenge management decisions made on ESG-related matters which were taken in good faith.

Notably, the formulation of director's duties under the Hong Kong and English regimes share substantive similarities, both being phrased as high-level and general duties to promote the interests of the company and to exercise reasonable care, skill and diligence. As such, to the extent that the English High Court refused to impose any specific or absolute duties on directors with regard to climate risks because doing so would undercut these general and holistic duties of directors, such reasoning would likely be of precedential and persuasive value to Hong Kong Courts.

Key takeaways

In summary, the key takeaways from this English High Court decision are as follows:

• The English High Court was reluctant to interfere in companies' ESG-related management decisions.
• The Court ruled that there was no separate and absolute duty upon directors to formulate and implement strategies in a manner that would fully mitigate against ESG risks, especially when such a duty would be inconsistent with directors' duties to consider the interests of the company and its shareholders holistically. It was sufficient that the management decision taken fell within the range of options that could be taken by a reasonable board.
• Minority shareholders will be criticised for using derivative actions as a vehicle to challenge management decisions that they disagree with and to achieve their own collateral motives.
• This is welcome news to directors who may well be tasked with balancing a myriad of factors, of which ESG concerns only form part. This approach will likely offer persuasive value to Hong Kong Courts.

For more details, please see our blog post on the High Court decision here.

For more information, please contact Gareth Thomas, Partner, Rachael Shek, Partner, Jojo Fan, Partner, Troy Song, Associate, or your usual Herbert Smith Freehills contact.