Edward Davies KC and Jack Rivett of Erskine Chambers (who acted for Shell plc) analyse the High Court's reconsideration of ClientEarth's application for permission to continue a derivative claim against the directors of Shell plc
In ClientEarth v Shell plc  EWHC 1897 (Ch), the High Court confirmed its earlier decision to refuse permission for the environmental non-profit organisation to pursue a derivative claim under Part 11 Companies Act 2006 brought against the directors of Shell plc (Directors) for alleged breaches of duty. Dismissing ClientEarth's application, Trower J held that ClientEarth had failed to establish a prima facie case that the Directors acted in breach of their duties in relation to their management of Shell's climate change risk.
ClientEarth's derivative claim
ClientEarth, which held 27 shares in Shell at the time of the proceedings, sought permission to bring a statutory derivative claim against the Directors on the basis that their mismanagement of climate change risk to Shell gave rise to an actionable breach of duty on Shell's behalf.
ClientEarth contended that the Directors' approach to managing climate change risk, as described in Shell's energy transition strategy published in 2021 and subsequent progress reports, was flawed and fell outside the range of reasonable responses to the risks identified by Shell. It argued that certain alleged inadequacies and deficiencies in the strategy meant that the Directors were in breach of their duty to promote the success of Shell under s 172 and their duty under s 174 to exercise reasonable care, skill and diligence. In addition, ClientEarth contended that the Directors were in breach of a further six supplementary duties relating to climate risk that it alleged were necessary when considering Shell's specific circumstances.
In addition to a declaration that the Directors had breached their duties to Shell, ClientEarth sought a mandatory injunction requiring the Directors to adopt and implement a climate risk management strategy that complied with their statutory duties.
High Court decision on the papers
Initially, Trower J considered ClientEarth's application on the papers alone (ie without a hearing) to determine whether there was a prima facie case for giving permission to continue the claim (see Q&A here). Trower J dismissed the application on the grounds that the application and supporting evidence filed by ClientEarth failed to demonstrate a prima facie case for giving permission (ClientEarth v Shell plc  EWHC 1137 (Ch)). He was satisfied that a person acting in accordance with the s 172 duty would not seek to continue the claim, which meant that the court was required by s 263(2) to refuse permission to continue the claim (see Q&A here and Q&A here).
Although not strictly necessary, Trower J also considered the discretionary factors under s 263(3) which the court had to take into account where it was not bound to refuse permission under s 263(2) (see Q&A here). Amongst other things, the judge considered that the very small size of ClientEarth's shareholding and the fact that it was seeking to continue proceedings of very considerable size, complexity and importance gave rise to a very clear inference that ClientEarth was not acting in good faith in seeking to continue the claim. The judge also concluded that the court had to take into account the overall support of Shell's members for the Directors' strategic approach to managing Shell's climate change risk (with 80% voting in favour of the strategy at the 2022 AGM) when considering a permission application.
ClientEarth subsequently exercised its right under CPR 19.15(10) to ask the High Court to reconsider its decision to dismiss the permission application at an oral hearing.
This Case Feature focuses on issues that arose or were developed at the reconsideration hearing. For a detailed analysis of Trower J's reasoning at the paper stage and more information on the framework for statutory derivative claims, see FC Case Feature 12 June 2023.
High Court decision following the reconsideration hearing
At the oral hearing, Trower J reaffirmed that ClientEarth had not made out a prima facie case for permission to continue its derivative claim. His consolidated judgment gives detailed guidance on the court's role in applying the prima facie test and further consideration to ClientEarth's breach of duty argument.
Prima facie case threshold
Trower J rejected the suggestion that the court must, at the permission stage, take the claimant's evidence at its highest. He agreed with Shell's submission that the test of a prima facie case required the court to take ClientEarth's evidence at its "reasonable highest". This did not mean that the court had to assume that the facts alleged were true: the evidence had to be sufficiently substantial to justify granting permission to continue the claim.
As to the nature of the test at the prima facie stage, Trower J held that ClientEarth was wrong to suggest that the court should treat the prima facie stage as distinct from the substantive application for permission when having regard to the relevance of the permission criteria set out in s 263(3) and (4). As the court was required to take those criteria into account when deciding whether or not to grant permission, they must also be taken into account when assessing whether the evidence adduced by the applicant at the initial stage established a prima facie case.
Breach of Directors' duties
Trower J confirmed his decision at the paper stage that ClientEarth had failed to disclose a prima facie case that the Directors were in breach of their general duties under ss 172 and 174.
At the oral hearing, ClientEarth maintained its case that the Directors were subject to an additional six duties which ClientEarth said were necessary incidents of their statutory duties. However, Trower J observed that there was a "subtle but important shift" in the way ClientEarth put its case on the supplemental duties at the oral hearing compared with the pleaded case. The way the case was pleaded alleged that directors of companies "such as Shell" are necessarily subject to the alleged incidental duties. In oral argument, ClientEarth said that what were described as the incidental duties arose as a matter of logic once it was appreciated that the Directors had already identified that its climate strategy was a commercial objective which was most likely to promote the success of Shell. In other words, by adopting the climate strategy, the Directors allegedly became subject to the incidental duties.
Trower J dismissed this aspect of ClientEarth's case as misconceived. He found that these duties were inconsistent with the well-established principle that it is for directors themselves to determine, in good faith, how best to promote the success of a company for the benefit of its members as a whole. In his view, the court was ill-equipped to intervene with its own assessment of how best to proceed, as the weighing of considerations under the s 172 duty was essentially a commercial decision. In addition, the s 174 duty required the Directors to manage Shell's business with an open mind, having regard to a range of competing considerations. ClientEarth's formulation of incidental duties owed by the Directors assumed that the management of climate risk had an overriding status. However, the Directors' adoption of a climate strategy could not change the nature of the underlying duties in ss 172 and 174. Trower J reaffirmed his earlier view that ClientEarth's formulation of the incidental duties sought to impose absolute duties on the Directors in a manner that was incompatible with their statutory duties.
Trower J also rejected ClientEarth's argument that the Directors were in breach of their s 172 duty on the basis of irrationality, finding that it had incorrectly conflated the concepts of irrationality and good faith. The judge noted the subjective nature of the s 172 duty, which requires the court to consider whether there was proof that a director had acted other than in good faith. Although irrationality could be "part of the mix" when assessing whether the Directors had acted in good faith, it could not establish a breach of duty under s 172 alone. Furthermore, in the context of commercial decision-making, this approach would cut across the principle that there is no appeal to the courts on the merits of management decisions.
In relation to the specific breaches of directors' general duties alleged by ClientEarth, the court held that very little weight could be attached to opinions expressed in a witness statement made by ClientEarth's senior in-house lawyer. The fact the witness believed that the opinions expressed in the statement were widely accepted by governments and capital markets did not, in the judge's view, mean that these opinions could be presented as fact. As the evidence relied on by ClientEarth was not supported by expert analysis explaining why the Directors' strategy was so flawed as to be actionable, a prima facie case for breach of duty could not be made out. Trower J did not accept ClientEarth's submission that it was unreasonable to expect expert evidence to be adduced at this stage.
Even if it was appropriate for the court to place any real weight on ClientEarth's evidence, Trower J emphasised that the Directors had to take into account a whole range of considerations in the management of Shell's business towards promoting its success for the benefit of its members as a whole, and not just their response to the risks posed by climate change. ClientEarth focused on one aspect of the Directors' decision-making and gave no substantial recognition to the fact that the Directors were obliged to balance that feature against many other competing commercial considerations.
Trower J considered that it was useful for the court to ask itself whether, standing back from the detail, an independent director, acting in accordance with their s 172 duty, would consider it appropriate to launch the kind of litigation contemplated in the present case against the entire board of Shell. Trower J's view was that the application and the evidence adduced in support of it admitted of only one answer: such a director would not do anything other than decline to continue the claim. As a result, the court was bound to refuse ClientEarth permission to do so come what may.
By way of confirmation of his decision, Trower J also reiterated his earlier finding that ClientEarth's permission application was not made in good faith. ClientEarth's motivation in bringing the proceedings was different from a balanced consideration of what was in the interests of Shell. The organisation had failed to counter the clear inference that it was acting for the single-minded and ulterior purpose of imposing its own views as to the right strategy for dealing with climate change. Trower J endorsed the application of a 'but for' test as a matter of principle: in essence, where the claim would not have been brought at all but for that ulterior purpose, the claim will not have been brought in good faith.
Trower J confirmed his initial view that the terms of the mandatory order sought by ClientEarth were too imprecise for enforcement by the court. He rejected ClientEarth's contention that the court could fashion the appropriate injunctive relief at the conclusion of the trial. In his view, it would be inappropriate for the court to countenance the continuation of the proceedings where the claim was directed towards obtaining a mandatory injunction and the nature of the relief sought was not described in a form which was both precise and capable of supervision in the event of breach. He noted that the relief sought would also cut across the court's reluctance to interfere with the Directors' bona fide commercial decision-making.
The decision of Trower J to dismiss ClientEarth's derivative claim against Shell at the first stage under the statutory procedure signals the preparedness of the court to give effect to the 'filter' afforded by the prima facie test in cases brought by 'activist' shareholders.
The judgment is notable both for the guidance it contains regarding the application of the prima facie test and for its robust application of orthodox principles in respect of directors' duties.
Regarding the statutory derivative claim procedure, and specifically the approach to be taken to applying the prima facie test at the first stage, Trower J cited the dicta of David Richards J in Abouraya v Sigmund  EWHC 277 (Ch), to the effect that the prima facie test is a higher test than a seriously arguable case and held that although that case had been under the common law rules for derivative claims, a similar approach would apply under the statutory regime. Thus, the question for the court at the first stage of the statutory procedure was "whether, on the face of the case advanced by ClientEarth, and in the absence of an answer by Shell, ClientEarth will obtain the permission it seeks".
For the purposes of the application of the prima facie test, Trower J rejected the notion that the claimant's evidence should be taken at its highest and held that the correct approach in considering whether the claimant had shown a prima facie case was to take the evidence adduced by the claimant at its "reasonable highest". Moreover, if the establishment of a prima facie case requires expert evidence, the judgment firmly supports the proposition that it is incumbent upon the claimant to obtain the court's permission to adduce such evidence so that it can be considered at the first stage.
Regarding directors' duties, Trower J referred to well-established authority, including Howard Smith Ltd v Ampol Ltd  AC 821 and Regentcrest plc v Cohen  2 BCLC 80, as support for the fundamental proposition that it is for the directors themselves to determine, in good faith, how best to promote the success of the company for the benefit of its members as a whole. The attempts by ClientEarth to establish breach of duty on the basis of a 'rationality test' were rejected on the grounds that "good faith, not irrationality, is the cornerstone and an honest but unreasonable and mistaken belief that a particular course of action is in the company's best interests is not sufficient" to establish breach of s 172. This reiteration of the subjective nature of the duty under s 172 constitutes a firm rebuttal of the notion that a public law style test of irrationality might apply to company directors.
Likewise, the judge held that the attempt by ClientEarth to introduce additional duties, whether as necessary incidents of the statutory duties in the case of a company such as Shell, or on the basis of particular decisions already taken by the Directors, was misconceived. The alleged incidental duties would operate to restrict the decision-making freedom of the Directors in a manner that was incompatible with the statutory duties, pursuant to which the Directors are required "to continue to manage Shell's business with an open mind and to continue to have regard to a range of competing considerations". In short, the duties to which the Directors are subject are simply those as set out under CA 2006.
Finally, the judge's view that a derivative claim brought for the primary purpose of advancing a particular policy agenda, in circumstances where, but for that purpose, the claim would not have been brought at all, will not have been brought in good faith, is particularly significant in relation to the prospects of future claims by activist shareholders.
Under s 263(3)(a), the court is required in deciding whether to permit a derivative claim to continue to take into account whether the claimant is acting in good faith. In the present case, Trower J held that ClientEarth had failed to rebut the "very clear inference that its real interest is not how best to promote the success of Shell for the benefit of its members as a whole", but was instead an ulterior purpose in the form of "a single-minded focus on the imposition of its views and those of its supporters as to the right strategy for dealing with climate change risk".
It is clear, therefore, that the court will be astute to recognise where there is a mismatch between the policy objectives espoused by a claimant, on the one hand, and the objectives that the directors are required to pursue in the discharge of their duties, on the other, and that where the pursuit of a singular policy objective is causative of the proceedings, this will militate against the grant of permission to continue. This approach presents an obvious impediment to the pursuit of derivative claims by activist shareholders.
First published on the Corporate News Service on 7 August 2023
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