Recent years have shown a rise in activist shareholders striving to shape corporate conduct around ESG matters, particularly climate change. Institutional investors are increasingly backing such initiatives, driven by the need to showcase their ESG commitments, fulfil investment strategies and reduce risk associated with their investment labels.
In England and Wales, shareholder activism has traditionally taken the form of shareholder resolutions during general meetings. However, investors are now expanding the climate agenda beyond such forums and looking to the courts to put pressure on large corporates. This article looks at emerging shareholder claims related to climate change in the courts of England and Wales and provides an international perspective by briefly considering the position in the US and Australia, two other key jurisdictions.
Claims under the Financial Services and Markets Act
Businesses are facing increasing demands to disclose how their operations and products might impact the climate. Their positions on ESG issues are also becoming distinguishing factors in communications with investors, consumers and the public. However, the more public declarations made, the greater the risk of a discrepancy between words and action, often referred to as the "say-do gap".
Where listed companies make claims about their response to climate change that later prove – or are thought to be – false or misleading, shareholders may resort to causes of action available under Section 90 and Section 90A of the 2000 Financial Services and Markets Act (FSMA).
Section 90 relates to statements in both prospectuses and listing particulars where there are untrue or misleading statements or omissions of necessary information. It enables any person who has acquired the securities (or an interest in the securities) and has suffered a loss as a result of the defect, to claim compensation from those responsible for the defective document. Typically liable will be the issuer and the issuer's directors. There is no express requirement for investors to prove that they relied on the alleged mis-statements or omissions. The fault standard is essentially negligence (albeit with the burden of proof reversed so it is for defendants to show they were not negligent) by virtue of a defence of "reasonable belief" that the contents of the document were complete and accurate.
Section 90A (and its successor, Schedule 10A FSMA) imposes civil liability in respect of untrue or misleading statements in (or omissions from) other information published to the market via a recognised information service. There is also liability for dishonest delay in publishing information to the market. This provides an additional avenue for claims by shareholders who have suffered loss when buying, selling or holding securities. This only applies, however, in circumstances where a person discharging managerial responsibilities (PDMR) at the issuer knew, or was reckless as to whether, the statement was untrue or misleading, or knew the omission to be a dishonest concealment of a material fact or dishonestly delayed making the market announcement. Unlike Section 90 FSMA, there is an express requirement the shareholder must have reasonably relied on the statement to make good their claim and this cause of action is only available against the issuer.
It is likely that the UK market will start to see claims challenging the integrity of climate-related disclosures made by listed issuers, for example, where there has been a mischaracterisation of the company's climate profile leading to reputational damage and a loss of share price. The risk of claims is heightened by the rapid growth in mandated reporting and disclosure requirements and exacerbated by the fact that standards are continuing to evolve, creating a moving target for companies to hit. FSMA claims may also be fuelled by the general growth of the class action market in the UK, supported by the availability of litigation funding. While claims under Section 90A are likely to be more common, given that every announcement to the market creates a potential trigger for liability, these are more challenging claims to bring for shareholders because of the higher fault standard as well as the requirement to prove reliance.
Another avenue for shareholders to challenge a company's approach to climate change risks is via derivative action in accordance with Section 261(1) of the Companies Act 2006 (CA 2006). Derivative claims allow minority shareholders to bring a claim on a company's behalf and for its benefit, typically with a view to challenging the conduct or decisions of the company's directors.
The most prominent derivative action to date in the ESG space was brought by the environmental charity ClientEarth against the directors of Shell. In bringing these claims, ClientEarth claimed to have the support of a group of institutional investors collectively holding more than 12 million shares in the company. The outcome in this case suggests it will be difficult for shareholders to use the statutory derivative action procedure to challenge directors’ decision making relating to environmental strategy.
In summary, ClientEarth alleged that Shell's board of directors breached their statutory duties owed to Shell (including under Section 172 and 174 of the CA 2006) by failing to implement an energy transition plan that aligned with targets set out in the Paris Agreement. Also cited was an alleged failure to comply fully with a May 2021 judgment of the Dutch Court regarding the reduction of the company's emissions.
The procedural mechanism for derivative actions under CA 2006 is complex, involving a permission stage aimed at weeding out weak claims. In considering the case on the papers, the High Court ruled that ClientEarth failed to meet the initial threshold of establishing a prima facie case for granting permission to continue the claim. ClientEarth exercised its right to have an oral hearing, where the High Court confirmed its earlier decision to refuse permission. Interestingly, in a departure from the usual costs rules for applications of this type, the court concluded that it was appropriate for Shell to attend the oral permission hearing and make submissions in this case, ordering ClientEarth to pay Shell's costs for the proceedings. However, ClientEarth has already appealed the costs result and announced its intention to appeal the permission outcome.
ClientEarth sought declarations the directors had breached their duties. In the court's view, the declaratory relief would not fulfil any legitimate purpose: it was not the court's function to express views as to the directors' conduct and the proper forum for ClientEarth to voice its concerns was by way of a vote of the members in the general meeting. The court emphasised that it will not generally interfere in management decisions, particularly where they require directors to balance competing considerations. The court was also critical of ClientEarth's attempts to formulate new and absolute duties in respect of climate change on directors, which cut across their general duties under CA 2006. Notably, the court was prepared to look at ClientEarth's motivation behind the action, which was to publicise and advance its own policy agenda, rather than to secure the directors' compliance with their duties for the benefit of Shell's members as a whole. The court was also interested in the views of other members with no personal interest in the matter, quoting support for Shell's energy transition strategy in votes cast by members at Shell’s previous annual general meetings.
ClientEarth also sought a mandatory injunction requiring Shell's directors to adopt and implement a strategy to manage climate risk in compliance with their statutory duties, which the court said was too imprecise to be suitable for enforcement, requiring constant court supervision. This is likely to be a significant hurdle for any campaign group seeking similar relief.
ClientEarth v Shell is not an isolated example of the derivative action procedure being used to shift the dial on corporate approaches to climate change. In McGaughey v Universities Superannuation Scheme (heard in the High Court and then the Court of Appeal), members of a pension scheme sought permission to continue a common law derivative claim. The common law procedure is generally used only where the statutory route is not available because the minority shareholders wish to challenge the wrongs done to companies further down the corporate chain (a so-called "double" or "multiple" derivative action).
In the McGaughey case, the applicants were members of a pension scheme (the Universities Superannuation Scheme, one of the UK's largest pension funds). They sought to continue proceedings on behalf of the pension trustee company (not the pension scheme itself), against the directors of the pension trustee company. The directors' alleged breaches of duty included direct and indirect investments in fossil fuels. The Court of Appeal found that the applicants could not establish a prima facie case on permission, with the judgment suggesting it will be difficult to harness the common law derivative procedure to pursue climate-related objectives.
Shareholders and others have filed claims in the US alleging climate and other ESG-related misstatements or omissions, thus far without much success. In 2019, a New York judge held that the state’s Attorney General had failed to prove that Exxon had misled shareholders over the true cost of climate change. In particular, the Attorney General failed to establish that Exxon had made any material misstatements or omissions about its practices and procedures that misled any reasonable investor. In 2022, Enviva Inc., a company that develops wood pellet production plants, was sued by one of its investors, who filed a putative securities class action in Maryland alleging the company made false and misleading statements regarding the environmental sustainability of its wood pellet production and procurement. Motions to dismiss that case are pending. Similarly, in 2021, an investor filed a putative securities class action against Danimer Scientific, a biodegradable plastics company, in New York, alleging that statements touting the company’s biodegradable plastic product as revolutionary were merely greenwashing. The court in that case recently granted the defendants’ motion to dismiss, holding that, although the plaintiffs had adequately alleged that the defendants had made some materially misleading statements, they had failed to adequately allege scienter (ie, the adequate intent). It is not difficult to envision additional securities fraud class actions based on alleged climate-related misstatements or omissions, although US law provides various defences to such actions, eg, the failure to adequately allege loss causation and a lack of materiality.
Regulators and in particular the Securities and Exchange Commission (the SEC) have also taken enforcement action in connection with climate disclosures. The SEC charged Vale, S.A. in April 2022 with making false and misleading statements regarding the safety of its dams following the 2019 collapse of the company’s Brumadinho dam. Earlier this year, Vale agreed to pay $55.9 million (disgorgement and penalties) to settle the charges. Similarly, in May 2022, the SEC announced that a US bank had agreed to pay $1.5 million to resolve charges that it had issued false and misleading statements regarding ESG investment policies for certain mutual funds. There have also been recent media reports of the SEC serving ESG-related subpoenas on various investment advisers.
The SEC has also proposed a climate disclosure requirement that, should it become law, is likely to lead to additional litigation.
Australia continues to be an active jurisdiction for climate-related disclosure litigation and complaints. This includes direct litigation by shareholders challenging climate-related commitments, disclosures and policies. It also includes a campaign of legal demands made against institutional investors from fund members seeking to challenge investments said to be not in the best interests of those members. Shareholder litigation risk in Australia is also impacted by heavy regulatory enforcement activity, repeated challenges to project approvals and an active shareholder class action landscape. It will be further impacted by the proposed introduction of a mandatory climate reporting regime, which will have a phased introduction, starting from 2024-25 for Australia’s largest entities. The Australian Securities and Investment Commission – which has identified greenwashing as an enforcement priority – has said that disclosing and managing climate-related risk is a key director responsibility.
To date, there have been no Section 90/90A FSMA claims based on climate-related disclosures in the English jurisdiction. However, given the growth of securities class actions in recent years, including in relation to the social and governance aspects of ESG, and considering the various types of disclosure actions in the US and Australia, a rise in environmental claims seems highly likely, particularly set against emerging mandatory disclosure requirements. Likewise, while it has proven difficult for shareholders to get any traction using the derivative action procedure, the ClientEarth v Shell litigation obtained significant publicity, which may be of equal importance from the perspective of activist shareholders and should not be underestimated.
It is important for boards to remember that it is not only activist shareholders who will be tracking corporate climate-related disclosures and management decisions. Increasingly other shareholders are scrutinising and holding to account the companies in which they hold investments.