Derivative claims against directors for alleged climate change mismanagement

By Barry Leon and Eric Morgan

Law360 Canada (March 7, 2023, 10:50 AM EST) --
 Barry Leon
Barry Leon
 Eric Morgan
Eric Morgan
Can directors of a Canadian company be sued in a derivative action for allegedly mishandling climate change risks and energy transition?

ClientEarth, a non-profit organization, commenced a lawsuit against Shell’s board of directors in the High Court of England and Wales seeking to bring such a claim by way of a derivative action in the name of Shell.

Environmental, social and governance (ESG) issues are increasingly prominent concerns for corporate directors, particularly for large, publicly traded corporations. The ways in which, and the extent to which, ESG issues translate into legally enforceable obligations is also a developing area.

The ClientEarth/Shell derivative action claim raises the important question of whether directors can be sued by way of a derivative action in a claim asserting that they failed to manage the risks of climate change and energy transition, allegedly causing harm to their company.

Given that Canadian jurisdictions allow derivative actions, there is the possibility that a similar claim could be brought in Canada, with stakeholders focusing on the personal duties that directors owe to their corporation.

ClientEarth’s claims against Shell’s directors are that:

  • the board has breached its legal duties by failing to manage material risks posed to the company by climate change, leaving the company seriously exposed to the risks that climate change poses to Shell’s future success;
  • it is in the company’s best interest to adopt an energy transition strategy aligned with the Paris Agreement, which will protect the company and long-term shareholder value; and
  • the company is not on track to deliver a 45 per cent reduction in group wide emissions by the end of the decade, as was ordered by a Dutch court in May 2021 — on the contrary, the board has continued to invest in new oil and gas projects.  

The proceeding is seeking an order requiring the Shell directors to adopt a strategy to manage climate risk in line with the Dutch court’s judgment and English company law.

ClientEarth says that its lawsuit is backed by a group of large institutional investors holding over 12 million shares in Shell.

Shell denies the allegations, saying that the directors have complied with their legal duties and that the majority of its shareholders support Shell’s energy transition strategy. Shell also denies ignoring the Dutch court ruling, calling the suggestion misleading. Pending an ongoing appeal, Shell says it took active steps to comply and cites associated investments as evidence.

ClientEarth has brought its proceeding through a derivative claim under the U.K. Companies Act which allows a shareholder to bring a claim in the name of a corporation against a party allegedly causing harm to the corporation.

Under the Companies Act, the court must give permission before a proceeding may go ahead by way of a derivative claim. The court will consider, among other factors, whether the shareholder is acting in good faith; the importance that would be attached to the claim by a director acting in accordance with the duty to promote the success of the company; and whether the shareholder could pursue the claim in the shareholder’s own right. The court will also have particular regard to any evidence before it as to the views of shareholders who have no personal interests in the matter. The court will not give permission where the act or omission has been authorized by the company.

ClientEarth’s strategy is different from a shareholder or other stakeholder proceeding directly against a corporation for climate change-related harm a corporation is alleged to have done. Here, ClientEarth is targeting the corporation’s decision-makers — the directors — for harm that they have allegedly done to the corporation related to allegedly mismanaging the risks of climate change and energy transition.

Canadian corporate statutes permit derivative actions to be brought in the same manner as in the U.K. A court in Canada performs a similar gatekeeping function, with leave from the court being required before a derivative action can proceed. If leave is granted, the litigation against the directors proceeds in the name of the corporation.

While the tests for granting leave under the Canadian corporate statutes are not identical to the test under the U.K. statute, the Canadian and U.K. statutes require the claim to be in the corporation’s interest. For example, under Ontario’s Business Corporations Act, a derivative action cannot be brought unless the court is satisfied that the directors of the corporation will not bring or diligently prosecute the action; the complainant is acting in good faith; and it appears to be in the interests of the corporation that the action be prosecuted, among other factors.

Importantly, a derivative action in Canadian jurisdictions can be brought by parties other than a shareholder. Under Ontario’s Business Corporations Act, a “complainant” can bring a derivative action. “Complainant” includes a current or former shareholder, a current or former director, or any other person who, in the discretion of the court, is a proper person to make an application to bring a derivative action. Groups other than shareholders could therefore consider derivative actions in Canada.

However, ultimately an applicant seeking leave to bring a derivative action in either Canada or the U.K. will need to demonstrate how the action is in the interest of the corporation and how the corporation has allegedly been harmed. As the Ontario Court of Appeal noted in Rea v. Wildeboer, 2015 ONCA 373, a derivative action “is an action for ‘corporate’ relief, in the sense that the goal is to recover for wrongs done to the company itself.” It is also worth considering whether a Canadian court would order a board of directors to pursue a particular course of action on a complex issue like climate change, essentially granting a mandatory injunction that interferes with the internal decision-making of a company and conflicts with the usual deference the court shows to boards under the business judgment rule.

A derivative action may be a method for activists to draw attention to ESG issues, but these actions will only proceed beyond the leave stage where, at a minimum, the ESG issues, or failing to manage the risks associated with them appropriately, have damaged or are damaging the corporation itself.

Whatever the outcome of the ClientEarth/Shell derivative action claim, it is likely that directors of other companies will face ESG claims brought by way of derivative actions. This appears to be a risk about which corporations, their directors and those who advise them will want to be increasingly mindful.

The Honourable Barry Leon is an independent arbitrator and mediator with Arbitration Place, 33 Bedford Row Chambers (London) and Caribbean Arbitrators. He was presiding judge of BVI’s Commercial Court (2015-2018) and is a former chair of ICC Canada’s Arbitration Committee. Eric Morgan is a partner at Kushneryk Morgan LLP where he practises corporate commercial litigation, including shareholder disputes at closely held companies.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the author’s firm, its clients, LexisNexis Canada, Law360 Canada, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

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