Governments, regulators and investors are increasingly aware of the enormity of the climate crisis. The summer of 2021 alone has seen unprecedented extreme weather events: catastrophic flooding in Germany, Belgium and China, a “heat dome” affecting much of western North America, and record wildfires across the US.
Climate change has made its way to the board room and is expected to pose increased risks to companies and their Directors & Officers (D&Os). This can be seen from the recent case in the Netherlands in which the Hague District Court ordered Royal Dutch Shell plc (“Shell”) to reduce its group-wide global emissions by 45% compared to 2019 levels by the end of 2030.
In advance of the forthcoming 26th UN Climate Change Conference (COP26, which takes place in Glasgow in November 2021) we consider the risks to directors arising from climate change and how these may be reduced.
The risk of litigation
In July 2021, the London School of Economics reported that the cumulative number of climate change-related cases (proceedings filed before international, national or regional courts and tribunals) globally has more than doubled since 2015, with over 1,000 in the past six years. Claims are no longer simply being brought against “Carbon Major” companies and governments, but also against directors.
Breach of directors’ duties
Directors have a duty, amongst others, to promote the success of the company for the benefit of its members as a whole. There is an express obligation on directors to have regard to specific factors including the impact of the company’s operations on the community and environment. Directors have a separate duty to exercise reasonable care, skill and diligence.
Directors risk claims for breach of these duties if they fail to understand, consider and/or reduce a company’s environmental impact or adapt green investment strategies.
A case argued on similar grounds was brought in Poland in ClientEarth v ENEA (2019). ENEA was sued by one of its minority shareholders, ClientEarth, as it argued a resolution that consented to the construction of a coal fired power plant risked a breach of the board members’ fiduciary duties of due diligence and duties to act in the best interests of the company. The claimant successfully argued that the project would be an indefensible financial risk to the company, given the rising carbon prices and concurrent falling price of renewables. While the claim was not brought against the directors, it has been reported that ClientEarth put the directors on notice in relation to a breach of directors’ duties for a failure to consider the material economic transition risks with the project.
Derivative Actions
Under English law it is, generally, only the company (acting via its board of directors) that can bring a claim for breach of directors’ duties. A derivative claim is an exception to this general principle; such a claim may be brought in limited circumstances by shareholders on behalf of the company against a director for breach of duty.
We have seen a rise globally in activist shareholders and institutional investors putting pressure on directors and the companies they invest in to do more to tackle climate change. In the UK, this year at Shell’s AGM a shareholder resolution was proposed asking for the setting and publishing of targets consistent with the Paris Climate Agreement (adopted at COP 21 in 2015). A similar resolution was proposed at BP plc’s AGM. Both resolutions did not pass but received significant support (34.47% at Shell and 20.65% at BP plc).
While not an English case, ClientEarth v ENEA also shows how minority shareholders, and in this case an activist shareholder, can influence a company's behaviour.
It is against this backdrop that we may see a rise in derivative actions against directors for breach of duty through failing to properly consider climate change.
Failure to disclose climate risk
Investors and shareholders are increasingly calling on companies to report transparently on climate risks. For example, Climate Action 100+ is a group of over 600 investors managing $55 trillion of assets; it has committed to engage with companies critical to the net zero transition seeking to reduce greenhouse gas emissions and provide enhanced corporate disclosure.
As well as being intrinsically linked to directors’ duties as outlined above, if shares are bought relying on a statement which is false or misleading, directors could face a claim by investors for misstatement or misrepresentation. Claims can also be brought against directors under section 90 of the Financial Services and Markets Act 2000 in circumstances where a prospectus or listing particulars is published which contains untrue or misleading statements and an investor suffers loss as a result.
We have seen litigation in other jurisdictions responding to a failure to properly disclose material climate-related risks. ExxonMobil, its Chairman, CEO and other directors face claims in the US alleging material misrepresentations and breaches of fiduciary duties (e.g. re Exxon Mobil Corp. Derivative Litigation (Montini v Woods) (2019)).
The rise of stricter regulation on climate related disclosures (which we discuss below) will increase this legal risk for companies, and their D&Os.
The prospect of increased regulation
Climate change is now being taken seriously by regulators. In 2019, the PRA introduced rules that require certain financial services firms to nominate a senior manager responsible for identifying and managing financial risks from climate change. Similarly, the FCA brought in new rules in December 2020 that require UK firms with a premium listing to include a statement in their annual financial report which sets out whether their disclosures are consistent with the recommendations of the Taskforce on Climate-related Financial Disclosures (the “TCFD”), and provide an explanation if they are not.
The TCFD was created to develop consistent climate related financial risk disclosures for use by companies, banks and investors. HM Treasury has since published “A Roadmap towards mandatory climate-related disclosures” (available here). This suggests that by the end of 2023 mandatory climate-related disclosures will apply to the majority of UK registered companies, banks, insurance companies, asset managers, life insurers, FCA-regulated pension schemes and occupational pension schemes.
Regulators are also alive to “greenwashing”, defined by the FCA as “marketing that portrays an organisations’ products, activities or policies as producing positive environmental outcomes when this is not the case” or “exaggerating their green credentials”, misleading customers and investors. Companies and directors must ensure any climate change communications are clear, fair and not misleading.
Failure to comply with regulatory rules risks regulatory investigations, civil or criminal proceedings, and fines or other penalties.
What can directors do to mitigate the risks?
Directors need to get ahead to protect themselves against claims. They should ensure that their company is taking proactive steps to:
(a) identify, disclose and mitigate climate and other environmental related risks; and
(b) identify their own environmental impact and emissions (Scope 1 to 3 emissions[1]), and reduce emissions and / or become greener.
Directors may consider nominating a board member or establishing a committee with responsibility for the company’s climate change objectives.
In Milieudefensie et al. v. Royal Dutch Shell plc., the Hague District Court in the Netherlands ordered Shell to reduce its group-wide global emissions by 45% compared to 2019 levels by the end of 2030. In its decision, the Court criticised Shell’s existing sustainability policy, deeming it insufficiently “concrete”, noting that the “policy intentions and ambitions for the Shell group largely amount to rather intangible, undefined and non-binding plans for the long-term”. Any plans or climate change objectives should, therefore, be clear, tangible and well-defined. Simply paying lip service will not be sufficient.
Conclusion
The courts in England and Wales have not yet seen large amounts of climate change litigation especially against directors. Claims against directors are occurring elsewhere (notably the US) and there is now an expectation that financial risks caused by climate change need to be considered by directors.
Society’s expectations with respect to climate change are changing, and the court’s interpretation of what constitutes compliance with a director’s duties, as well as the regulatory landscape, is likely to adapt to reflect that.
In the short-term we expect this will lead to more scrutiny of D&Os from investors and regulators on climate change disclosures and the steps they are taking to mitigate environmental risks and reduce their company’s emissions. In the medium to long term, we expect to see claims in the UK.
Directors need to get ahead - not only for moral reasons to alleviate the financial risks climate change poses to their companies - but also to mitigate against litigation and regulatory risks.
[1] Scope 1 emissions – emissions that a company makes directly, e.g. from its production process or vehicles; Scope 2 emissions – emissions a company makes indirectly, e.g. energy it uses to heat its buildings which is being produced on its behalf; and Scope 3 emissions – all emissions that a company is indirectly responsible for in its value chain, e.g. the extraction of raw materials used in manufacturing products or emissions from gas used by customers of energy providers.
