Environmental decision making in the boardroom
Recent times have seen the emergence of environmental and social governance (“ESG”) as something at the front of directors’ minds. According to PwC, ESG is “a framework for businesses to consider the impact and dependencies on the environment and society, along with the quality of their corporate governance. It encompasses all non-financial topics that are not typically captured by traditional financial reporting.” Essentially, then, ESG is where businesses think about environmental and social responsibility implications when they make their decisions. The growth of ESG has partly been a result of a recognition that things like climate change, energy vulnerability and unsustainability pose a major risk to profits and reputation alike. Sustainability, therefore, is good for business.
But how can ESG be incorporated into ordinary company decision making? The day-to-day operation of a company is typically conducted by its directors, appointed either by shareholders or by resolution of the board itself. Directors will be responsible for making decisions, furthering the company’s aims and making sure the business is complying with its regulatory obligations. When taking decisions, directors are under various statutory duties. Many of them are set out in chapter 2 of the Companies Act 2006.
General Duties under the Companies Act 2006
Section 172 of the Companies Act 2006 provides that directors must act in the way which they believe would promote the success of the company for the benefit of its members as a whole. It is generally recognised that in this context, “success” means ‘long-term increase in value’. In so doing, they must have regard to “… (d) the impact of the company’s operations on the community and the environment…”. This is one of six mandatory considerations which directors must weigh to properly exercise the section 172 duty. Others include the likely consequences of any decision in the long term and the need to act fairly as between members of the company. In practice this means that each factor could be recorded in board minutes to demonstrate that it has been thought about.
ClientEarth v Shell Plc [2023] EWHC 1897 (Ch)
The case of ClientEarth v Shell Plc [2023] EWHC 1897 (Ch) presents an interesting example of where the “community and the environment” has been used to hold directors (and the companies they control) to account. In ClientEarth the environmental charity had purchased 27 shares in Shell, the well-known oil and gas company. The charity, as shareholders, then brought a derivative claim against Shell’s directors on the basis that they had failed to act in a way that promoted the success of the company.
A derivative claim is a claim made by shareholders (on behalf of the company in which they have a shareholding) against the directors for alleged breach of directors’ duties, or any other cause of action vested in the company. Shareholders ‘derive’ their ability to bring the claim from the company.
Relying in part on the “community and the environment” factor, the charity alleged that Shell’s efforts to produce a strategy to reduce their carbon emissions were inadequate. Shell had recently published its Energy Transition Strategy outlining how it intended to reduce its carbon emissions. However, ClientEarth asserted that the strategy failed to set appropriate targets and was incompatible with legal rulings in other jurisdictions which directed Shell how to behave in relation to its emissions. In those circumstances, no reasonable director would have allowed the Energy Transition Strategy to be published in its final form. Rather, a reasonable director would have included targets and made it much more comprehensive such as by setting out a more complete methodology for how carbon reduction was to be achieved.
Derivative claims are notoriously difficult to succeed in. There are two permission stages at court which claimants have to surmount before they even get to a final substantive hearing. In ClientEarth, the charity failed at the first permission stage. The court held that the evidence fell short of there being a prima facie case that the way in which the company was being managed could not properly be regarded as being in the best interests of the company’s members as a whole.
Final Remarks
That directors must have regard to the impact of their decisions on the community and the environment is a good thing. It enables directors to bring ESG into the boardroom and gives companies the ability to have their cake and eat it: i.e. to have a positive impact on nature while making profit and boosting their reputation. But the “community and the environment” is of course just one of six factors in a non-exhaustive list. Moreover, considerations will almost always invariably pull against one another and directors will be left to make a value judgement as to which should be given primacy. There is nothing to elevate the “community and the environment” criterion above others. Perhaps there should be. Either way, as ESG becomes more important we are likely to see more claims like ClientEarth in the courts in the future.
