Climate change and directors’ duties: where are we now?

Background

Since 2016, we have seen a flurry of legal opinions and reports, setting out the legal duties of directors and speculating on how these should be applied or could be breached in the context of climate risks. The conclusions were perhaps predictable, not only because of the practices of the authors and sponsoring institutions, but also because the reports simply state the law as it is: where something poses a risk to the success of a company, a director is under a positive duty to ensure that they identify the risks, assess the likelihood and severity of its effects on the company, and take action to mitigate or avoid those risks. 

In England, these duties have been enshrined in statute since the 2006 Companies Act (in combination with common law duties), in particular, the duty to exercise reasonable care, skill and diligence (section 174) and the duty to take into account the impact of the company’s operations on the community and the environment, while promoting the success of the company for the benefit of its members (section 172). Since 1 January 2019, companies must include in their strategic reports, a statement as to how directors have had regard to the matters in section 172(1) in performing their section 172 duty.

It is now accepted that climate change poses three main categories of risks to companies: physical risks, transition risks and litigation risks. Each of these has the ability to directly affect a company’s bottom line (and shareholder value), in the short, medium and long term. Consideration of these risks by companies has come under increasing scrutiny, with governments and regulators increasingly requiring disclosure of and encouraging interrogation of the assessment of these risks both through mandatory reporting regimes and increased adoption of relevant accounting and auditing standards from international bodies. 

More widely, the increased access to information both about the nature of the risks and the way other companies are dealing with them, has the potential to affect the application of directors’ duties in practice in this area and how they may be tested in court. As more information is made available, there is more for directors to educate themselves about and be judged against.

The ClientEarth v Shell judgment

The ClientEarth claim was denied permission to proceed for strictly legal reasons, as well as practical reasons. The legal reasons for refusal included that the case as set out was not considered to have a reasonable prospect of meeting the relevant legal tests. The main practical reasons were that the vast majority of the shareholders of Shell had already voted in favour of the challenged strategy and that there was a strong suspicion that ClientEarth was bringing the claim not necessarily in the best interests of the company, but to push a specific view on the ‘correct’ approach to climate change.

Ultimately, the claim was always going to be difficult where ClientEarth argued not that there had been a failure of Shell's directors to consider the relevant issues, but that they had not come to the right decision. That argument ignores the fact that, despite the general acknowledgment of a climate emergency and the need to cut emissions, climate risk is not the only risk that directors need to take into account when considering how best to safeguard the overall success of the company. Directors can and should take into account the full range of risks and must exercise judgement as to the weight given to each.

Conclusion

That is not to say that directors now have nothing to fear from legal challenges in relation to climate change. The number of climate change related litigation cases worldwide has more than doubled since 2015, with approximately one fourth of all cases being filed between 2020 and 2022. While much of this litigation is against governments, it still affects a company’s ability to do business. This includes, for example, the ability to obtain planning consents, likely future pricing risks, the focus of regulators and regulations, sanctions and customs rules. 

As the understanding of risks and the ability of scientists to better predict the causes, directors will need to continue to keep themselves informed of climate issues, actively consider them among other matters of risk and strategy and document the reasonable bases for their decisions.

Sarah Ellington is a dispute resolution partner at Watson Farley & Williams
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