Peters & Peters

Activist investors and NGOs leaving regulators in their wake

On May 12, ClientEarth, the environmental law charity, saw its claim against the directors of Shell plc dismissed by the UK High Court. The claim has been touted as a “world-first lawsuit”: a derivative action against directors of a listed company for failing to manage climate-change risks that was backed by institutional investors.

The claim is one of two actions brought by ClientEarth this year, the second being a judicial-review challenge against the FCA (Financial Conduct Authority) for its approval of Ithaca Energy plc’s prospectus.

The two claims reflect a wider trend of activist litigations brought by NGOs (non-governmental organisations) and investors in the United Kingdom and overseas in bids to move the dial closer toward the target of net zero, even when governments and regulators appear to lack the same resolve.

A new type of ESG litigation

ClientEarth claims that Shell’s directors failed to adopt and implement an energy-transition strategy aligned with the Paris Agreement, in breach of their general duties under the Companies Act 2006, thereby posing risks to investors as the world shifts away from fossil fuels. The claim is backed by a group of investors, including two UK pension funds and the Swedish national pension fund.

The dismissal “on the papers” is not surprising. It is not the court’s role to supervise directors, and the judge found that ClientEarth’s evidence did not establish that their actions were outside the range of the reasonable decisions available. The judge also opined that using derivative claims to promote a policy agenda is contrary to their purpose and may limit their use in the future. ClientEarth are challenging the decision, so this is not the end of the matter.

A similar claim against the directors of a pension scheme was rejected last year on the basis that no loss was identified from the failure to devise a plan to divest from fossil fuels. Permission to appeal was granted last November. The door, therefore, remains open for a new judicial approach to this type of claim. If the appellants succeed, it could fundamentally change the climate-change litigation landscape.

The FCA case will also require the court’s permission to proceed. ClientEarth argues that the FCA acted unlawfully in approving Ithaca’s prospectus as it failed to describe the climate-related risks faced by the company adequately. This is the first known action of its kind.

The clear trend in litigation is to hold businesses accountable for addressing climate-change risks. Investors and NGOs are now arguing that their failures to do so pose a threat to investors themselves. Even if the general risk is identified, as it was in Ithaca’s prospectus, these investors expect the impacts to be addressed in detail.

ESG legislation and enforcement

The FCA case is significant in that it focuses on the failure of a public body to enforce existing requirements at a time when the noise is all about the need for new regulations. Even then, the UK Government has been slow to introduce the legislation it claims is needed to support its net-zero ambitions.

The Climate-related Financial Disclosure Regulations, which apply to listed and large private companies, were introduced last year (the FCA adopted equivalent rules for premium and standard listed companies in 2021 and 2022, respectively). As such, we are only now beginning to see reporting under this regime.

Other regulations are still wading through the treacle. One of the FCA’s aims is to create transparency and trust in ESG (environmental, social and governance)-labelled instruments and products through rules on labelling, disclosures, naming and marketing. However, the “Sustainability Disclosure Requirements” consultation paper was only published in October 2022, and the rules will not be enacted until the third quarter of 2024.

One rule that should be implemented next year is the general “anti-greenwashing” rule, requiring all sustainability-related claims to be clear, fair and not misleading. However, this substantially overlaps existing general requirements for regulated firms and the Guiding Principles for ESG funds. It is, therefore, unlikely to be a significant game-changer.

Amidst the push for new tools, there is a notable absence of enforcement. The FCA’s ESG strategy essentially ignores enforcement, focusing instead on engagement and “active investor stewardship”. It would seem that the FCA is content to let investors wield the stick on this issue.

Institutional bodies that have recently announced crackdowns on ESG concerns include the Competition and Markets Authority (CMA) and the Advertising Standards Authority (ASA), with the former currently investigating eco-friendly and sustainability claims made by fashion retailers ASOS, Boohoo and ASDA. The three investigations, announced in January 2022, are the first since the CMA adopted the Green Claims Code in 2021. We can expect further investigations—the CMA publicised in January that there would be ongoing, wider investigations into greenwashing in the “fast-moving consumer goods” industry. However, the outcomes of these investigations have yet to be seen.

The ASA recently announced that it is monitoring carbon-neutral and net-zero claims and is planning to take further action in 2023. However, the body, which has issued rulings against Ryanair, HSBC and Lufthansa in the past two years, has not made public its current investigations. Again, we will have to wait and see what forms its actions will take.

EU trends

The European Commission (EC) is currently attempting to harmonise ESG duties across Europe with its Proposal for a Corporate Sustainability Due Diligence Directive (CSDDD) to tackle human-rights and environmental impacts across global value chains.

France already took the lead on the issue by adopting the Duty of Vigilance Law in 2017, which requires companies to establish a Vigilance Plan to “identify and prevent risks of severe violations of human rights and fundamental freedoms, health and safety of people and to the environment in their entire sphere of influence”.

Armed with the legislation, investors and NGOs filed a number of claims in the French courts for breaches of the Duty of Vigilance. Oxfam France, Friends of the Earth and Notre Affaire à Tous have accused BNP Paribas of financing companies that aggressively develop new oil and gas fields.

BNP was also one of the financers of the East African Crude Oil Pipeline (EACOP), the subject of a separate Duty of Vigilance claim lodged by NGOs against TotalEnergies. The claim was dismissed on procedural grounds. However, it is clear that NGOs are taking the lead where traditional enforcement actions appear to be lacking—or at least not moving sufficiently quickly.

BNP has also announced it will no longer finance new gas field projects, demonstrating the impacts of ESG litigations, which, whilst unsuccessful in the courts, appear to be effecting change in the direction of climate activists.

Specific legislation, though, is not always required for companies to have their feet held to the fire—a Dutch court judgement was obtained requiring Royal Dutch Shell plc to reduce its emissions by a net 45 percent by the end of 2030 based on an “unwritten standard of care”.

What’s next?

As climate change becomes more pressing, activist investors and NGOs are finding new and innovative ways of holding companies to account. Businesses may well find that they are unprepared for the avalanche of ESG litigation that is to come. We will have to wait and see whether the courts find ways to accommodate such claims. But avoiding potentially costly and damaging litigations may be possible only if businesses place themselves in positions to address environmental and supply-chain issues head-on.

This article was first published on 23 May 2023 in International Banker and is republished with permission.