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August 12, 2022

Climate risk: Liability tide turning against directors

A recent Malaysian legal opinion adds to the pressure on directors to consider the impact of climate change. Failing to do so is increasingly exposing both companies and individuals to the risk of litigation and fines, as is underlined by a new case against energy major Shell.

By Elizabeth Meager

Oil majors are facing a growing wave of climate litigation, with individual board directors now increasingly on the hook – and the liability risks look to be spreading to other sectors. (Photo by Hoptocopter via iStock/Getty Images)
  • Recent legal opinions have confirmed financial and other corporate executives’ liability for climate risk, with implications for investors.
  • A proposed climate litigation case against Shell in the UK targets board directors, naming 13 individuals for the first time ever.
  • Targeting individuals is seen as more effective at forcing behavioural change, but companies and directors are increasingly exposed to all kinds of shareholder litigation and regulatory attention.

With companies across all sectors under rising pressure from investors and regulators to take account of environmental issues in their financial risk management and reporting, they are now also facing rising legal concerns on this front. Corporate directors are, in a growing number of countries, increasingly liable for failing to adequately consider the impact of climate change on their business, a trend with clear implications for investors and thus capital flows.  

In the past year legal opinions in Hong Kong, India, Singapore and, late last month, Malaysia, have confirmed what NGOs have been saying for years: that company directors and board members are required by law to incorporate climate change considerations into their decision-making processes. Failing to do so could expose them to shareholder litigation or regulatory enforcement.

In an example of what this means in practice, British legal charity ClientEarth in March started action against 13 directors at oil major Shell, claiming they had breached their duty to adequately prepare the company for the energy transition.

The recent legal opinions in Asia, sought by the UK-based Commonwealth Climate Law Initiative (CCLI), are not binding and do not set legal precedent in the same way as a court ruling. They do, however, send a clear signal to boardrooms that they are free to consider climate risk without worrying that they may be breaching their fiduciary duties, says CCLI.

“For those directors that are already proactively considering climate issues and want to set emissions reduction targets and climate-aligned business strategies, the opinion finds that the business judgment rule could protect directors as they navigate the disruption of the net-zero transition,” says CCLI executive director Ellie Mulholland.

That said, it is not necessary for climate-related specifics to be enshrined in law, says CCLI lawyer Alex Cooper. In fact, he adds, being more specific could be detrimental to a country’s broader sustainability goals by making it too clear what is and is not permitted – and therefore too easy to work around.

Arild Skedsmo of Norwegian pension fund KLP points to pros and cons of legal action against companies and directors. (Photo courtesy of KLP)

Investors were generally not keen to remark on the implications of the Shell case directly. The company’s five biggest shareholders – including Norwegian sovereign fund Norges Bank Investment Management and US fund house Vanguard – either did not respond to emailed requests or declined to comment.

However, Arild Skedsmo, senior responsible investment analyst at $95bn Norwegian pension fund KLP, says it can be useful to test both companies and directors on their legal liability on climate change. As of the start of July, KLP held $58m of Shell stock.

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“Ongoing, often protracted, court cases also contribute to negative exposure and increased risk for companies,” Skedsmo tells Capital Monitor. “This is something investors consider, and it is likely to have a negative effect on the attractiveness of a company.

“But there is also the downside risk that an unsuccessful court case could be taken as approval of operations, despite being counter to political goals and social approvals,” he adds.

As to whether KLP would consider joining such litigation, Skedsmo says the fund would prefer “a clear regulatory framework consistent with political goals”. But if other options were exhausted, it would be “sympathetic to exploring a legal avenue”.

The Malaysia climate liability opinion

The Malaysian legal opinion is significant for several reasons. While the country generates just 0.78% of global greenhouse gas emissions, it is a major player in the world’s supply chains, with exports – mostly integrated circuits – accounting for nearly 70% of its GDP.

“Many customers [of Malaysian businesses] have made it clear that if those in their supply chain cannot meet their Scope 3 emissions targets, they will cut these suppliers,” says Sunita Rajakumar, an independent non-executive director and founder of Climate Governance Malaysia in Kuala Lumpur, the local chapter of a wider World Economic Forum programme. “There is a huge amount of pressure on Malaysian companies from companies that do not want to be accused of outsourcing environmental destruction to another part of the world.”

Since April 2021 Malaysia’s corporate governance code has included references to managing sustainability risk, and the central bank has confirmed that financial institutions are required to consider sustainability-related risks.

“A real concern among directors is that they feel they cannot properly consider climate risk because their legal duty is to embrace only short-term profiteering,” says Cooper. “But we want them to know that their duties actually require a long-term view.

“We could next start to see regulatory investigations against boards for failing to do this,” he adds, “because that could now be a violation of their duty to act in the best interests of the company and to act with due care, skill and diligence.”

Shell: A landmark climate liability case

The opinions tackle the same theme as the case brought by ClientEarth against Shell. The derivative action – a claim brought by a shareholder on behalf of the company following a director’s breach of duty – is seen as “strategic”, reflecting a rising trend for such cases, outside the US at least (see chart below). That is, actions being brought with the aim of creating broader changes in society rather than merely winning the case at hand.

It is seen as unlikely to reach the courts but, if it did, the 13 Shell senior directors would be the first globally to be tried for failing to adopt a climate strategy that aligns with the Paris Agreement goal to keep the global temperature rise to below 1.5°C by 2050.

Bringing claims and seeking legal opinions about the liability of individual directors on climate are relatively new activities. Cases addressing historic wrongdoing, which are often seeking damages or other remedies, are more likely to focus on corporate liability. Shell is no stranger to such actions – in August 2021 a judge ruled that it must pay $111m to communities in southern Nigeria for a series of crude oil spills dating back to the 1970s.

Director liability is more appropriate when seeking a current or future behavioural change from a company, says Russell Butland, counsel at law firm Allen & Overy in London, who advises big companies and financial institutions on commercial disputes.

“The risk to individual directors is under-appreciated because much of the focus to date has been on corporate liability [for climate],” he tells Capital Monitor. “But the letter of action against Shell shows that individuals will be targeted, whether because there’s a truly meritorious legal claim against them, or as a campaigning tactic.”

Shell has been a particular target for non-government organisations in recent years. In May 2021 it lost a case, in which a judge made history by ordering the oil major to accelerate its transition plan. Shell is appealing the decision.

Climate claims proliferating

Whether or not the Shell case makes it to court, the impact on the company’s share price could be significant, given the potential reputational damage. That could in turn prompt a flurry of subsequent claims from bigger investors.

And oil majors are not the only companies facing landmark legal actions.

ClientEarth and Dutch campaign groups are taking legal action against Dutch airline group KLM for misleading adverts that promote the sustainability of flying, in the first lawsuit to challenge airline industry greenwashing. And in the finance sector, German and US regulators last year launched an investigation into whether German asset manager DWS had overstated its sustainable investment credentials.

If individual directors themselves end up on receiving end of shareholder litigation and regulatory fines related to climate change – whether they say too much or too little on the subject – that may well focus their minds more on this topic.

Capital Monitor is hosting a webinar series: ‘Making Sense of Net Zero’. Find more information at NSMG.live.

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