Risk of climate-related shareholder litigation in UK grows

Claims under the 2006 Companies Act

Under section 171 of the 2006 Companies Act, a director must act, within their powers, in accordance with the company's constitution and only exercise powers for the purposes for which they are conferred. Section 172 makes clear that a director must act in a way that they consider is most likely to promote the success of the company and for the benefit of the shareholders.

Under s172, a director must also consider “the impact of the company's operations on the community and the environment.” Because of this, shareholder activists can seek to bring derivative claims against the directors of a company if they authorise or promote activities that the activists think are detrimental to the environment. While such claims are likely to be unsuccessful because it is difficult to obtain the court’s permission to pursue a claim, non-government organisations (NGOs) and activists may still go on to launch them on the basis that they will generate publicity and have other tactical benefits

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In 2021, for example, two academics launched a claim under sections 171 and 172 of the Companies Act against the Universities Superannuation Scheme Ltd (USS), and its current and former directors. The USS, the largest private pension scheme in the UK, had around £1 billion invested in fossil fuel assets – but said the financial risk that climate change posed to the returns generated by its assets meant it aimed to reach net zero by 2050.

The academics claimed USS had failed to form an adequate plan to address the financial risk posed by climate change. They said USS's continued investment in fossil fuels without a plan for divestment constituted a breach of the directors' duties under sections 171 and 172 of the Companies Act. The academics also alleged that the long-term interests of USS could only be met by an immediate plan for disinvestment, and that failure to devise and implement such a plan as soon as possible was a breach of the directors’ statutory and fiduciary duties.

But in May 2022, a judge refused to give the academics’ permission to pursue the claim. He said that they had not satisfied him that the USS had suffered any immediate financial loss as a consequence of the directors’ alleged failure to adopt an adequate plan for long-term divestment of investment in fossil fuels. Even if they had done so, the judge said, the academics had not demonstrated that they themselves had suffered financial losses as a result USS’s losses. Without this causal connection between the investment in fossil fuels and any changes to their benefits, the claim was unsuccessful.

The action, although unsuccessful, was the first of its kind in the UK. It followed a trend of claims against pension funds, first started in Australia, that take advantage of the fact that pension funds have a clear investment strategy. Because of this, pressure can be put on them by members to divest their investments in fossil fuel companies, they are inevitably the first target for environment-based breach of duty claims.

Claims under the Financial Markets and Services Act

Companies are facing increasing requirements and investor pressure to make disclosures related to environmental, governance and social (ESG) issues in their market-facing information. As a result, shareholder actions for allegedly inaccurate ESG related information under sections 90 and 90A of the 2000 Financial Services and Markets Act (FSMA) – known as ‘greenwashing’ or ‘sustainability washing’ – are likely to become more prevalent.

Sections 90 and 90A of FSMA are often described as opening the scope for ‘securities litigation’ in the UK – such litigation is currently more common in the US, where it frequently takes the form of class actions. The growth of the litigation funding market in the UK means that, where causes of action exist by multiple investors against businesses, mass or collective actions will be easier to launch than ever before.

Despite this, s90 and s90A claims have not been widely used in the UK to date, and these provisions are not yet known to form the basis of any issued ESG claims. Instead, ESG disputes in the UK so far have tended to involve challenge to public policy or planning consents, regulatory complaints and, more recently, directors’ duties’ claims.

However, the financial and reputational risks of potential s90 and s90A claims in the ESG arena – as well as the uncertainty in how these provisions will be applied as a result of their relative novelty – mean that it is important for publicly listed businesses and their legal teams to be aware of these routes of redress for investors now and to take steps to mitigate the risks.

FSMA statutory provisions

Broadly, actions under s90 and s90A of FSMA provide statutory routes for shareholders of listed companies to seek compensation for loss suffered as a result of untrue, incomplete or misleading statements contained in information published by a company.

For a s90 claim to succeed, a prospectus must contain an “untrue or misleading” statement or an omission of information that investors or their advisors would reasonably expect to find in a prospectus for the purpose of making an informed decision about the company and its prospects.

A claimant does not need to show dishonesty or recklessness on the part of the company, but it is a defence for the company to show that it reasonably believed the statement to be true and not misleading or that the omission was justifiable. To bring a s90 claim, the investor must have acquired securities to which the particulars in question apply, but it appears that it does not have to have relied on the false statement or omission.

ESG-related claims under s90 or s90A are most likely to be brought by investment firms committed to ethical investment and who bought shares based on the company’s ESG claims.  That said, any shareholder can in principle bring such a claim and - given the rise in popularity of mass actions - activists could encourage other parties with securities in the company to join any claim under s90 or s90A.

Challenges for ESG claimants

While the breadth of the type of published information which may give rise to exposures under s90A is a concern for companies, the need to show recklessness or dishonesty on the part of directors – and the requirement of reliance – under s90A can be a real obstacle to many investors’ claims. Recklessness or dishonesty is a high bar, though as expectations of directors’ engagement with ESG issues and what that involves increase, it may be easier to identify those who have, for example, “turned a blind eye”.

Regarding reliance, based on the cases to date it appears that the claimant investor must specifically state on which misleading statement or omission it relied and provide evidence that it relied on the statement when dealing in the shares. Reliance on an annual report as a whole will not suffice. This can be particularly difficult given investment decisions are usually made based on the content of a report as a whole, as opposed to one particular statement. This requirement may well, however, be more straightforward for ESG conscious investors to meet.

For either type of claim to be successful, the investor needs to demonstrate that it has suffered financial loss as a result of the false statement. A false ESG statement might not always be directly relevant to a company’s profitability, and it is not possible to claim for purely non-financial matters such as damage to reputation or compromised ethical objectives. We are likely to see a range of approaches by claimants to establishing that they have suffered loss.

For example, ESG-conscious investors may argue that, had they known the company’s true ESG credentials, they would not have bought the shares at all, and so claim back the share price paid. They might also argue that they have suffered reputational damage as a result of having invested in a company which made false statements and that this has caused a demonstrable reduction in new investors.

More standard commercial shareholders may say that, had they known the true position on the ESG credentials, they would have bought the shares at a lower price that was reflective of the correct position. These investors will still need to be able to point to a drop in the company’s share price, which might occur where a company is involved in a well-published “greenwashing”, “sustainability-washing” or other related scandal. Given the growing market focus on the importance of ESG issues, it is likely to become easier to demonstrate a fall in share prices as a result of ESG-related inaccuracies coming to light.

Current trends

While shareholder actions under s90 and s90A of FSMA are becoming more frequent, they are still a relatively novel area of litigation and are not known to have been used specifically in the context of issued ESG claims yet. This means that many of the details of such claims remain untested. This poses a risk to companies, both of the unknown and because investor claimants may have greater scope to make novel arguments.

For example, now, the fact that there is no explicit requirement in a s90 claim for the investor to have relied on the false statement or omission is currently untested in the courts. This may well mean a claim can be brought even if the false statement had no bearing on the investor’s decision to buy securities. Other key issues, including how damages are to be calculated, also remain unresolved.

Overall though, due to the increase in ESG investments, more stringent disclosure obligations on companies and increasing litigation funding options available, the risk of securities litigation is increasing. Following the US pattern, many s90 or s90A claims are likely to manifest as class actions brought on behalf of a group of institutional investors. This unlocks potentially high-value global claims that would otherwise be limited to lower value individual claims. The potential large exposures, reputational issues and costs securities litigation can mean such claims present a significant risk for companies.

Practical steps to manage ESG-related risks

As the risk to organisations posed by s90 and s90A claims grows, it is important to be aware of what can and should be done to protect against such claims. While the risk of claims cannot be avoided in its entirety, good corporate governance is key to protecting against these actions including by factoring ESG risks into financial risk assessments, compliance and training programmes.

Legal teams, whether external or in-house, as well as other advisers should be closely involved in the creation of public documents including prospectuses, annual reports and other investor communications, and also includes the content of websites. They should ensure that detailed, well-documented steps are taken to verify and ensure the accuracy of all ESG statements made.  Directors should independently satisfy themselves of the adequacy of these statements – including by taking an active role in the due diligence and disclosure process and documenting all the steps they take.

Directors and other staff should be provided with regular training on their responsibilities and duties in putting together and approving disclosures. Similarly, insurance should be kept under review to ensure companies and directors are protected. Together, this will provide important evidence that the company reasonably believed in the accuracy of disclosures when made, which should provide a defence to s90 claims and help defeat allegations of recklessness or dishonesty made in s90A claims.