What the Shell Judgment Means for US Directors

The recent decision of a Dutch court in Milieudefensie and Ors. v Royal Dutch Shell plc reinforces the expansion of tort law to climate change issues. As this application of tort increases, directors will need to be aware of and manage the increased risks in order to comply with their company law duties. Investors should also adopt a forward-looking approach to managing climate-related liability risks in their portfolios and consider whether to ask questions of investee companies in their stewardship and engagement. 

In May 2021, the Hague District Court ordered Royal Dutch Shell plc (RDS) to reduce the CO₂ emissions of the Shell group by 45% by 2030, relative to 2019 levels, across all its value chain emissions (scopes 1, 2 and 3) (Milieudefensie and Ors. v Royal Dutch Shell plc C/09/571932 / HA ZA 19-379). The court found that as a result of the CO₂ emissions of the Shell group, certain Dutch citizens would suffer harm, meaning RDS would fail to meet the “unwritten standard of care” in the Dutch Civil Code and fail to act in accordance with the due care exercised in Dutch society. Therefore, the court ruled that RDS must reduce the CO₂ emissions of the Shell group through implementing a compliant Shell group corporate policy. The ruling is provisionally enforceable, meaning that Shell must comply with it during any appeal process.

In determining the unwritten standard of care—what would simply be called the “standard of care” in a U.S. tort law case—the Dutch court considered a number of factors, including how onerous it would be for RDS to meet the standard. The court assumed that:

“the reduction obligation will have far-reaching consequences for RDS and the Shell group [and] could curb the potential growth of the Shell group. However, the interest served with the reduction obligation outweighs the Shell group’s commercial interests”.

From a company law perspective, this is striking. It obliges a company to update its business model and strategy and take actions to meet the emissions reduction obligation which may not be profitable, at least in the short term. This appears to oblige the RDS directors to take actions which, on one view, may not be in the best (financial) interests of the company, narrowly interpreted through a short-term shareholder wealth maximization lens. Yet the court was not applying company law; it was applying tort law. This is not surprising from this wider legal perspective. Companies, like any other legal person, are subject to the rule of law; the fact that committing a tort or acting in breach of the law may be more profitable for the company than not, obviously does not permit the company to commit the tort or break the law. The effect of the court’s decision on RDS’ bottom line does not affect RDS’ requirement to comply with the law, and indeed RDS has stated that it will comply with the ruling.

The Shell case may go well beyond what could be expected today in a U.S. tort law case raising similar climate law claims. Yet directors should be alert to the risk of similar claims arising even in the U.S.

Climate litigation is dynamic and standards of liability are evolving. Where a court might not have intervened five years ago, courts are showing an increasing willingness to rule in favor of outcomes that lead to greater climate action. Whether due to advances in climate science, the growing weight of evidence of the economic and human rights impacts of climate change and the net zero transition, shifting societal norms on the imperative and urgency of climate action, or a combination of these factors—courts are responding. Those seeking to use the courts to accelerate climate action have celebrated a series of landmark judgments in the past 12 months.

Climate change isn’t just a financial, business or systemic risk—although it is those too. It is acknowledged as an existential threat from voices as diverse as the UN Secretary General António Guterres to Treasury Secretary Janet Yellen. Courts apply the law to the facts. Tort law in particular is informed by standards of ‘reasonableness’ and ‘foreseeability’. It would be remiss, in the face of these facts and these shifting societal norms, to assume that courts in the U.S. and across the world will stand down.

Yet it would be equally remiss to say that the Shell judgment means all oil and gas companies need to reduce emissions by 45% by 2030 or they will be in breach of their duty of care under tort law. Even more so, the Shell judgment doesn’t tell us what could be a breach of the duty of care under company law.

But that is not to say that it is irrelevant to directors’ duties and climate change. The Shell case provides an opportune moment for U.S. directors to reflect on and update their understanding of the interaction of tort law standards for proper corporate actions, and corporate law standards for the standard of proper fiduciary conduct.

Directors’ duties and climate change

The need for directors to consider ESG risks generally and climate change risks specifically in order to fulfil their corporate law duties has been discussed extensively. For climate change, see, for example, legal opinions by influential lawyers in Australia, Canada, Japan and Singapore, recent consideration of the U.K. context, and a Primer by the Climate Governance Initiative of the World Economic Forum and Commonwealth Climate and Law Initiative which discusses the implications for climate change on directors duties in 20 jurisdictions around the globe, plus the EU. For an analysis of the position under U.S. law, the Primer has a summary for climate change, while a 2020 memo published by the PRI and Debevoise provides an analysis for ESG risks generally.

In the U.S., directors should be aware of the impact of climate change risk, including the increased risk of tort claims, on their duty of oversight. As well as failures to oversee climate-related regulatory issues, directors may face litigation for alleged failures to oversee and manage operations which give rise to tortious liability.

In 2017 and 2018 alleged failures of the Pacific Gas and Electric Company (PG&E)’s power transmission equipment caused devastating wildfires in drought-affected California, causing extensive property damage and loss of life. Following this, PG&E faced a huge number of civil lawsuits, regulatory investigations, and criminal charges, which led to PG&E facing liabilities of up to USD 30 billion. PG&E shareholders then brought derivative actions against PG&E’s current and former directors for alleged breaches of their fiduciary duties including the duty of oversight, which gave rise to PG&E’s criminal and civil liability losses (Trotter v Chew and Ors. Case No. CGC-18-572326. This shareholder claim has been transferred to the trustee of the fire victim’s trust. It has yet to proceed to trial, but a copy of the complaint can be read online).

Some liability risks may have already been heightened by the effects of climate change. For example, an increase in the frequency and severity of drought and heatwaves as the world warms is likely to lead to more losses similar to those incurred by PG&E underlying Trotter. However, Shell may signal a movement towards an increased willingness of the courts to find that companies may become liable to third parties for the wider effects of climate change caused by their emissions. As we discuss below, such tort law claims are in the beginning stages of litigation in the U.S.

As tort liability relating to climate change expands—and the Shell case and others signals this is happening—U.S. directors’ fiduciary duty obligations will require them, as part of their duty of oversight (which is a duty of loyalty), to pay greater attention to the potential for their company being a tortfeasor. The potential for a company being a tortfeasor is obviously high for a company already issued with proceedings or otherwise put on notice of the risk of litigation. However, the risk could be elevated for a company that is a peer company to one that is found to be a tortfeasor, issued with proceedings or otherwise put on notice, where the alleged tortious activities are common practice to an industry. Recent cases suggest there is an increasing potential for some companies to be found to be tortfeasors. These include oil and gas companies, companies in other high-emitting industries, or companies that operate infrastructure or fixed assets highly vulnerable to the effects of climate change in circumstances where there is a high risk of consequent loss and damage. Directors of these companies could be required to meet an elevated standard of oversight to avoid risks of tortious liability to their companies.

The Shell case is part of a broader trend in tort liability relating to climate and environmental harm

The ability of tort law to cover issues which may be considered to be matters of public or environmental regulation is not novel. Douglas Kyser has written on the Harvey Aluminium litigation (Renken v Harvey Aluminum Inc 226 F Supp 169 (D Or 1963)) as an example of tort law preceding and potentially informing subsequent environmental legislation. Indeed, U.S. courts may come to rule on the same sort of liability as the court in Shell. Although a recent New York decision has held that climate change is a matter for federal regulation, rather than tort law (City of New York v Chevron Corporation and Ors. Case no. 18-cv-182), cases brought in California, Maryland, and Rhode Island have been remanded to state courts, meaning that the case on state tort law may be heard (County of San Mateo and Ors. v Chevron Corp. and Ors. Case no. 17-cv-04929-VC; B.P. Plc and Ors. v Mayor and City Council of Baltimore Case no. 1:18-cv-02357-ELH, cert. den’d B.P. Plc and Ors. v Mayor and City Council of Baltimore Case no. 19–1189; State of Rhode Island v Chevron Corp. and Ors. Case no. 1:18-cv-00395-WES-LDA) (note that the orders remanding these cases are currently under appeal, following the decision of the Supreme Court in B.P. Plc and Ors. v Mayor and City Council of Baltimore Case no. 19–1189). Similarly, the federal court has remanded a claim by Massachusetts alleging breaches of the Massachusetts Consumer Protection Act by Exxon Mobil to the state court (Commonwealth of Massachusetts v Exxon Mobil Corporation Case no. 19-12430-WGY). This consumer law claim by Massachusetts passed a key hurdle this month when the court denied Exxon’s motion to dismiss and will now proceed to trial.

Other common law jurisdictions have also indicated the potential for tort law to cover climate change issues. Recently, an Australian court ruled on a case brought by several young claimants against the Minister for the Environment in respect of the climate impacts of the extension of a coal mine (Sharma by her litigation representative Sister Marie Brigid Arthur v Minister for the Environment [2021] FCA 560 and No.2 [2021] FCA 774). The court held that the Minister owes a duty of care to Australian children when deciding whether to approve the extension of a coal mine. Unlike the Dutch court’s order obliging Shell to change its corporate policy, the Australian court declined to issue an injunction obliging the Minister to refuse permission for the coal mine to be extended. It did, however, state that the Minister would need to consider her duty to take reasonable care to avoid causing personal injury or death to Australian children arising from carbon dioxide emissions when deciding whether to approve coal mine extension. The Minister is appealing the decision.

In Shell, the court ordered the parent company RDS to reduce the emissions of the entire corporate group. The willingness of the court to take into account the corporate group as a whole is similar to several recent cases in which courts have found parent companies liable for the actions of their subsidiaries where the parent company has a degree of control or management over the actions of those subsidiaries. In the U.K., there have been two recent Supreme Court decisions which have reinforced this route for liability—see Vedanta Resources Plc and anor. v Lungowe and Ors. [2019] UKSC 20 and Okpabi and Ors. v Royal Dutch Shell Plc and anor. [2021] UKSC 3.

Considerations for directors and investors

As Shell and the other cases show, it is clear that there is a great deal of uncertainty—and therefore risk—facing companies and their directors on modern tort law claims involving climate change.

In order to ensure that they are complying with their legal duties, boards will need to think expansively about potential tortious liability risks relating to climate change, and ensure they have systems in place to avoid being sued and potentially found liable by a court. This may include considering whether and how to adopt and implement Paris-aligned business strategies that are consistent with emissions trajectories that limit global average warming to 1.5°C. If directors do not take steps today, they may breach their duty of oversight or duty of care, skill and diligence.

Looking more broadly at climate transition plans, there is now some authority that ‘Paris alignment’ requires a decarbonization trajectory consistent with 1.5°C and that this equates to 2030 targets of 45% reduction across all emissions (scopes 1, 2 and 3). While the Shell judgment is not binding on U.S. courts, it is influential. Accordingly, companies with 1.5°C consistent plans across all scopes should consider whether statements that their emissions reduction targets are ‘Paris-aligned’ or ‘science-based’ may expose them to risks of allegations of greenwashing or misleading disclosures.

Investors too should take note of the Shell judgment as a sign of a broader trend towards climate-related tort liability, rather than an aberration, even if the decision is overturned on appeal. In assessing and pricing climate-related financial risks to their portfolio, investors should take a forward-looking approach to the direct and indirect financial consequences that could arise if their investee companies face litigation or liability for tort claims. Investors should expect directors of their investee companies to be cognizant of these legal risks and ask what steps they are taking to avoid being next in the firing line.

And for some investors, the imperative comes not just from financial and reputational risks, but from their own legal duties. For example, pension fund investors—who are also subject to fiduciary duties—may need to consider liability risks to investee companies within their portfolios in order to meet their own fiduciary duties.