UK Court of Appeal confirms derivative action relating to climate change should not proceed

In 2022, the High Court decided that an application for a common law derivative action against the directors of the USS (Universities Superannuation Scheme) pension scheme alleging breaches of directors’ duties (including in relation to climate risk handling issues) should not be allowed to proceed. 

An appeal against this decision has also now been dismissed by the Court of Appeal. 

This is one of two recent cases in which permission to proceed with a derivative action has been denied concerning directors' handling of climate risks. The other case involved a High Court decision in an action brought by ClientEarth against Shell’s board of directors under the statutory derivative action mechanism (see our previous blog post).

Key Takeaways

• Stakeholders that are not shareholders in a company will need to consider very carefully whether they have standing to bring a “derivative action”, being a claim against the directors of a company on the company’s behalf.
• The case reconfirms that the test for permission for a common law derivative action (which is separate from the derivative action regime under the Companies Act 2006) is very high. Claimants need to show a prima facie case that directors have committed a deliberate or dishonest breach of duty or have dishonestly benefited themselves at the expense of the company, that this has caused the company to suffer loss and also that the claimants have suffered loss which is reflective of the company's loss. 
• Like the Judge in the ClientEarth case, the Court was reluctant to see the derivative action mechanism used to further a policy agenda or to challenge the investment decisions of the directors. The Court did consider that other routes (such as a breach of trust claim) may be more appropriate. It remains to be seen whether such approaches will be taken by other individuals or NGOs, although there are significant procedural hurdles to such claims. 
• Even where unsuccessful, such claims often result in publicity and public scrutiny of the company involved and its climate strategy, which can consume significant management time and attention. However, the emphasis on the significant amount of evidence and detail required at the initial stage to meet the relevant thresholds may ultimately prove cumbersome and off-putting to potential claimants. 

Background facts

Universities Superannuation Scheme Limited (“USSL”) is a company limited by guarantee, which acts as the trustee and administrator of the Universities Superannuation Scheme (one of the largest private occupational pension schemes in the UK). 

The claimants were two members of the pension scheme. They sought to bring a derivative action on behalf of USSL against its current and former directors for breach of directors’ duties and equivalent equitable duties. 

As USSL is a company limited by guarantee, it is not subject to the statutory regime under the Companies Act 2006 for shareholder derivative actions (unlike the recent case of ClientEarth v Shell). 

The claimants argued that the USSL directors had acted in breach of their statutory duties because: 

• the directors should have taken into account later valuations which gave a more favourable picture of the fund’s assets, post the Covid pandemic (the “Valuation Claim”),
• the proposed cuts to pension scheme benefits and increase in contributions amounted to unlawful discrimination because female, younger and/or black and minority ethnic beneficiaries would be disproportionately affected in comparison to older staff members who are more likely to be white males (the “Discrimination Claim”),
• there had been dramatic increases in the costs of running the USS scheme (the “Costs Claim”); and 
• the scheme directly and indirectly invested in fossil fuels, which was contrary to USSL’s plan of being carbon neutral by 2050, was not in the beneficiaries’ financial interests, and USSL did not have a credible divestment plan (the “Fossil Fuels Claim”). 

This post will focus on the issues considered by the court and the court’s findings in respect of the Fossil Fuels Claim. 

Procedural background 

The claimants needed the court’s permission to continue a derivative action. In December 2021, permission to proceed was denied without an oral hearing. The High Court allowed the claim to go to a hearing (in accordance with the relevant procedural rules), but again denied permission following the hearing in May 2022. 

An appeal against that decision was made and the Court of Appeal has now issued its judgment which dismisses the appeal on all grounds and confirms that the derivative action against the USSL directors cannot proceed.

The nature of the Fossil Fuel Claim 

The claimants argued that the pension scheme’s continued investment in fossil fuels without any (or any adequate) plan for divestment constituted a breach of the directors’ duties under the Companies Act 2006, i.e. to:

• act for proper purposes (Section 171), including by making investments that avoided a significant risk of financial detriment to the pension scheme, and
• promote the success of the company, including with regard to its long-term interests (Section 172). 

They also claimed that the directors had failed to take relevant considerations into account, including the 2015 Paris Agreement, the results of an ethical investment survey in November 2020 and calls by the University and College Union and individual universities to sell the scheme's investments in fossil fuels. The claimants alleged that, as a result of these failings, the interests and success of USSL had been prejudiced and USSL had suffered loss. 

Regarding the approach taken by USSL to fossil fuel investment, there had been evidence before the first instance court (and the Court of Appeal) that the directors had taken account of climate change risks in its decision making, had established a guiding set of principles to move towards net zero, were undertaking a climate data review and that the board had received annual updates and training on climate change, the most recent training having taken the view that divestment was not the proper way of achieving net zero. Conversely, the claimants submitted that the company’s long term interests could only be met by an immediate plan of divestment and in not having one the directors had taken an irrational view and had favoured themselves over its members.

Appeal 

The Court of Appeal addressed three main issues, all of which were relevant to the Fossil Fuels Claim:

• does the common law test for a derivative action require a claimant to show that the company has suffered loss and that the claimant has suffered loss which is “reflective” of that loss (Issue 1);
• under the common law test for a derivative action, what kind of “improper benefit” on the part of the directors needs to be established (Issue 2); and
• what is the right approach for determining whether the claimants had a prima facie case regarding the alleged breach of duty (Issue 3).

The Court of Appeal also heard a challenge against the judge’s finding that, even if the claimants had established a prima facie case for the Fossil Fuels Claim, he would not have exercised his discretion to permit the claim to be continued as a derivative action (Issue 4). 

In summary, the Court of Appeal found as follows:

Issue 1 - Loss

The Court of Appeal confirmed that:

• the first and essential element of any derivative action is that the claim is brought for the company in order to seek a remedy for a loss or harm suffered by the company which would not otherwise be remedied and is for the benefit of the company; and 
• a claimant must show they have suffered harm which relates to or correlates with the harm suffered by the company. Otherwise, there is a clear risk that the derivative action is being brought for an ulterior purpose i.e. to further the claimants’ individual grievances in the name of the company. 

The Court of Appeal noted that the derivative action regime was not designed to monitor or question the general decision making of the directors, it is to be used only exceptionally, and the suffering of loss is a part of what justifies an exceptional use of this remedy. 

In relation to the Fossil Fuels Claim, the Court of Appeal agreed with the High Court judge that there was no evidence that: (a) USSL had suffered any loss as a result of the alleged breach of duties relating to the investment strategy on fossil fuels; or (b) that there was a causal connection between the investment in fossil fuels and the claimants’ benefit changes under the pension scheme.  

Issue 2 – Improper benefit

The Court of Appeal reaffirmed the High Court judge’s finding that the claimants had to establish a prima facie case that the defendants had committed a deliberate or dishonest breach of duty or that they had improperly benefited themselves at the expense of the company. It confirmed that the improper benefit did not need to be a financial benefit (and the first instance judge had not so limited it). 

As regards the Fossil Fuels Claim, the Court of Appeal agreed that there was no evidence to show that the directors of USSL were acting in bad faith or were furthering their own interests and putting their own beliefs regarding fossil fuels above the interests of USSL and the scheme beneficiaries. 

Issue 3 – Prima facie case

A prima facie case is a higher than seriously arguable case. The Court of Appeal confirmed that, to decide whether there was a prima facie case of fraud, as alleged, it was necessary for the judge to look at the totality of the evidence before him, including any evidence submitted by the defendants (i.e. the company and the directors). However, the Court of Appeal also confirmed that, where the issue to be considered is not one that can be answered on the documents, such as whether a director is acting in good faith to promote the success of the company for the benefit of members as a whole, it should not be assumed that the evidence submitted for the company/directors will be accepted at trial and the claimant’s evidence should prevail for the purposes of determining whether there is a prima facie case. 

As regards the Fossil Fuels Claim, the Court of Appeal agreed with the first instance judge’s finding that no prima facie case regarding breach of duty had been established. It noted “…the Fossil Fuels Claim is an attempt to challenge the management and investment decisions of USSL as trustee without any ground upon which to do so. There is nothing in the pleading or the evidence to suggest that USSL has exercised its powers in an improper fashion. In all the circumstances, this was a claim which was bound to fail.” 

Issue 4 – Exercise of discretion

The Court of Appeal agreed with the judge’s conclusion regarding the exercise of discretion, as the claim was well suited to be brought as a direct claim in breach of trust and there was no reason to bring the claim as a derivative action, except to avoid the difficulties in relation to costs and representation of the alternative route (see more below). The Court of Appeal noted that “…The derivative procedural mechanism is not intended to enable would be claimants to avoid other procedural hurdles. It is an exceptional remedy when a wrong would otherwise go unremedied. In effect, the Fossil Fuels Claim is a challenge to USSL’s investment policy and should be brought against it as just that.”

What’s next?

It is worth noting that the Court of Appeal said the Fossil Fuels Claim was more suited to being brought as either:

• an administrative action, where a beneficiary of a trust commences an action against a trustee to compel them to take steps to enforce a claim vested in them (such as a claim against a director of a corporate trustee who in breach of duty causes the corporate trustee to commit a breach of trust); or 
• a “beneficiary derivative action”, where a beneficiary of a trust brings an action in his own name on behalf of the trust against a third party.

In either scenario, it would have been necessary for the claimants to follow a different procedure, known as a representative action under Civil Procedure Rule 19.8. The claimants in this case would have needed to identify the other members of the pension scheme who had the same interest as theirs (which may not have been all scheme members). It remains to be seen whether either route will be used in the future by trust beneficiaries who are dissatisfied by the approach of trustees to fossil fuel investment.  

A copy of the judgment of the Court of Appeal is available here.

It is understood that the applicants, Mr McGaughey and Mr Davies, are considering their options to appeal the judgment. The grounds for any such appeal have not yet been articulated.