[authors: Kimberly Logue and John Peiserich]
The material in this paper was researched, compiled, and written by J.S. Held. It was originally published in Natural Resources & Environment (NR&E), a quarterly magazine published by the Section of Environment, Energy, and Resources of the American Bar Association (SEER).
Mitigating climate change impacts is becoming a critical business priority, and the pressure to achieve corporate sustainability objectives is mounting as investment-focused regulations continue to drive companies toward net-zero emissions. While the focus remains largely on compliance with these regulatory mandates and other similar guidance, a new private judicial strategy is emerging in Europe to force corporate commitment to emissions reduction through shareholder derivative lawsuits.
Though similar suits have yet to gain traction in the United States, shareholder derivative litigation is nothing new to American jurisprudence. American courts have already recently seen a surge of shareholder derivative actions focused on the “S” component of ESG—namely, allegations that companies have failed to satisfy their fiduciary duties with respect to sexual misconduct and diversity and inclusion. It is not a leap to anticipate that this type of activist shareholder litigation could expand, as it has in Europe, to environmental and sustainability concerns. Accordingly, corporate lawyers should encourage senior executives to take proactive steps now to mitigate the risks of potential future litigation and judicially-mandated corporate reform.
Derivate shareholder actions have a long history in the United States and were first filed in the early 1830s. Once seen as a cornerstone of corporate law, commentators have periodically sounded the death knell for these types of suits in favor of more modern means of policing corporate governance like securities class actions. However, a 2010 empirical study demonstrates that derivative shareholder litigation remains alive and well in the 21st century with an average of more than 200 such lawsuits filed each year. A brief scan of the headlines reinforces this conclusion. In 2020, Wells Fargo made global news when it agreed to the largest derivative shareholder lawsuit settlement ever—$320 million. It only makes sense that the frequency of cases filed is likely to increase in economically turbulent times when stakeholder returns are less healthy.
Perhaps the reason that derivative shareholder litigation is sometimes assigned a premature expiration lies in a distinction from traditional civil litigation. In contrast to a typical plaintiff who files suit to recover a loss to a direct financial interest, a shareholder derivative suit plaintiff asserts claims on behalf of the corporation against its directors or officers with any recovery going to the corporation itself. Derivative suits can include a variety of subject matters such as self-dealing, mismanagement, waste of company assets, transactional objections, or breaches of the fiduciary duties of loyalty and care owed to the corporation. Relatively few of these actions end with the corporation receiving headline-making monetary payouts. Instead, they more commonly end in settlements that may encompass changes to corporate governance practices, board composition, and executive compensation.
The real value of contemporary shareholder derivative litigation lies not in achieving a windfall for the company but in policing management and forcing corporate governance reform. As recent case law has shown, derivative actions can also be an effective vehicle for obtaining corporate documents. In Delaware, where many companies choose to incorporate, shareholders have long held a statutory right to demand inspection of corporate books and to take discovery upon demonstrating a “proper purpose.” Unsurprisingly, businesses often resist such pre-suit attempts to explore the factual basis of potential claims. In December 2020, however, Delaware held that shareholders need not specify the “ultimate objectives” of their investigation or establish that any corporate wrongdoing would be “actionable.” Instead, a shareholder need only provide a “credible” basis—the lowest possible burden of proof—from which a court can infer “possible mismanagement as would warrant further investigation.” Companies should anticipate this to encourage pre-suit inspection demands that are more aggressive in scope and to create risk beyond traditional litigation costs.
Of course, derivative shareholder lawsuits are subject to specific procedural requirements which may be utilized as corporate defenses. These vary somewhat by jurisdiction, but state and federal rules almost universally require that a derivative plaintiff demonstrate that a pre-suit demand was made on the board of directors. However, this requirement can be excused as “futile” if the board would face a conflict of interest such as where the action alleges board or executive misconduct. Courts recognize the unlikelihood that management will voluntarily sue itself. One recent study showed that derivative plaintiffs made a pre-suit demand in only 15.4% of cases. The demand requirement also does not eliminate disputes over the adequacy of a demand.
From the beginning, Europe has led the way, globally, for increased attention on sustainability in business practices and responsible investing. The term “ESG” was, itself, coined on an international stage before it became commonplace vernacular for American policymakers and corporate leaders. In 2021, the European Parliament was the first to propose sustainability reporting requirements which obligate businesses to regularly disclose information on their societal and environmental impacts. The proposal was overwhelmingly adopted in November 2022. As early as 2017, the International Task Force on Climate-Related Financial Disclosures issued practical guidance concerning accurate and timely disclosure of the potential impacts of climate-related risks and opportunities. In January 2022, the United Kingdom became the first European Union country to enact nation-specific laws mandating certain ESG disclosures.
This historical trend supports utilizing European ESG activities as a leading indicator of what is to come for ESG in the United States. In terms of climate-related litigation, May 2021 was a watershed moment for prospective plaintiffs as a Dutch court held Europe’s largest private oil company, Royal Dutch Shell, civilly liable for its contributions to climate change. Filed in 2019, Milieudefensie v. Royal Dutch Shell alleged that Shell’s oil and natural gas production violated a duty of care and the company’s human rights obligations. Instead of demanding damages, the nonprofit plaintiffs asked that Shell be ordered to reduce its carbon emissions. Shell defended that climate change is a broader social issue and that it was not appropriate to hold an individual defendant responsible. The court disagreed, finding that the applicable standard of care necessitated emissions reduction in line with United Nations guidance for member states. The court ruled that Shell’s existing plan to lower emissions by 20% by 2030 was “not concrete and is full of conditions […] that’s not enough.” Shell was ordered to cut emissions by 45% by 2030. The court also extended Shell’s responsibility to include a “significant best-efforts obligation” with respect to its suppliers’ emissions.
Shell has appealed the decision; however, the court’s ruling that companies must comply with global climate policy in addition to applicable emissions limits has already begun to usher in the filing of other private civil lawsuits in Europe aimed at forcing corporate responsibility for climate change. In a novel move in the United Kingdom in March 2022, nonprofit ClientEarth gave notice of shareholder claims seeking to hold Shell’s directors personally liable for failing to devise a corporate strategy aligned with a transition to net zero emissions. The notice letter alleges that directors violated statutory duties, including the duty to act in a way that best promotes the company’s success for the benefit of its members and to exercise reasonable care, skill, and diligence in the discharge of their duties. The directors’ mismanagement is claimed to have endangered Shell’s long-term commercial viability and economic competitiveness.
Volkswagen is facing a similar shareholder lawsuit in Sweden. In an action filed in October 2022, shareholders demand a change to the company’s articles of incorporation to require the board to provide more extensive information about direct and indirect climate change lobbying activities. According to the claimants, membership in various associations that run counter to Volkswagen’s public commitment to a green transition may result in reputational damage and endanger the security of shareholder investments.
This growing use of derivative shareholder claims to address climate concerns has not yet found footing in the United States. At least two recent state court decisions have rejected attempts to inject sustainability considerations into American business litigation. Three years before Milieudefensie was decided, New York v. Exxon asked whether, under federal securities law, ExxonMobil’s public disclosures of models estimating future supply and demand misled investors on how the company was making project planning decisions today. The court rejected these claims, finding that “[n]o reasonable investor during the period from 2013 to 2016 would make investment decisions based on speculative assumptions of costs that may be incurred 20+ or 30+ years in the future with respect to unidentified future projects.” In denying the state’s demands, however, the court noted, “this is a securities fraud case, not a climate change case,” indicating a potential distinction if a different cause of action had been filed.
More recently, in Earth Island Institute v. The Coca-Cola Co., a District of Columbia court dismissed an environmental nonprofit’s claims that various corporate statements about sustainability initiatives, including those regarding the company’s container recycling practices, constituted false and deceptive marketing practices. Unlike the Milieudefensie court, which held Shell at fault for not making more “concrete” climate change commitments, the District of Columbia found that Coca-Cola’s statements about its environmental goals were not provably false or plausibly misleading as they were only “forward-looking or aspirational statements.” The court reasoned that there was no precedent for the plaintiff’s claims “in part because the law does not regulate expectations. Moreover, goals cannot be promises.”
Even though climate change-driven business litigation has yet to gain traction in the United States, the “S” component of ESG has already made its way into American courtrooms. Recent social movements like #MeToo and Black Lives Matter have spurred derivative shareholder litigation focused on corporate sexual misconduct and diversity and inclusion.
In 2019, shareholder derivative actions were filed against directors and officers of Google parent, Alphabet, Inc., that alleged breaches of fiduciary duty, unjust enrichment, and corporate waste. These claims were based on a purported “culture of concealment” by management that covered up a pattern of sexual harassment and discrimination by male executives. Alphabet ultimately agreed to a global settlement that included the devotion of $310 million to diversity and inclusion initiatives and reforms to various governance, incident investigation, and reporting processes.
The year 2020 saw a similar wave of novel shareholder derivative suits alleging executive failure to act on corporate commitments to diversity and inclusion. In July 2020, a shareholder filed suit against twelve members of the Facebook board of directors asserting claims for breach of fiduciary duty, abuse of control, unjust enrichment, and securities fraud violations. The complaint alleged that, despite public statements touting commitment to diversity and inclusion (including the company’s SEC filings and its annual report to shareholders), directors had failed to achieve diversity among senior executives, engaged in discriminatory hiring and pay practices, allowed discrimination against Black employees, facilitated discriminatory advertising, and failed to restrain hate speech on its platform. The plaintiff sought numerous remedies including financial commitment to promoting diversity and inclusion, the resignation of board members, and the appointment of diverse replacements. She argued in her complaint, “Platitudes in proxy statements are not progress,” and alleged that Facebook’s board had “deceived shareholders and the market by repeatedly making false assertions about the Company’s commitment to diversity.”
The same month, another shareholder derivative lawsuit was filed against fourteen Oracle board members making similar claims for breach of fiduciary duty, abuse of control, and securities fraud violations based on allegations that directors had consistently refused to appoint Black individuals to the Board and engaged in compensation and hiring discrimination despite representing in proxy statements that the company had numerous internal policies and controls to ensure diversity at both the management and board level.
Even if ultimately dismissed, these lawsuits and numerous others like them have placed increasing pressure on corporate America to back statements about corporate commitment to prominent social issues with real action under the “S” of ESG. It is not a stretch to anticipate that derivative shareholder litigation may move toward demanding similar sustainability-focused and judicially-driven corporate reform under the “E” of ESG. The United States Supreme Court has itself already waded into the climate change debate in West Virginia v. EPA with Justice Elena Kagan warning in her dissent that, “[t]he Court appoints itself—instead of Congress or the expert agency—the decision-maker on climate policy.”
Corporate boards, executive leadership, and those who advise them should expect continued pressure and accountability for sustainability-related disclosures, recalling that ESG is the reporting component of sustainability as well as initiatives whether they be regulatory, political, or judicial. There are, however, measures businesses can take now to mitigate the risk of activist shareholder derivative litigation.
View Sustainability as a Business Opportunity
Gone are the days when companies could view sustainability as aspirational or limited to greenhouse gas reporting. In today’s global economy, investors, shareholders, customers, and even employees are increasingly choosing to entrust their dollars and talents to companies committed to sustainability goals, and they are pressing for transparency in what corporations are doing to increase their sustainability.
By the beginning of 2020, sustainable investment had reached $35.3 trillion in Europe, the United States, Canada, Australasia, and Japan—a 55% increase from just four years earlier. Virtually every institutional investor has ESG fund offerings. Even average Americans are paying increasing attention to sustainability-conscious investing. A 2019 Morgan Stanley study reported that 85% of individual investors surveyed were interested in sustainable investing, a 10% increase from 2017. Among millennials, the fastest growing investor demographic, 95% were interested. If companies are not proactive in their approach to sustainability, they risk falling behind in a competitive global investment market. By the end of 2021, 81% of Russell 1000® publicly-traded companies had published a sustainability report, which included 96% of the companies on the S&P® 500 Index.
Focusing on sustainability can also strengthen risk assessment and management, inform innovative strategy development, and help identify growth opportunities. Corporate attention to supply chains can promote volume growth and encourage premium pricing through the development of customer loyalty. A company’s commitment to sustainability can also increase its attraction to talented employees and improve job satisfaction, which has been shown to result in stronger corporate performance.
Exactly how a company should address sustainability in corporate strategies will depend on their industry or sector. But it is clear that companies can no longer afford to downplay sustainability’s importance to remaining competitive in a global market.
Make Sustainability a Permanent Fixture of Board Discussions
Even organizations with progressive sustainability goals can fail to meet their targets if they do not adequately prioritize or elevate them to the Board or executive level. Senior leadership should be involved in identifying which sustainability factors are most important to operations, shareholders, investors, and customers. Board governance and meeting agendas should be structured to allow consideration of material factors in company strategy development discussions. This does not mean that every board meeting should include extensive sustainability debate, but there must be a clear plan for integrating sustainability considerations into the business. This should include a clear division of responsibilities for the various components of sustainability among individual board members and any committees as well as an understanding of how often sustainability topics should be on the board’s agenda and the level of information to be presented. Failing to involve senior executives in sustainability oversight may produce undefined corporate goals, unclear ownership of those goals, siloing important and relevant information, inadvertently creating gaps in risk coverage, or failing to achieve a consistent approach across business units and locations. Sustainability is too broad and too complex for bolted-on treatment as an isolated initiative.
Including sustainability as a regular board agenda item also has the ancillary benefit of potentially restricting a potential shareholder plaintiff’s access to company documents if a legal dispute arises. The Delaware Supreme Court signaled in a recent opinion that observation of traditional corporate formalities such as documenting actions through board minutes, resolutions, and official letters might satisfy a company’s pre-suit document disclosure obligations under state law and prevent further inspection of more invasive company documents such as employee emails.
Carefully Monitor Public Statements and Disclosures
One of the key features of the ongoing European climate litigation is that it seeks to hold individual board members responsible for corporate environmental statements and reporting. This has also been the aim of “S”-focused shareholder derivative litigation in the United States. If these examples show us anything, it is that board members cannot simply assume that a company’s chief compliance officer, sustainability director, or some other employee is adequately monitoring sustainability risk and compliance. Instead, board members should understand the company’s approach to sustainability and how its performance will be measured and reported. Directors should be wary of variations in disclosure and reporting requirements across jurisdictions or specific documents. The current patchwork of sustainability disclosure and reporting expectations is among the most significant risks facing companies today. Thoughtful preparation and understanding of the underlying data are key. Responsibility should be clearly assigned for regular director engagement with management and outside consultants to understand how sustainability impacts corporate operational and financial performance and associated risks.
Give Serious Consideration to Shareholder Demands for Corporate Action or Information
If a shareholder makes a pre-suit demand on the board, directors have a fiduciary obligation to act reasonably and in good faith in considering that demand and formulating an appropriate response. The board should move quickly to investigate the substance of the demand, determine if any directors have conflicts which necessitate their recusal from considering it, and provide a timely written response. If directors refuse a demand as nuisance without first having satisfied their fiduciary obligations, they may find themselves facing a denial of a motion to dismiss in a subsequent shareholder derivative lawsuit based on wrongful refusal. A history of summarily ignoring shareholder demands could lend support to a “futility” argument. Leadership should also recognize that courts have found less formal shareholder grievance communications to constitute a pre-suit demand upon the board and should give timely consideration to any such communications.
Shareholder requests for information or corporate document disclosure should be given similarly appropriate attention. States like Delaware are allowing shareholders a broadening right to pre-suit investigation of possible mismanagement. Companies can avoid litigating the scope of this right and potentially encourage nonjudicial resolution if they act early and openly to provide reasonable disclosures when requested.
Recognize that Sustainability Accountability Is More Than a Public Relations or Enforcement Issue
It is becoming increasingly clear that sustainability is here to stay. While sustainability-focused derivative suits have so far shown themselves to be open to dismissal on procedural and other grounds, the possibility for increased use of civil judicial avenues to force corporate sustainability governance reform can still result in the imposition of other substantial costs, including reputational harm and other negative effects. In today’s rapidly greening economy, elevating sustainability to a top corporate priority just makes good business sense.
We would like to thank our colleagues Kimberly Logue and John Peiserich for providing insight and expertise that greatly assisted this research.
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