When might directors, trustees and others exercising fiduciary duties find themselves under a duty to divest from fossil fuel investments?
Alex Lerner considers the environmental aspects of the recent decision in McGaughey v Universities Superannuation Scheme Ltd  EWHC 1233 (Ch) and analyses the lessons for practitioners and those exercising fiduciary duties.
In McGaughey, the judge refused permission for two members of the Universities Superannuation Scheme to continue common law multiple derivative claims (ie claims where shareholders in a parent company pursue a cause of action vested in a subsidiary of the parent company’s subsidiary).
The claims were made against the directors and former directors of the scheme’s corporate trustee in respect of alleged breaches of fiduciary and/or statutory duty concerning, among other things, the scheme’s continued investment in fossil fuels.
As ESG law and regulation emerges as a key consideration for both consumers and legislators, directors are encouraged to give due consideration to their ESG responsibilities.
Background to the claim
The claimants, Dr Ewan McGaughey and Dr Neil Davies, were members of the Universities Superannuation Scheme, a defined benefits and a defined contribution scheme established for the purpose of providing superannuation benefits for academic and comparable staff in universities and other higher education institutions in the United Kingdom.
The first defendant was the Universities Superannuation Scheme Limited (the company), a company limited by guarantee, and was the corporate trustee of the Universities Superannuation Scheme (the scheme). The second defendants were the company directors as at the date of the claimants’ application notice, plus a shadow director. The third defendants were former directors who had been in office during the events giving rise to the claim.
The company had chosen to carry out a statutory actuarial valuation in 2020, earlier than required, and proposed various changes to benefits and contributions. The claimants began proceedings alleging that:
- the directors had acted in breach of their statutory duties by proceeding with the 2020 valuation (claim 1),
- an increase in costs and expenses since 2007 had benefitted the directors (claim 2),
- the benefit changes indirectly discriminated against women, younger and black and ethnic minority members (claim 3), and
- the directors had continued to invest in fossil fuels without an immediate plan for divestment contrary to the company’s long-term interests (claim 4).
The decision in McGaughey is interesting in several respects, not least because it provides a detailed analysis of a multiple derivative claim in respect of a company limited by guarantee. However, this article focuses on the claimants’ allegations regarding the scheme’s continued investment in fossil fuels (ie claim 4).
The divestment allegations
The Companies Act 2006 (CA2006) provides, among other things, that directors must act:
- in accordance with the company’s constitution and only exercise powers for the purposes for which they are conferred (section 171), and
- in the way that they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole (section 172).
Trustees and other fiduciaries will often have similar duties in the different contexts in which they operate.
The claimants alleged that, in breach of the sections 171 and 172 CA2006, and notwithstanding the company announcing on 4 May 2021 that its ambition was to be carbon neutral by 2050, the directors of the company continued to invest directly and indirectly in fossil fuels without an immediate plan for divestment. It was argued that this was contrary to the company’s long-term interests, that this prejudiced the company’s success and that the company suffered loss in consequence.
Notably, however, section 172(1)(d) CA2006, which obliges directors to have regard to environmental matters, does not appear to have been specifically argued by the claimants. Neither was there any allegation of a breach of section 174 CA2006, being a director’s duty to exercise reasonable care, skill and diligence, which Lord Sales had previously concluded was inter-related to section 172 CA2006 in this context (see ‘Directors’ duties and climate change: Keeping pace with environmental challenges’, Anglo-Australasian Law Society, Sydney Lord Sales, Justice of the Supreme Court, 27 August 2019).
A duty to divest for ethical reasons?
McGaughey is notable as much for what the claimants did not argue as for what they did. The claimants did not allege that the company had a duty to divest from fossil fuel investments for ethical reasons, likely because of the decision in Cowan v Scargill  Ch 270, which held:
- Trustees owe a duty to exercise their powers in the best interests of the present and future beneficiaries of a trust, holding the scales impartially between different classes of beneficiaries. When the purpose of the trust is to provide financial benefits for the beneficiaries, as is usually the case, the best interests of the beneficiaries are normally their best financial interests. In the case of a power of investment, the power must be exercised to yield the best return for the beneficiaries, judged in relation to the risks of the investments in question. The prospects of the yield of income and capital appreciation both have to be considered in judging the return from the investment.
- In considering what investments to make, trustees must put aside their own personal interests and views. Trustees may have strongly held social or political views, but if investments contrary to those views would be more beneficial to the beneficiaries than other investments, the trustees must not refrain from making the investments because of the views they hold.
- By way of caveat, however, financial benefit is not the inevitable or sole means of assessing benefit to beneficiaries, even where the object of a trust is to provide financial benefits. For instance, if the only actual or potential beneficiaries of a trust are all adults with strict views on moral and social matters, the beneficiaries might well consider that it was far better to receive less than to receive more money from what they consider to be evil and tainted sources.
In McGaughey, the judge noted the guidance in Cowan and held that it was consistent with Regulation 4 of the Occupational Pension Schemes (Investment) Regulations 2005, which imposed a duty on the company to exercise its powers of investment in a manner calculated to ensure the security, quality, liquidity and profitability of the portfolio as a whole.
The judge found that although the claimants may have disagreed with the directors’ approach to investments in fossil fuel companies on ethical grounds and, in particular, with their view that divestment is not the appropriate way to reach net zero, they did not put their case on the basis of those objections (and would not therefore have triggered the caveat in (3) of Cowan).
Overall, although a duty to divest from fossil fuel investments for ethical reasons could arise in principle, in practice the caveat in (3) of Cowan represents a high bar to such claims. On the basis of the law as it stands, therefore, divestment claims founded on purely ethical grounds are unlikely to arise except in obvious and defined circumstances. That said, there are a number of critical views in the academic literature regarding the approach in Cowan and “the old dichotomy between a company’s financial success and its environmental profile is collapsing” (see Directors’ duties and climate change: Keeping pace with environmental challenge), so it is notable that the claimants elected not to put their case on the basis of their own objections (if held) with a view to overturning Cowan on appeal. Whether or not the Cowan approach will continue to be followed in the future remains to be seen.
A duty to divest in order to avoid financial losses?
The claimants failed to persuade the judge that the company had suffered immediate financial loss due to the directors’ failure to adopt an adequate plan for long-term divestment of investment in fossil fuels. The judge identified that:
- the claimants had not provided particulars of the losses alleged to have been suffered,
- the claimants did not specify which investments the company should have sold or when or what the consequences would have been if the company had done so, and
- the claimants did not specify why the company would have avoided those consequences if it had adopted an immediate plan for divestment or the plan the company should have adopted instead.
For instance, the claimants did not allege that the company should have sold its investments in fossil fuel companies overnight or that if it had adopted a long-term divestment plan, it would have avoided any immediate losses as a result of its holdings in Russian fossil fuel companies or, indeed, in any other companies. Although there was a general allegation that the claimants had suffered loss in the past, the claimants’ pleaded case was primarily directed at the company’s future conduct, but no particulars had been provided in respect of that conduct.
Assuming the lessons for practitioners are heeded (see below), arguments in favour of divesting from fossil fuel investments to avoid financial losses are likely to provide more fertile grounds for prospective claimants than arguments founded purely on ethical considerations, at least until Cowan has been overturned. Even then, however, there are two important points to note:
- Just because someone disagrees with a chosen course of action, that will not render such a course of action actionable. In McGaughey, whether or not the claimants agreed with the company’s approach and policies, the company’s chosen course was well within its discretion in exercising its powers of investment, and the claimants had not identified any policy or decisions that amounted to a breach of the directors’ duties.
- There are steps directors and fiduciaries can take to protect themselves. In McGaughey, the company had put forward evidence that the directors had exercised their powers of investment in a manner consistent with their duties. In particular, the company (and the directors) had taken legal advice, conducted a survey of members, adopted an ambition of net zero by 2050 and policies for working with the companies in which it invests in the meantime.
Lessons for practitioners
For the reasons given above, the first lesson is that it is important that prospective claimants plead out a cogent and sufficiently detailed claim in relation to causation and loss, as well as providing sufficient details of any relevant counter-factual scenario relied on. Although the decision in McGaughey was principally concerned with such issues because of the common law test applicable to multiple derivative claims, the court’s findings in this respect are nevertheless instructive.
The second lesson underlines the importance of expert evidence. In McGaughey, the principal evidential support for the claimants’ case was found in Dr McGaughey’s witness statement, which asserted that investment in fossil fuels “has caused significant financial detriment to the interests of beneficiaries in recent years”. Notably, he did not claim to have any expertise in expressing this view and his evidence was based on a selection of Financial Times articles. Separately, Dr Davies had expressed the view that the company’s decision to sell Russian fossil fuel companies was too late (ie to avoid losses arising from recent sanctions). The judge commented that the evidence in support of the claim was so weak that it rendered the claim liable to being struck out.
The first two lessons, therefore, point to early engagement with an expert (at the very least on a consulting basis) to assist with pleading and, subsequently, proving the claim. The decision in McGaughey provides a helpful indication of how a court might respond if such steps are not taken.
The third lesson goes to the nature of the claim itself. The judge held that even if he had been persuaded by the evidence in support of the claimants’ case, he would not have exercised his discretion to allow the claimants to continue claim 4. The judge said the better approach would have been for the claimants to pursue a direct claim against the company for breach of trust, notwithstanding the difficulties inherent to such a claim.
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