The Stakeholder Conundrum: Navigating the Efficacy of ESG Litigation in India

Introduction

ESG refers to environmental, social and governance (ESG) concerns that are both the backbone and primary source for responsible investing. The environmental factors consist of issues associated with pollution, resource depletion, climate change, etc. Social factors consider issues like labour practices, human rights, etc. Finally, the governance factor is concerned with transparency, business ethics, etc. Collectively, it is a broad set of considerations that have the potential to affect the company’s long-term performance and its capacity to implement its business strategy that generates sustainable value. Thus, calibrating ESG in corporate governance leads to what may be called a pluralistic or “stakeholder” model of corporate governance, which is inclusive of the needs, aspirations and interests of the community and environment with which the corporate operations interact.

Hence, under the Companies Act, 2013¹ (ICA), directors are obliged to weigh ESG concerns regardless of their associated financial implications. The authors’ through this essay attempt to analyse whether the positive duty statutorily casted upon the directors towards the stakeholders (environment and community) through Section 166(2)² of the ICA has permeated into an enforceable right through judicial forums is enforceable at the hand of the affected stakeholders and thus can it lead to increasing ESG litigations under the current legislative framework, in doing so, the rights of stakeholders and the existing corresponding remedies (if any) under the ICA, the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015³ (LODR) and the Stewardship Code for all mutual funds and all categories of alternative investment funds (AIFs) in relation to their investment in listed equities⁴ (Stewardship Code) released by Securities and Exchange Board of India (SEBI) are analysed. As a suggestive finding of this essay, the authors try devising an enforcement mechanism for ESG claims through derivative action suits and conclude while forecasting the scope of ESG litigation in India.

A comparative outlook: India’s standing in terms of legislative mandate

The English “shareholder centric” model

The strong shareholder value concept serves as the foundation for United Kingdom (UK) corporate law. According to this approach, the foundational understanding of maximising shareholder profit is to also maximise public welfare and benefits to stakeholders. The Companies Act, 2006 (GB) (UK)⁵, which views the identification of stakeholder interests as a method of boosting shareholder value, departs from a pluralistic approach. This is evident from Section 172⁶ of the Companies Act, 2006 (GB) (UK) which lays:

172. Duty to promote the success of the company.—(2) Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, sub-section (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes.

Clearly, the interests of the company, its members, its shareholders, etc. have been raised to the highest pedestal in English law with no comparable standing granted to rights of the community or environment. Thus, should a dispute emerge, shareholder interest takes precedence over stakeholder concerns according to the hierarchy set down by English law.

The Indian “stakeholder-centric” or “pluralistic” model

The Indian framework, on the other hand, unites the interests of stakeholders and shareholders, embodying a pluralist perspective. As a result, Section 166(2) of the ICA is deeply ingrained in the company law stakeholder model. First, the ICA adopted a pluralist stance about the purpose of corporations and the responsibilities of directors after many rounds of discussion and review in Parliament. Put another way, our business law recognises stakeholder interests independently of shareholder interests, seeing them as legitimate in and of themselves rather than as a way to increase shareholder profit. The interests of shareholders are prioritised alongside community rights and environmental concerns, among other things. Further, under Section 166(2), directors are exempt from having to prove a link between their choices and stock returns since their actions may be supported by an internal standard — the desire to achieve well in company and contribute to society.

Similarly, Schedule 4 of the ICA⁷, which mandates that independent directors “safeguard the interests of all stakeholders, … (and) balance the conflicting interest of the stakeholders”, further strengthens the wide definition of directors’ obligations found in Section 166(2).

Through the lens of the classical “Berle-Dodd debate”

This tale of two divergent approaches between the English law and Indian law, wherein the former represents shareholder-centric model of corporate governance whilst the latter advocating for pluralist or stakeholder model of corporate governance, can be understood through the classic Berle-Dodd debate.⁸

The Berle-Dodd debate is a leading testament to the fact that there has always been perceived to be an inherent antagonism in shareholder versus stakeholder model of governance. The classic Berle-Dodd debate, penned in the Harvard Law Review in 1932, is a sublime example illustrative of such a debate. Adolf Berle advanced that corporate powers are “at all times exercisable only for the ratable benefit of the shareholders”, whereas Merrick Dodd postulated a divergent stance that corporations are “economic institutions that have a social service as well as a profit-making function”. India, through the ICA, has philosophically chosen to abide by Dodd by adopting a pluralistic approach to the harmonisation of shareholder and stakeholder interests. Section 166 of the ICA places the obligations owed by directors to shareholders, the environment, and the community at large on the same pedestal. This pluralistic approach is considered a departure from the “shareholder” model of governance, which Berle advocated. For example, the UK, which endorses a shareholder model of corporate law by virtue of Section 172 of the Companies Act, 2006 (GB) (UK), primarily intends to maximise shareholders’ interests and stakeholder consideration is at best a means to achieve the end.

Thus, India for good has moved from the shareholder model of corporate governance and chosen to adopt a more inclusive and community-conscious approach through its 2013 legislation (ICA) as one of its philosophical understandings, as reflected in Section 166 of the legislation (ICA). However, the picture is not entirely merrier and painted with the same tint on a larger canvas. For example, since the Indian Stewardship laws suggest that their individual goals are to safeguard and increase the wealth of their investors, they do not align with this larger ideology. The dichotomy in even the Indian stance on the issue, through studies of selected instruments, is, however, brought up in the later part of this article.

Legislative and jurisprudential analysis

Directors have a genuine responsibility, not just a choice, to take into account the interests of numerous stakeholders, as shown by the legislative legislation procedure and the specific wording of the provision in India. That is why it is not only a discretionary clause, but an obligatory one. Notably, independent directors are also required by the ICA to “assist in protecting the legitimate interests of the company, shareholders, and its employees” in addition to having to “safeguard the interests of all stakeholders” and “balance the conflicting interest of the stakeholders”. It is evident that the law mandates independent directors on Indian Company Boards as well to consider the interests of constituents that are not shareholders.

It needs to be underlined that when it comes to the available remedies, there is a sharp distinction between the remedies available to shareholders for enforcing their rights and those available to stakeholders. Shareholders are entitled to a class action under Section 245 of the ICA⁹ and remedies against oppression, prejudice and mismanagement under Sections 241¹⁰ and 242¹¹ of the ICA. However, the ICA lacks a concise remedial framework for the stakeholders for bringing any claim for breach of duty by directors casted by Section 166(2).

In the jurisprudential domain, the positive duty casted upon the directors by virtue of Section 166(2) has received less attention in India, with a major development in M.K. Ranjitsinh v. Union of India¹², wherein the Supreme Court (SC) underlined the mandate of the duty casted on the directors, specifically that they must act in good faith “for the protection of environment”. Similarly, the context of Section 166(2) was again delineated by SC as “a regime of social accountability and responsibility” in Tata Consultancy Services Ltd. v. Cyrus Investments (P) Ltd.¹³

Gainful reference can also be made to a catena of other decisions given by the SC in National Textile Workers’ Union v. P.R. Ramakrishnan¹⁴ wherein the Supreme Court enunciated that “… a company is now looked upon as a socio-economic institution wielding economic power and influence the life of the people”. Similarly, Gujarat High Court in Panchmahals Steel Ltd. v. Universal Steel Traders¹⁵ endorsed Belgian Professor De Wool. According to whom, the business exists in three distinct realities:

the company has a three-fold reality—economic, human and public —each with its own internal logic. The reality of the company is much broader than that of an association of capital; it is a human working community that performs a collective action for the common good.

The National Green Tribunal in Aam Janta v. State of M.P.¹⁶, in a similar vein, held that businesses should include social, environmental and economic objectives into their operations with an emphasis on how profits are created. Thus, the scope of corporate operations has been explained to be integrating and promoting economic, environmental and social objectives in a catena of judgments referred herewith.

However, the authors submit that the jurisprudence on this issue has yet to permeate significant discourse and that these decisions can at best be said to be of limited help in ascertaining the scope and enforceability of duty cast under Section 166(2) in the aspect that the courts have not authoritatively dealt with the said provision of law but have taken it as an aid or for corollary purposes.

Stewardship Codes: An ESG impetus through institutional investors

Principle 1, along with Principle 3 of the Stewardship Code, requires institutional investors to monitor and actively engage with the listed investee companies on matters of ESG. Similarly, Principle 4 of the Stewardship Code calls for more intervention by the investee companies on ESG risks. However, there are twin problems with respect to the Codes: first, the language of the Code, which is framed as being mandatory in nature, suffers from the same cavity as Section 166 i.e. the question of enforcement, if any, remains an ambiguity as the Code is silent on this aspect. Thus, it has been argued that this enforcement gap can be resolved by allowing derivative or class action suits by the shareholders of these institutional investors against their portfolio companies, where such remedies are specifically enabled under the Stewardship Code.

However, the authors submit that the scope of the Stewardship Code is limited to fostering participation and a considerate approach (through monitoring) by institutional investors in their investee companies; therefore, the duty owed (if any) is by these institutional investors to their shareholders, and this cannot be read as the portfolio companies owing fiduciary duty to the shareholders of these institutional investors, and thus there cannot be any case for derivative suits by the shareholders of institutional investors against the investee companies. Secondly, scholarship¹⁷ on this issue has premised on the limited participation of institutional investors to argue that such Stewardship Codes remain ineffective unless they are in principle extended to promoters. Thirdly and lastly, there is also a lack of information on the manner in which stakeholder-shareholder issues should be resolved and how they should be implemented.

Right-enforcement dichotomy: A remediless disclosure-based regime

Regulation 4(2)(d)¹⁸ of the LODR does require the listed entities to accord respect to the rights of the stakeholders, provide remedy for breach of their rights, and give access to information on a regular basis, which would allow them to participate in corporate governance. With the incorporation of Business Responsibility Reporting in the LODR in 2019, a principle-wise disclosure based on “essential” factors (nine in number) was mandated initially for top 500 listed companies¹⁹ and then for the top 1000 listed companies.²⁰ This can be said to be a logical extension to achieving the broad objective of “material” disclosures to stakeholders.

However, the LODR also does only the “lip service” by doing an empty talk, as the subsequent chapters of the LODR do not specify any enforcement mechanism for such rights. All of the subsequent chapters of the LODR are premised only on the protection and enforcement of shareholder rights as allowed by Regulation 4(2)(a) of the LODR. The reason can be very well gauged from the purpose of the LODR, which is pivoted on protecting and making sacrosanct the interests of the potential inventors (shareholders) and thus the scope for accommodation of rights of stakeholders may be at best made a concession, which in essence Regulation 4(2)(d) of the LODR has attempted to, with the LODR not providing a corresponding enforcement mechanism.

Toothless tiger: Remedying the lacuna

The rights vested in the stakeholders [in the sense that directors owe them a statutory duty under Section 166(2)] do not find a corresponding enforcement mechanism under the ICA. Neither the stakeholder nor the plaintiff can file the class action suits, as by virtue of Section 245 of the ICA, the same can be filed by either members or depositors of the company. There may, however, appear to be scope for actions relating to oppression, prejudice and mismanagement because, by virtue of Section 241 of the ICA, such actions may be brought if the affairs of the company have been conducted “prejudicial to public interest”. Thus, the ambit for taking such actions is wide, transgressing the mere consideration of shareholder interests. It can therefore be concluded that if the directors’ neglect of the ESG considerations of the actions of the corporation arises, the cause for such actions may arise. This is true, but the right to bring such action is limited to members of the company and the stakeholders; even here, violations of their rights remain remedial with no right to enforcement action.

Rule in Foss v. Harbottle: Extent of applicability in India

Given the above analysis, it is appropriate to conclude that the stakeholders remain remediless under the current statutory framework of the Act. There, thus, needs to be an inquiry being made on their remedy in the form of derivative action suits. Cursorily summarised, the common law as laid in Foss v. Harbottle²¹ is antithetical to the idea of derivative action suits. However, Indian courts allow derivative action suits as an exception to the rule in Foss case²² on exceptional grounds (see, Rakesh Malhotra v. Rajinder Kumar Malhotra²³). However, the common law restricting such an exceptional right to bring a derivative action suit has been limited to shareholders, and the said rule has also been imported into Indian corporate governance (see, Darius Rutton Kavasmaneck v. Gharda Chemicals Ltd.²⁴). Scholarship on this aspect has advanced that courts have relaxed the rule in Foss case²⁵ to allow derivative action suits only on three exceptional grounds²⁶: (i) illegality of the transaction; (ii) where the matter required special resolution to be passed but such special resolution was dispensed with; and (iii) fraud on minority shareholders.

An argument for derivative action suits

However, an argument can be made against the strict applicability of the common law rule in the Indian corporate paradigm. The SC in Ahmed Abdulla Ahmed Al Ghurair v. Star Health & Allied Insurance Co. Ltd.²⁷, though admitting derivative action suits as exception to the general principle of locus, has held that such action can be claimed “only in a particular situation” and that “Such a situation has to be seen contextually from the point of view of the entity, on whose behalf the suit is filed.” Thus, the strict adherence to the three exceptional grounds laid out in Foss case²⁸ under which a derivative action may arise is not strictly applied in India, as the “situation” under which the actions may arise remains a question of fact. This needs to be read with regard to cases such as Volkswagen India (P) Ltd. v. Satvinderjeet Singh Sodhi²⁹, where the corporate entity was penalised for deceitfully bypassing emission tests. Hence, since the stakeholders are owed duty by the directors of the corporation, their disregard for the environment and the community may give rise to a “situation” contextually seen from a rightholder perspective, thus giving rise to a derivative action suit.

Conclusion

The authors have critically examined the scope of ESG litigation in the Indian corporate paradigm and found that the current framework renders any action by stakeholders against corporations for violations of ESG considerations inefficacious. Thus, there is not to be seen a major leap in ESG litigation in Indian corporate governance. As for the suggestive finding of the essay, the authors suggested an alternative way of interpreting the law relating to derivative action suits to plug in the lacuna in the enforcement mechanism of stakeholder rights.