[Divyanshu is a student at National Law University Delhi.]
Recently, in an international conference in the United Kingdom, Justice BR Gavai of the Hon’ble Supreme Court of India discussed the necessity of introducing legal sanctions to achieve the goals of corporate social responsibility. According to him, corporate social responsibility / corporate sustainability refers to the obligation of companies to integrate social and environmental concerns in their operations and policies. He discussed the rising international awareness about corporate sustainability obligations and the use of self-regulatory market-based mechanisms to hold companies accountable for the same. Terming these self-regulatory mechanisms inefficient, Justice Gavai argued for use of legal sanctions to ensure that companies act in a sustainable and responsible manner. He even discussed some provisions of the Indian legal system which recognise the obligation of companies to avoid any harm to the environment or society.
In this piece, the author assesses the efficacy of Section 166(2) of the Companies Act 2013 (Act), which even Justice Gavai refers to, in holding directors accountable for their unsustainable decisions and actions. The author argues that the existing provision is quite broad in its ambit and is thus inefficient to hold directors accountable for violating corporate sustainability norms. The author believes that is important to amend Section 166 and introduce a narrower sustainability-based duty of directors under the Act. Such an amendment coupled with Section 166(7) of the Act, which prescribes a monetary penalty of INR 5,00,000 for violation of directors’ duties, would be a strong incentive for directors to fulfil their corporate sustainability obligations.
The Limited Potency of Section 166(2)
The rising pressure of corporate sustainability requires companies to internalize the values of environmental and social responsibility. This is possible only with the active participation of the board of directors, who control the helm of the company and steer it in the desired direction. In the corporate setup, directors are the ones who decide the policies on which decisions ought to be taken and enforce those policies through creation of strategies and goals. Thus, directors’ allegiance to the goals of sustainability become imperative to ensure that companies are not operating in an unsustainable manner. Research has shown that voluntary corporate social responsibility norms have limited efficacy vis-à -vis mandatory provisions. Even Justice Gavai recognised the same and suggested the use of legal sanctions to ensure that directors mandatorily and consistently act in a sustainable and responsible manner.
In light of this, Section 166(2) of the Act encapsulates the duty of directors not only towards the shareholders of the company but also the company’s stakeholders, including the environment. Per the Hon’ble Supreme Court [refer to paragraphs 19.23 and 19.30], Section 166(2) is a blend of public and private interest, wherein the directors are required to give equal attention to the interests of shareholders (who want maximum returns on their investment) and the community (which wants companies to act in a responsible manner). However, due to the absence of any enforcement mechanism for the companies’ stakeholders, Section 166(2) is a half-baked measure which reinforces the shareholder-centric approach to corporate governance which overlooks the legitimate interests of stakeholders, akin to the enlightened shareholder value model of the United Kingdom. Due to this absence of any enforcement mechanism, Section 166(2) reinforces the short-termism of boards, which makes the achievement of sustainability goals through directorial obligations quite difficult. As internalization of sustainability norms require boards to sacrifice short-term goals for long-term success, Section 166(2) fails to ensure that directors would adopt sustainability measures over short-term profits.
Along with this conceptual shortfall of Section 166(2) is the practical difficulty posed by its interplay with the business-judgement rule. As Abhijnan Jha and Urvashi Misra have shown, while the business-judgement rule might not be statutorily recognised in India, courts have time and again recognised the need to respect the business decisions of directors. Moreover, the recent judgement of Client Earth v. Shell Plc is testament to the fact that in imposing sustainability obligations on directors, business judgement rule can be a major impediment. The rule gives deference to directors to an extent that if the board has taken an informed decision to protect the company’s interest and, in the process, has preferred a socially / environmentally irresponsible approach over adherence to sustainability norms, courts would be reluctant to overturn the decision of the board. Thus, Section 166(2) would only be useful for enforcement of sustainability norms when the company’s interests are intertwined with social / environmental factors and even then the directors adopt an unsustainable approach.
Hence, while Section 166(2) might recognise the obligation of directors to recognise and protect community interests and environmental concerns, it is not potent enough to prohibit and penalize directors for violating their sustainability obligations. The broad scope of the section coupled with the business judgement rule makes it inefficacious in holding directors accountable for not fulfilling their sustainability obligations. This requires the Indian legislature to amend Act to introduce a stringent obligation on directors to integrate sustainability norms in their decision-making process.
Conceiving the Amendment
John Quinn has argued that company law amendments incorporating the mandate for directors to act in a sustainable manner are imperative to ensure that companies respect their sustainability obligations. A provision in the company law, which mandates the fulfilment of sustainability norms by directors, would liberate the corporate setup from the clutches of shareholder primacy, which undermines sustainability norms. An express provision mandating directors to consider their impact on the environment and society would ensure that directors are not able to evade their sustainability obligations in the name of success/interest of the company. According to Guido Ferrarini, directors’ duty to fulfil corporate sustainability obligations should be framed in a specific and narrow manner vis-à -vis broadly framed provisions under the UK law (which is similar to the Indian law, as discussed earlier).
The author proposes an amendment to Section 166 of the Act on the lines of Beate Sjåfjell’s proposal for an amendment which obliges directors to ensure that the company’s operations lead to sustainable value creation and mitigate the pressures on planetary boundaries. The author believes that such a defined scope of directors’ duties, which expressly calls for sustainable value creation, would bind the directors to not only consider the impact of the company’s operations on environment and society but also mandate them to ensure that no harm is caused to the two. This would ensure that directors are not able to circumvent their sustainability-based obligations in the name of the interest of the company. Moreover, it would enable socially and environmentally responsible directors to freely pursue the goals of corporate sustainability, without being restrained by the interests of shareholders.
However, the stringency emanating from narrowly defined director’s sustainability duty needs to be balanced with sufficient leeway for the board to define the nature and extent of their obligations. Directors should be held accountable for their (in)actions considering the company’s size, sector, ownership structure, and its relationship and impact on social and environmental factors. This requires that the proposed amendment to Section 166 should provide leeway to the company to define the scope of ‘sustainable value creation’ based on the nature of its operations, as has also been proposed by Beate Sjåfjell. This leeway is imperative for a successful corporate sustainability policy, which cannot be conceived in a one-size-fits-all manner.
Conclusion
Justice Gavai’s remarks for the incorporation of legal sanctions to ensure that directors do not violate corporate sustainability norms mandate an amendment to the Act. The existing provision of Section 166(2) read with Section 166(7) is ineffective to ensure that directors would not violate their sustainability obligations. In such a situation, it is imperative that a new sustainability obligation is imposed upon directors which mandates them to ensure sustainable value creation through the companies’ operations and to avoid any harm to the social and environmental factors surrounding the companies activities. However, this new duty should provide sufficient leeway to the company to decide its sustainability goals, basis which obligations should be imposed on directors, to avoid the one-size-fits-all approach. Justice Gavai’s observations read with the author’s proposed amendment would prove to be highly efficacious in ensuring that directors are not scot-free after violating their company’s sustainability obligations.