INTRODUCTION
Sustainable Finance incorporates environmental, social and governance factors (ESG) in investor decision-making processes both to address growing awareness of environment and social concerns, as well as an effort to generate sustainable, long-term financial returns., investors and public authorities seek to identify long-term factors environmental, social and governance categories that are associated with erosion of equity value and credit risk.[1] For sustainable investment, then the effort and performance of a company on these identified parameters, primarily constituting non-financial information, becomes the basis for investor decision-making.
With the growth of ESG investing, a corresponding demand for a standardized rating mechanism emerged that resulted in ESG related disclosures, being the basis of ESG ratings being disseminated for improving sustainable investment practices[2]. ESG disclosures are essentially the communication of a firm’s sustainability objectives, corresponding to the three pillars of Environment, Social and Governance, and their strategic implementation in the operational practices of the firms.[3] This information, often reported in a standardized form based on one of the global or jurisdictional reporting frameworks, enables different stakeholders to evaluate the performance (“ESG performance”) of the firm on the identified parameters to effectively utilize non-financial data in their decision-making. Non-financial data, a largely undefined term, refers to additional accounts of firms pertaining to information relevant for the long-term sustainability and invoking investor confidence.[4]
The proliferation of ESG funds and rapidly growing investor keenness was notable enough to garner regulatory concerns, as SEBI sought to engage with the market on ensuring protection of the investors and foster the development of the securities market.[5] SEBI has mandated the top 1000 listed companies (by market capitalization) to make ESG disclosures as per the Business Responsibility and Sustainability Reporting (BRSR) from Financial Year 2021-22 on a voluntary basis and mandatory from Financial Year 2022 -23.[6] Moreover, SEBI has developed a more specialized sub-set of BRSR known as the BRSR Core that is mandatory for the top 150 listed entities from the Financial Year 2023-24 with progressive widening of the targeted entities in subsequent financial years.
SEBI ESG disclosure framework builds upon the ideology existing regimes for ESG disclosures of opportunities, threats, risks and concerns as part of their annual reports under Regulation 34(3) of the SEBI (Listing Obligation and Disclosure Requirements) Regulation, 2015 (“LODR Regulations”). By virtue of LODR Regulations (Second Amendment), 2023 notified on 14th June, 2023[7], Regulation 34(2)(f) was amendment to establish the BRSR framework that pertains to specialized ESG metrics and Key Performance Indicators. It is sought to be implemented in a phased manner to progressively permeate the corporate fabric on the basis of market capitalization thresholds.
This article seeks to explore the placement of ESG in the larger paradigm of corporate governance legal framework in India.
CORPORATE GOVERNANCE
The scholarship around corporate governance is progressively highlighting the need for incorporating long-tern sustainable values instead of only relying on financial performance for the protection of shareholder interests. ESG considerations are seen in this light as crucial for producing sustainable results for shareholders that can only be routed through a pathway aligned with the holistic concerns of society and environment. This, as a result, puts the onus on the directors to protect stakeholders other than shareholders such as employees, creditors, consumers and society. In that light, we must analyze the legal provisions of the Act to assess their reception of ESG factors on two grounds: firstly, whether the stakeholder approach to fiduciary duty of directors currently prevalent in India envisions a defensible ground for ESG considerations and secondly, even from the perspective of shareholder centric approach, can it be argued that directors are duty bound to acknowledge and mitigate ESG risks. As a flip side, shareholder rights under securities law may also form part of the solution as we discuss ahead.
The corporate legal framework in India may be termed predominantly as rule-based governance, with an archive of subordinate legislations that are codified rules and regulations.[8] As a result, there is a prescriptive approach as to the role of each participant in the market that requires compliance with the letter of the law[9] and consequently, avoids legal ambiguity or subjectivity. This is in alternate to the principle-based regulatory approach, observed for instance in the UK, that articulates broad principles without codifying its constitutive elements in detail.[10]
However, it is argued that the principles of corporate governance have been interpreted expansively and inclusively in India as well. Umakanth Varottil[11] traces the historical perspective of corporate law to find stakeholder approach imbedded in it, with the statutory inclusion of ‘public interest’ under the Companies Act, 1956 and the judicial adoption of approaching companies as a socio-economic institution capable of influencing society[12] as a result of which due consideration was paid to the impact of business transactions on the public interest.[13] Though this was not a consistent approach, the concerns were swept away by the codification of the duties of the directors under the Act in an inclusive and non-exhaustive manner.[14] Under the new legislation, each director is also bound by fiduciary duty owed to the company and its stakeholders to act in good faith[15] and the stakeholders include the community, employees of the company and environmental concerns. The common law based fiduciary duty cannot be understood as a rule consisting of identifiable components and instead is a principle that the director must prioritize the company’s interests over individualistic or personal pursuits.[16]
Section 166(2) is said to have adopted a pluralistic approach wherein there is no hierarchy between the interests of the different stakeholders so enumerated and neither can the concerns of the non-shareholder constituents be seen as subservient to the financial interests of the shareholders.[17] The observations of the Supreme Court in the case of Tata Consultancy Services Ltd v Cyrus Investments Pvt. Ltd.[18] may be relevant to the extent that the Court acknowledges the evolved understanding of corporate governance to be inclusive of social accountability towards the environment or employees for instance and that this multi-stakeholder concept is bound to arrive at conflicting and competing crossroads of interests.
Moreover, directors are also required to carry out their duties with reasonable care, skill and diligence along with exercising independent judgement.[19] Essentially, the duty of care owed to stakeholders does not need to necessarily arrive at a conflict since it is inscribed by a duty of good faith such that no injury can be claimed against the director where the duty has been exercised fairly, by considering all possible alternates and in the best interests of all stakeholders.[20] This duty of care has been held distinct from the duty owed to various stakeholders under Section 166(2) and is only owed to the company.[21]
Jurisprudence akin to the Business Judgement Rule[22] has also been acknowledged to a limited extent in India to uphold the validity of directors’ actions with the acknowledgement that the business decision-making process is complex and multi-factored.[23] The rule “is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”[24] While only persuasive in value, NCLT in the case of Fidaali Moiz Mithiborwala vs. Majolica Properties (P.) Ltd [25] relied on the business judgement rule to test the fairness and probity of management decisions and held that the yardsticks applied in civil cases cannot be mutatis mutandis be applied to company jurisprudence since the interest of the company normally would be higher on the pedestal than the rights of individual shareholders. Similarly, SEBI has been observed[26] to test management decisions and actions on the anvil of business judgment rule, subject to the caveat that the presumption of this rule would not be available where the director is in breach of his duty of care, loyalty or good faith.[27] However, while this rule does provide breathing space for the management to consider the interest of the company above the myopic urge to secure short-term value generation for shareholders, the rule itself originated as a limitation of the judiciary to substitute its own judgment for the commercial wisdom of the management. Thus, it will not validate actions taken for managing the ESG concerns of the company without a sturdy legal framework that may, through necessary implication in the present day circumstances, acknowledge ESG as part of corporate governance within the rule-based framework.
One such rule that can be enlarged is the requirement of mandatory risk assessment and management that the board must undertake as part of its annual report.[28] Interestingly, BRSR format also requires a similar risk assessment by the companies but specifically on “material responsible business conduct and sustainability issues pertaining to environmental and social factors that present a risk or an opportunity for the business and their financial implications”.
Secondly, the board of directors (“board”) embodies advisory and oversight functions to determine the strategic and operational direction of the company, ensuring its alignment with interest of the stakeholders.[29] In fact, this orientation allows the board to have a considerable impact on the business performance of the company and strategies for the company’s growth can be routed through the board. As a result, board characteristics such as board size, composition, director remuneration, Chairman-CEO duality etc, tend to be associated with the quality of corporate governance. Thus, corresponding to Principle 1 of NGBR that business should be governed in an ethical, transparent and accountable manner, there is a board characteristic of independence that is necessary to achieve the same. Board independence is mandated by way of board composition under Section 149(4) to the effect that out of the total number of directors, at least one-third must be independent directors in every listed public company and public listed companies with paid-up share capital over 10 crore, turnover over 100 crore and public debt more than 50 crore[30]. Further, Regulation 17(1)(b) of the LODR Regulations[31] stipulates that one-third of the board of a listed entity must be composed of independent directors if the chairperson is a non-executive director, and not a promoter or related to a promoter, or a person occupying a management position. In any other case, at least half of the board should be composed of independent directors. Thus, the dominance of the board by a chairperson who is the promoter or related to the promoter is considered to operate adversely to the independence of the board. SEBI has also mandated certain norms to ensure the integrity of this position. The role of independent directors is to safeguard the interests of all stakeholders, and balance any conflicting interests, which adds a layer of transparency to the process of decision-making.
However, there are a few limitations of this argument. Firstly, it may be a leap to conclusively determine that this stakeholder approach would necessarily support ESG considerations. To that, Umakanth Varottil argues that the fiduciary duty of directors owed to the company would be more aligned with long-term sustainability of the company that is supported by the financial model of ESG.[32] This is especially true for industries that are vulnerable to climate change impact and where there may be tangible reputational risk of side-lining ESG concerns.[33] Reliance was placed on the case of MK Ranjitsinh v Union of India (2021)[34] wherein the duty of director to consider environmental protection was treated at par with other stakeholders, in line with the pluralistic approach.
What may be said is that the essence of interpreting for these provisions is a dynamic process such that allows for the constituents of the fiduciary duty to reflect the contemporary business sentiments or the ‘general environment of expectations induced by regulatory initiatives, amongst others[35]. However, the evasiveness of ESG to be confined within a definition effectively means that while there is a legal foundation to argue that ESG considerations are not in contradiction with the duties of a director, to be defendable against legal action, a more substantial legislative initiative is needed. The context for the specific language of Section 166(2) was set in the backdrop of introduction of CSR in the new statute.[36] It was envisioned as at least an enabling provision to allow directors to consider non-shareholder interests but it is also argued that since the final text was based on the recommendation of ICSI, after its acceptance, it was also envisioned to be more than simply enabling and instead to cast a positive duty on the directors.[37] This positive duty is inscribed as an independent obligation to consider the interests of non-shareholder stakeholders instead of only for the purpose of ensuring shareholder value.
Nonetheless, theoretically we can engage with ESG in the context of a jurisdiction assuming sole shareholder approach in the alternate. The first hurdle in this consideration is that the initial perception itself that incorporation of ESG can only be argued tenably for jurisdictions that extend the concept of fiduciary duty to stakeholders other than shareholders and allow for consideration of non-financial factors alongside financial ones.[38] It must be acknowledged that this perception has been identified in the context of ESG investment done by trustees on behalf of their beneficiaries but we may transplant the idea to ESG conduct as well since besides ESG disclosures mandated for a small segment of listed entities, there are no readily available enforceable provisions for ESG. To that, it is argued that even from an entirely shareholder perspective, ESG considerations should in fact be a requirement since it is now essential for long-term interests.[39] This is especially true when ESG disclosures are being made mandatory for top listed companies and failure to compete on these parameters may carry ESG reputational risks for the company that tend to materially impact shareholder value and cost of external financing. A meta-study by Friede et al.[40] found that around 90% of the 2200 academic papers in their sample revealed improved financial performances of companies with better sustainability practices. The studies positing a positive relationship between ESG and firm value tend to rely on stakeholder theory[41] wherein it is posited that good stakeholder relations improves the financial performance of the company and helps firms reverse adverse financial conditions. Thus, since ESG is centred on improving stakeholder engagement with corporations, research appears to be vouching for the financial model of ESG to the extent of enabling an argument in favour of ESG considerations being necessary for long-term shareholder interests.
There is another argument to be made for shareholder rights. As a natural corollary to corporate governance obligations, there is a case to be made for shareholder rights if we shift away from perceiving ESG regulations as an onerous burden on the management of the company and instead look at it from the perspective of promoting information symmetry in the market and protecting investors from fraud[42].
CONCLUSION
A recent market survey sought to encapsulate the market response to the 2021 amendment to LODR Regulations and found that regulatory attention to enhanced disclosure and stricter governance practices predictably improve confidence of majority of investors to some extent while admittedly there was room for improvement.[43] Thus, in the larger interest of development of the market and investor protection[44], mandate under LODR Regulations may be beneficial for providing reliable ESG information in the market.
[1] Riccardo Boffo, Robert Patalano, ESG Investing: Practices, Progress and Challenges 11 (OECD 2020).
[2] Boffo, supra note 5, at 11.
[3] Muhammad Sani Khamisu, Ratna Achuta Paluri & Vandana Sonwaney, Environmental Social and Governance (ESG) Disclosure Motives for Environmentally Sensitive Industry: An Emerging Economy Perspective, 11 Cogent Business & Management 8 (2024).
[4] Council Directive 2014/95/EU, Amending Directive 2013/34/EU, 2014 O.J. (L 330) 1(EC).
[5] Securities Exchange Board of India Act, 1992, § 11.
[6] Securities and Exchange Board, Master circular for compliance with the provisions of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) (LODR) Regulations, 2015 by listed entities (Issued on July 2023).
[7] SEBI (LODR) (Second Amendment) Regulations, 2023. §11.
[8] Ministry of Finance, Report of the High Powered Expert Committee on Making Mumbai an International Financial Centre (2007) at 141.
[9] Id.
[10] Id. at 142.
[11] Umakanth Varottil, The Stakeholder Approach to Corporate Law: A Historical Perspective from India, in Res. Handbook on the His. Of Corp & Comp. L. 381 (Harwell Wells ed., 2018)
[12] See National Textile Workers v PR Ramakrishnan, (1983) 1 SCR 9; Hindustan Lever Employees’ Union v Hindustan Lever Ltd, AIR 1995 SC 470.
[13] Hindustan Lever Employees’ Union v Hindustan Lever Ltd, AIR 1995 SC 470.
[14] Companies Act, 2013 §166.
[15] Id.,§166(2).
[16] Sri Marcel Martins v. M. Printer and Ors., (2012) 5 SCC 342.
[17] Mihir Naniwadekar, Umakanth Varottil, The Stakeholder Approach Towards Directors’ Duties Under Indian Company Law: A Comparative Analysis (NUS Law Working Paper No. 2016/006, 2016) at 5.
[18] Tata Consultancy Services Limited vs Cyrus Investments Pvt. Ltd., 2021 SCC OnLine SC 272, ¶19.24.
[19] Companies Act, 2013, §166(3).
[20] Mihir Naniwadekar, supra note 166 at 5.
[21] Id.
[22] Aronson v. Lewis, 473 A.2d 805 (Del.1984).
[23] Tata Consultancy Services Limited vs Cyrus Investments Pvt. Ltd., (2021) SCC OnLine SC 272.
[24] Aronson, supra note 171 at 812.
[25] Fidaali Moiz Mithiborwala vs. Majolica Properties (P.) Ltd., (2017) SCC OnLine NCLT 20894.
[26] See Franklin Templeton Mutual Fund, In re, (2021) SCC OnLine SEBI 839; Kemrock Industries & Exports Ltd., In re, (2021) SCC OnLine SEBI 17; Inter Globe Finance Limited, In re, (2021) SCC OnLine SEBI 152.
[27] Emerald Partners v. Berlin, 787 A. 2d 85, 91 (Del. 2001).
[28] Companies Act, 2013, §134(3).
[29] Larcker (2011), supra note 33 at 68.
[30] Companies (Appointment and Qualification of Directors) Rules, 2014, Rule 4.
[31] SEBI (LODR) Regulation, 1915, Reg. 17(1)(b).
[32] Umakanth Varottil, The Legal and Regulatory Impetus towards ESG in India: Developments and Challenges (NUS Law Working Paper No. 3, 2023) at 8.
[33] Id.
[34] MK Ranjitsinh v. Union of India, (2021) SCC Online SC 326,¶14.
[35] Lord Sale J., Directors’ Duties and Climate Change: Keeping Pace with the Environmental Challenges, Speech to the Anglo-Australasian Law Society (Aug. 27, 2019), at 10.
[36] Standing Committee on Finance, Twenty-first Report on The Companies Bill, 2009 (August 31, 2010), ¶11.77.
[37] Id., ¶11.78.
[38] Jonathan A. McGowan, The Trouble with Tibble: Environmental, Social, and Governance (ESG) and Fiduciary Duty, The Uni. Of Chicago Bus. L. Rev (2022).
[39] Fiduciary Duty in the 21st Century (UN Global Compact 2015) at 15,16.
[40] Gunnar Friede et al.,. ESG and Financial Performance: Aggregated Evidence from more than 2000 Empirical Studies, 5(4) J. Sustainable Fin. & Investigation. 210-233 (2015).
[41] Srivastava, Anjali & Anand, ESG performance and firm value: The moderating role of ownership concentration, 20 Corp. Ownership and Control 169-179 (2023).
[42] G. Sabarinathan, Securities and Exchange Board of India and the regulation of the Indian Securities Market (Indian Institute of Management Bangalore Working Paper No. 309, 2012).
[43] Harsh Singh Chauhan, Arvind Kumar Singh, The Effectiveness of the SEBI (LODR) Regulations, 2021 in Regulating Indian Securities Markets, 72 Jur. of Engineering and Tech. Management (2024).
[44] Securities and Exchange Board of India Act, 1992, §11.