It is clear that directors ought to act in good faith
for the benefit of the company. Since the company is a separate legal
personality, there is often the question as to who represents the interests of
the company. Generally, the interests of the company are said to equate with
the interests of the shareholders, while in the case of an insolvent company
(or one that is in the zone of insolvency) the creditors’ interests become
paramount. The question whether other stakeholders such as the employees,
consumers, and the community and society in general constitute the interests of
the company leaves room for some controversy.
for the benefit of the company. Since the company is a separate legal
personality, there is often the question as to who represents the interests of
the company. Generally, the interests of the company are said to equate with
the interests of the shareholders, while in the case of an insolvent company
(or one that is in the zone of insolvency) the creditors’ interests become
paramount. The question whether other stakeholders such as the employees,
consumers, and the community and society in general constitute the interests of
the company leaves room for some controversy.
Historically, company law in India did not directly
address this question. As
we have seen before, the Companies Act, 1956 did not spell out directors’
duties and more importantly in whose interests the directors ought to act.
While it was generally understood that companies had to cater to shareholder
interests, other stakeholders too received some amount of recognition under
corporate law. This is because India’s corporate law had been shaped by India’s
socialistic origins whereby the role of corporate law extends beyond merely the
protection of shareholders. For instance, employees obtain certain special
rights under company law, such as preferential payment for dues in case of
winding up of a company, and also the right to be heard in case of significant
proceedings involving a company such as in a scheme of arrangement (merger,
demerger or other corporate restructuring) or in a winding up of the company. Furthermore,
as the Supreme Court of India has laid down in the context of mergers, “public
interest” constitutes an important element of Indian company law. Affected
parties may exercise remedies in case the affairs of a company are carried out
in a manner prejudicial to public interest, or if a scheme of arrangement is
not in consonance with public interest.
address this question. As
we have seen before, the Companies Act, 1956 did not spell out directors’
duties and more importantly in whose interests the directors ought to act.
While it was generally understood that companies had to cater to shareholder
interests, other stakeholders too received some amount of recognition under
corporate law. This is because India’s corporate law had been shaped by India’s
socialistic origins whereby the role of corporate law extends beyond merely the
protection of shareholders. For instance, employees obtain certain special
rights under company law, such as preferential payment for dues in case of
winding up of a company, and also the right to be heard in case of significant
proceedings involving a company such as in a scheme of arrangement (merger,
demerger or other corporate restructuring) or in a winding up of the company. Furthermore,
as the Supreme Court of India has laid down in the context of mergers, “public
interest” constitutes an important element of Indian company law. Affected
parties may exercise remedies in case the affairs of a company are carried out
in a manner prejudicial to public interest, or if a scheme of arrangement is
not in consonance with public interest.
The new Companies Act, 2013 extends the stakeholder
principle further while codifying directors’ duties. Section 166(2) provides:
principle further while codifying directors’ duties. Section 166(2) provides:
A director of a company
shall act in good faith in order to promote the objects of the company for the
benefit of its members as a whole, and in the best interests of the company,
its employees, the shareholders, the community and for the protection of
environment.
shall act in good faith in order to promote the objects of the company for the
benefit of its members as a whole, and in the best interests of the company,
its employees, the shareholders, the community and for the protection of
environment.
Even if there was a doubt under previous legislation as
to the extent to which stakeholder interests are to be considered by directors
of a company, that has been put to rest in the new legislation. In other words,
shareholders are not the only constituency that deserves the attention of
directors; other constituencies such as employees and event the community and
the environment are to be considered by the directors.
to the extent to which stakeholder interests are to be considered by directors
of a company, that has been put to rest in the new legislation. In other words,
shareholders are not the only constituency that deserves the attention of
directors; other constituencies such as employees and event the community and
the environment are to be considered by the directors.
This therefore clearly reinforces the stakeholder
principle into corporate law. This is also consistent with the historical
understanding of corporate law in India that extended beyond shareholder
protection, but it is also buttressed by other provisions of the Companies Act,
2013 such as those relating to corporate social responsibility while enlarge
the boundaries of constituencies deserving the attention corporate law and
corporate boards.
principle into corporate law. This is also consistent with the historical
understanding of corporate law in India that extended beyond shareholder
protection, but it is also buttressed by other provisions of the Companies Act,
2013 such as those relating to corporate social responsibility while enlarge
the boundaries of constituencies deserving the attention corporate law and
corporate boards.
While this approach is certainly advantageous from a
broader philosophical perspective, it could give rise to a number of practical
issues that may arise in Indian boardrooms. The attempt in this post is only to
set out some of these practical concerns that require further consideration
depending upon specific situations that may arise from time to time.
broader philosophical perspective, it could give rise to a number of practical
issues that may arise in Indian boardrooms. The attempt in this post is only to
set out some of these practical concerns that require further consideration
depending upon specific situations that may arise from time to time.
First,
directors may be confronted with a conflict between the interests of the
shareholders and those of other stakeholders. In that case, whose interests ought
to be preferred? For example, if a decision is made that benefits either
customers or employees, then they may potentially breach the duty to act in the
interests of the shareholders. In such a case, a question arises as to whether
the directors have breached their duties to the company giving rise to a legal
claim against them.
directors may be confronted with a conflict between the interests of the
shareholders and those of other stakeholders. In that case, whose interests ought
to be preferred? For example, if a decision is made that benefits either
customers or employees, then they may potentially breach the duty to act in the
interests of the shareholders. In such a case, a question arises as to whether
the directors have breached their duties to the company giving rise to a legal
claim against them.
Such a conflict has been resolved in a different
manner when the UK reformed its company law about a decade ago. There, in 1999
the Company Law Review came up with proposals to cater to stakeholder
interests. Essentially, two approaches that were considered: (i) the pluralist
approach, which states that “company law should be modified to include other
objectives so that a company is required to serve a wider range of interests,
not subordinate to, or as a means of achieving, shareholder value …, but as
valid in their own right”, which represents an expansive conception of
stakeholder interest; and (ii) the enlightened shareholder value (ESV)
approach, which takes the position that the ultimate objective of company law
to generate maximum shareholder value is also the best means of securing
protection of all interests and thereby overall prosperity and welfare. In
other words, the latter approach conceives of a merger of interests of
stakeholders and shareholders by adopting the position that if the company acts
to preserve stakeholder interests, then that would necessarily bring about
enhancement of shareholder value. However, after some extensive debate, it is
the ESV model that has received statutory recognition in the UK. This appears
to be a half-way or hybrid approach that is primarily for the benefit of
shareholders, but also obliquely takes into account the interests of other
stakeholders.
manner when the UK reformed its company law about a decade ago. There, in 1999
the Company Law Review came up with proposals to cater to stakeholder
interests. Essentially, two approaches that were considered: (i) the pluralist
approach, which states that “company law should be modified to include other
objectives so that a company is required to serve a wider range of interests,
not subordinate to, or as a means of achieving, shareholder value …, but as
valid in their own right”, which represents an expansive conception of
stakeholder interest; and (ii) the enlightened shareholder value (ESV)
approach, which takes the position that the ultimate objective of company law
to generate maximum shareholder value is also the best means of securing
protection of all interests and thereby overall prosperity and welfare. In
other words, the latter approach conceives of a merger of interests of
stakeholders and shareholders by adopting the position that if the company acts
to preserve stakeholder interests, then that would necessarily bring about
enhancement of shareholder value. However, after some extensive debate, it is
the ESV model that has received statutory recognition in the UK. This appears
to be a half-way or hybrid approach that is primarily for the benefit of
shareholders, but also obliquely takes into account the interests of other
stakeholders.
On the other hand, in the context of the aforesaid
dichotomy, the Companies Act, 2013 in India has preferred to adopt the
pluralist approach by providing recognition to both stakeholders and
shareholders, without necessarily indicating preference to either. In a more
practical sense, this means that the directors carry the burden of making the
difficult choices in determining the hierarchy of differing interests in a
given set of circumstances.
dichotomy, the Companies Act, 2013 in India has preferred to adopt the
pluralist approach by providing recognition to both stakeholders and
shareholders, without necessarily indicating preference to either. In a more
practical sense, this means that the directors carry the burden of making the
difficult choices in determining the hierarchy of differing interests in a
given set of circumstances.
Second,
there could potentially be conflicts among the interests of various
stakeholders themselves. While shareholders’ interests are generally homogenous
(except for differences that could arise between in the controlling
shareholders and the minority shareholders), stakeholders could possess vastly
differing interests that may require prioritization among themselves. This
results in added determination and adjudication responsibilities on the board.
there could potentially be conflicts among the interests of various
stakeholders themselves. While shareholders’ interests are generally homogenous
(except for differences that could arise between in the controlling
shareholders and the minority shareholders), stakeholders could possess vastly
differing interests that may require prioritization among themselves. This
results in added determination and adjudication responsibilities on the board.
Third,
shareholders’ interests are more tangible and measurable than stakeholder
interests. Shareholder interests are represented largely by financial
parameters of a company that indicate corporate performance (with the most
common resultant indicator being the share price of a company) as well as other
indicators that may represent corporate governance. Conversely, stakeholder
interests are somewhat more intangible and subjective in nature causing
decision-making to be more difficult for the board.
shareholders’ interests are more tangible and measurable than stakeholder
interests. Shareholder interests are represented largely by financial
parameters of a company that indicate corporate performance (with the most
common resultant indicator being the share price of a company) as well as other
indicators that may represent corporate governance. Conversely, stakeholder
interests are somewhat more intangible and subjective in nature causing
decision-making to be more difficult for the board.
Finally,
even if some of the aforesaid practical considerations can be addressed through
focused board measures and processes, the Companies Act, 2013 does not seem to
provide for remedies against breach of directors’ duties to take into account
stakeholder interests. Generally, for a breach of directors’ duties, the
company could initiate a legal claim against directors. If they fail to do so,
shareholders have the right to bring a derivative action against the directors
on behalf of the company. However, other stakeholders do not have similar legal
claims against companies or boards for breach of duties to act in their
interests. Hence, their rights may not be justiciable in nature thereby
questioning the extent of their efficacy.
even if some of the aforesaid practical considerations can be addressed through
focused board measures and processes, the Companies Act, 2013 does not seem to
provide for remedies against breach of directors’ duties to take into account
stakeholder interests. Generally, for a breach of directors’ duties, the
company could initiate a legal claim against directors. If they fail to do so,
shareholders have the right to bring a derivative action against the directors
on behalf of the company. However, other stakeholders do not have similar legal
claims against companies or boards for breach of duties to act in their
interests. Hence, their rights may not be justiciable in nature thereby
questioning the extent of their efficacy.
These issues may appear somewhat esoteric to
begin with, but they would have to be confronted by corporate boards to face
the new reality. They would also figure more prominently if and when legal
claims begin to get litigated before the courts for breach of directors’ duties
under the new law.
begin with, but they would have to be confronted by corporate boards to face
the new reality. They would also figure more prominently if and when legal
claims begin to get litigated before the courts for breach of directors’ duties
under the new law.