[Dhanshitha Ravi and Santosh S are third and final year law students respectively at Symbiosis Law School, Pune]
The United Kingdom High Court (“UKHC”) on the 12 May 2023 delivered a landmark judgment in the realm of corporate jurisprudence in a first of its kind climate-change based derivative action in ClientEarth v. Shell plc. This action was brought by ClientEarth, a minority shareholder in Shell plc, on behalf of the company, against the directors, to hold them accountable for breach of their fiduciary duties for not putting in place an adequate risk policy to combat climate change. Given Shell is one of the biggest carbon emitters, contributing 1.8% of the annual global emissions, the absence of such a policy was potentially detrimental to the long-term interests of the company.
The UKHC, however, dismissed the derivative action, which could potentially be a setback to corporate climate litigation across the globe, including in developing countries like India wherein such litigation is considerably nascent and rare. Unlike in instances such as the Sterlite case in Tamil Nadu, where environment-specific regulations have been invoked against corporations, India is yet to witness litigation in the form of a derivative action representing climate-related interests.
This post seeks to explain the Indian approach regarding directors’ duties in the context of the environment and how the thresholds established in ClientEarth do not squarely comply with the Indian approach.
Indian Position on Directors’ Duties Towards the Environment
Prior to the Companies Act, 2013, the Indian regime adopted a restrictive approach that cast an onus on the directors to discharge their duties to solely enhance the value of shareholders. With the 2013 Act, that model was replaced by a stakeholder model or a “pluralist approach” which envisages the duties of directors under section 166, drawing inspiration from section 172 of the UK Companies Act 2006. Directors are required to act in “the best interests” of the company as well as the community and towards the protection of the environment.
Furthermore, it also casts an onus on the directors to perform duties with reasonable care, skill and diligence. The language employed herein casts a positive obligation on the directors through an equitable approach which treats all stakeholders with parity. As opposed to the enlightened shareholder value (“ESV”) model prevalent in the UK, Indian law requires directors to unequivocally consider all stakeholders’ interests.
Pioneering this approach, in M.K. Ranjitsinh v. Union of India, the Supreme Court suggested that installation of overhead power lines in areas critical to the habitat of the Great Indian Bustard would potentially vitiate the contours of directors’ duties towards the environment under company law. Further, the Court observed that the high cost of adopting climate sensitive methods would not shield the directors from doing so, thereby reaffirming the positive obligations cast on the directors regarding climate.
Beyond the director duties under company law, the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR”) prescribe certain disclosure requirements as well as directors’ duties towards stakeholders that directly or indirectly require listed entities to have climate-sensitive policies in place. These include regulations 4(2)(f)(ii) and 17(9)(b), which require risk management measures on part of the board, keeping long-term interests of the company in picture. Regulation 21(4) also requires certain listed entities to formulate a risk management committee.
These regulations must be conjointly read with the requirement under regulation 34(2)(f) to furnish an annual report consisting of a business responsibility section that is supposed to contain the environment, social and governance (“ESG”) perspectives of certain listed entities. Given the specific emphasis on ESG and long-term interests of the company, a purposive interpretation of the LODR must imply the inclusion of climate-related risks within the meaning of “risk management”.
If a breach of such duties occurs, shareholders, in the absence of alternative remedies, are forced to bring a representative claim on behalf of the company against the directors in the form of a derivative action. Such an action is an exception to the proper plaintiff rule established in Foss v. Harbottle (1843) 2 Hare 461, which necessitates that only a company may sue wrongdoers for the loss that it suffers. Being a representative suit, a derivative action allows shareholders to sue on behalf of the company when a breach of fiduciary duties occurs.
In India, a representative suit can be brought under Order I, Rule 8 of the Civil Procedure Code and has strict requirements for a court to grant leave to the plaintiff, being, inter alia, satisfaction of the clean-hands doctrine, which requires a plaintiff shareholder to not have vested interests in the outcome of such an action. It is pertinent to note that Indian courts have treated the proper plaintiff rule as sacrosanct and, therefore, significantly curtailed the use of DAs.
Unduly Restrictive Thresholds Laid Down in ClientEarth
The UKHC in ClientEarth primarily makes two important observations relevant to this discussion (a detailed commentary of the judgement can be accessed here). First, by implicitly applying what is arguably a far-fetched interpretation of the business judgement rule, the UKHC refrained from assessing the decisions made by the directors while discharging their duties. It laid special emphasis on the fact that judicial bodies must exercise restraint and allow derivative actions for alleged breach of duties only in “limited and restricted circumstances”. The Court also suggested that such issues can be voiced and voted upon by members in an annual general meeting, following the rationale of the well-established majority rule in Foss.
Second, the threshold to satisfy the “good faith” requirement to admit a derivative action has been significantly heightened. Akin to the clean-hands doctrine in India, usually a court weighs the motives of the plaintiff and discourages litigation based on ulterior motives. In this case, one primary reason to dismiss the action appears to be the supposed failure of ClientEarth to adduce sufficient evidence to refute ulterior motives, merely because they were minority shareholders in the company. That reasoning only reasserts the rule in Foss, but does not view the countless instances where derivative action has been viewed as an exception to the said rule.
The manner in which the UKHC has applied both business judgment rule and the good faith requirement is narrow and can have a cascading effect by eliminating shareholder activism, especially in the form of climate-related litigation.
Comparing ClientEarth Standards vis-à-vis the Indian Approach
The UKHC’s strong presumption in favor of board decisions is not necessarily akin to Indian law. The Bombay High Court in Re Cadbury India Ltd. ruled that greater significance has to be given to protecting the rights and concerns of minority shareholders, thereby shifting the onus on the board to demonstrate that their actions were beneficial for the company and its stakeholders. More often than not, in climate-related questions, the business judgment rule viewed from the ESV perspective can lead to diametrically opposite conclusions, i.e., what may be in the interests of shareholder value for a climate-sensitive business may be entirely harmful to the environment.
Per contra, the pluralist approach in Indian law would give no room to such possibilities because board decisions would have to be weighed from the perspective of different stakeholders, without ipso facto prioritizing one interest over the other. Therefore, boards cannot use the business judgment rule as an immunity doctrine in India and refuse to address climate-related risks.
Additionally, requirements under the LODR make it explicitly clear that the board of a listed entity has to make environment-based disclosures on an annual basis, alongside satisfying the duty towards stakeholders in terms of active risk management bearing in mind long-term interests of the company. Failure to comply with the LODR is arguably outside the contours of the defence of the business judgment rule.
In so far as the “good faith” requirement is concerned, a well-established exception to Foss v. Harbottle states that when “wrongdoers are in control” of the company, a derivative action may lie at the behest of the minority in order to remedy the “corporate” wrongdoing [laid down in Wallersteiner v Moir (No 2) [1975] QB 373 and Waddington Ltd v Chan Chun Hoo Thomas]. In most circumstances where minority shareholders seek to remedy an alleged breach of fiduciary duties on behalf of the company, the directors are in control of the company, making it virtually impossible for a company to bring a claim against such alleged wrongdoing. This necessitates an exception to allow derivative actions when wrongdoers are in control of the company.
Therefore, the observation of the UKHC on the “good faith” requirement, albeit obiter dicta, ignores this pertinent exception to Foss. Further, the rarity of derivative actions in India, alongside the usage of clean-hands doctrine on a case-by-case basis evidences the extant safeguards to prevent an abuse of such a remedy. But the restrictive approach taken in ClientEarth by merely invoking plaintiff’s status as a minority shareholder renders obsolete the very purpose of resorting to derivative action as a remedy.
Reassessing ClientEarth: the Way Forward from an Indian Perspective
In rejecting ClientEarth’s derivative action, the UKHC ruled that a board of directors has no “absolute” duty towards the environment. While that stance is contestable within UK law in itself, it is clear that within Indian law stakeholders do not have a hierarchical order in priority. More importantly, it is within a company’s best interest to manage climate risk since an omission on this front can be detrimental to its own long-term interests.
For instance, in Re Caremark International Inc. Derivative Litigation, a different approach was sought and the Delaware Court of Chancery placed a higher onus on the board by requiring directors to show particular care and diligence on mission-critical issues. To justify a Caremark claim, the plaintiff has the option to prove one of the two prongs i.e., either no system of control or risk management existed to begin with or that such a system of control or risk policy did not have sufficient oversight mechanism, which eventually nullifies the purpose of risk control.
The application of such an approach would require climate-sensitive businesses to exercise reasonable skill and diligence to manage climate risks, in particular. This Caremark approach is also reflected in the LODR requirements under regulation 34 that mandate the top 1,000 listed companies by market capital to produce an ESG report on an annual basis. Such companies are more likely to contribute to emissions and have a greater impact on climate-related concerns, making it “mission-critical” for them to be environmentally conscious. Furthermore, the essence of the two-pronged approach to survive a Caremark claim has also been embedded in regulation 17 which specifically casts an onus on the board to frame, implement and monitor a risk management plan.
In our view, the absence of a climate-risk policy, especially with companies that are climate-sensitive (by size or nature of business), would amount to a square violation of the directors’ duties under Indian law. Further, going by the Dutch Court’s understanding in Milieudefensie et al. v. Royal Dutch Shell plc, merely acknowledging climate as a risk is untenable and directors ought to take affirmative steps to effectively control climate risk as part of an “unwritten standard of care”.
Conclusion
An analysis of both company and securities regulation in India clearly establishes a forward-looking approach on directors’ duties towards alleviating climate risk. While admitting derivative actions, especially at the behest of minority shareholders, does possess the threat of opening up floodgates, the safeguards, both in civil procedure and substantive law in the form of Foss, coupled with the sheer costs involved in such a litigation, are enough mitigating factors to limit the scope of such derivative actions.
Furthermore, the increasing set of ESG requirements has restricted the scope of business judgment rule. The duty of loyalty, skill and diligence requires directors to comply with codified ESG requirements. Failing to do so, either by violating legal obligations or neglecting their responsibilities in overseeing the company’s activities, renders board members ineligible for the protections provided by the business judgment rule. In such a regulatory landscape, forewarned is forearmed.
– Dhanshitha Ravi & Santosh S