Saturday, October 24, 2009

UN Corporate Law Tools project: Corporate Structures and Governance and Human Rights

The United Nations has been developing a project on Reports on Corporate Law Tools, which involves leading law firms from across the globe working with UN Special Representative John Ruggie to analyse how corporate structures in different legal systems foster respect for human rights. The idea behind the project is found in this note prepared by the Special Representative.

Reports from several countries are now available, including the report from India prepared by AMSS.

The Indian report consists primarily of answers to the several questions framed. Some of the specific questions include:
+ Briefly explain the broader legal landscape regarding business and human rights.
+ Did incorporation or listing of companies historically, or does it today, require any recognition of a duty to society, including respect for human rights?
+ To whom are directors’ duties generally owed (i.e. to the company, non-shareholders etc.)?
+ Are companies required or permitted to disclose the impacts of their operations (including human right impacts) on non-shareholders, as well as any action taken or intended to address those impacts, whether as part of financial reporting obligations or a separate reporting regime?
+ Are institutional investors, including pension funds, required or permitted to consider such impacts in their investment decisions

According to the executive summary of the report, in relation to the role of directors, “Directors are in a fiduciary relationship vis-à-vis their companies. They are therefore required to act in a bona fide manner for the benefit of the company. In certain circumstances, the directors are required to extend their duty of care to the shareholders and other third parties (including creditors and employees). Whilst the Companies Act does not mandatorily require directors to consider non-business related impacts, the requirement may be read into the duties of directors not to carry out business in a manner which is prejudicial to public interest. Certain environment protection statutes also impose obligations on companies (and their directors) to consider and prevent environmentally harmful activities. Additionally, given that the Courts have been active to condemn cases of grave violation of fundamental rights by companies, it would be advisable for directors to be circumspect of any human rights violations in which their companies could get involved…

This blog has carried several discussions of directors’ duties; the most recent one is found in the comments to this post. Among other issues raised by the report is the role of institutional investors in India. As the report notes, there is neither any requirement nor any bar on institutional investors to consider human rights or governance impacts in their investment decisions.

Theoretically, institutional investors can exhibit shareholder ‘activism’ in two ways – either by challenging management decisions, or by relying on the markets to immediately exit the company in the event of any governance irregularities. Typically, these are referred to as the ‘voice’ and ‘exit’ strategies. In requiring institutional investors to adopt the ‘voice’ strategy rather than the ‘exit’ strategy, one factor which must be taken into account is that the institutional investor also has a duty to its customers to ensure a good return on the customer’s investment. The practicability of requiring institutional investors to play an ‘activist’ role is therefore problematic, considering that for customers, ‘exit’ may often be economically the best option (at least in the short-term).

Among the other forms of shareholder activism in India highlighted by the AMSS Report is the Investor Protection Fund under Section 205-C of the Companies Act. One step which the proposed Companies Bill seems to have taken in this regard is the formation of the Stakeholders Relationship Committee. Under the proposed Section 158(12), “The Board of Directors of a company having a combined membership of the shareholders, debenture holders and other security holders of more than one thousand at any time during a financial year shall constitute a Stakeholders Relationship Committee consisting of a chairman who shall be a non-executive director and such other members of the Board as may be decided by the Board.” This Committee is to be tasked with “considering and resolving” the grievances of stakeholders. The Report notes that the term ‘stakeholder’ in this context is likely to refer to “… security holders and creditors of the company, rather than other third parties such as representatives of communities affected by the company’s activities…

The Report highlights the fact that while legislations do exist requiring directors to take into account the interests of some categories of non-shareholders, issues of control over the actions of the management are still unresolved. This is particularly true considering the peculiar relationship between ownership and management in India, which is in practice often not distinct.

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