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.
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.
The new Companies Act, 2013 extends the stakeholder 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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.