By Shreya Govil

Abstract

The treatment of shareholder and stakeholder interests in corporate legislation in the United Kingdom (UK) and India is thoroughly compared in this article. It looks at how legal frameworks have changed over time, with particular attention to how India’s Section 166(2) of the Companies Act recognises stakeholders’ interests in directorship responsibility and how the UK adopted the “Enlightened Shareholder Value” (ESV) model under Section 172 of the Companies Act 2006. The analysis draws attention to the difficulties in striking a balance between these interests and illuminates the constraints and difficulties in offering stakeholders actionable legal remedies in the event that directors’ duties are violated. Although both regimes acknowledge the rights of stakeholders, there are no direct legal remedies available to them, which restricts their options for seeking justice in comparison to shareholders.

Introduction

Stakeholders are defined as any group or individuals who are impacted by or can impact the achievement of a corporation’s purpose. Corporations cannot deny any stakeholders their rights. Stakeholder theory seeks a much larger perspective and expects companies to be managed more sustainably which is inclusive and keeps the interests of non-shareholder constituencies in mind. These non-shareholder constituencies include employees, creditors, the environment, and the larger community.

The director of a company has a duty to act in good faith towards the company and work towards the growth of the company. In this process, the director ends up working for the benefit of the stakeholders and shareholders. But often it is seen that shareholders end up getting primacy over stakeholders. This paper helps in resolving that dilemma and getting a better understanding of what can be done to resolve that issue. To get a better understanding of this differentiation we would first look at the United Kingdom and how it dealt with the question of shareholders and stakeholders.

United Kingdom’s Context

The British Parliament intervened under Section 172 of the UK Companies Act 2006 by adopting “Enlightened Shareholder Value” (ESV). If the aim is to increase shareholder value in the long term, directors must focus on non-shareholder interests to do so.

In common law jurisdictions, most power is in the hands of the shareholders. The traditional role of directors is to promote the interests of the shareholders. The shareholder primacy approach does not expect the director to refrain from considering the interests of other shareholders. The recognition of stakeholder interests happened before the codification of directors’ duties in India and the UK.

The UK had a shareholder-centric approach. But there is still enough space to take care of stakeholder interests. It is often observed that the interests of shareholders as a collective body are most of the time similar to the interests of the company. But whether the interests of the shareholders are to be looked at on a long-term or short-term basis is still not clear. The long-term view of shareholders is broader than the short-term view, as the short-term view focuses on the shareholder’s interests. Shareholder long-term interests require that the interests of other stakeholders such as employees, creditors, and consumers must also be kept in mind. Long-term consistent with the ESV model.

Section 309 of the Companies Act 1985 in the UK requires companies to consider employee interests, although, in case of a breach, employees don’t have any protection. Due to the rise of concepts like CSR (Corporate Social Responsibility) and SRI (Socially Responsible Investing). The interests and preferences of investors gained importance and the way in which stakeholders were viewed also changed. Important to note that even prior to the reforms in the 2006 Act, stakeholder interests did get attention. Although not legally enforceable, it was part of the director’s duties.

UK’s ESV model, common law does not equate shareholder interests to short-termism. In the UK shareholder interests are of paramount importance. The act clearly mentions that the director’s duties are towards the company and not the shareholder or stakeholder. There is a disparity in the treatment of stakeholders as beneficiaries of directors’ duties. Due to this, stakeholders are unable to assert their rights and take benefits from the regime. In the UK the Company Law Review Steering Group (CLRSG) helped in analyzing and responding to questions of interests and basically whose interests should be prioritized by the company

CLRSG model believes that there are two approaches available here. Shareholder Value Approach and pluralist Approach. CLSRG adopted a hybrid ESV model and rejected the pluralist approach because it required complete reformulation of the director’s duties. The UK itself has rejected the pluralist model. The ESV model in the UK does not have an independent cause of action against the company or director to assert their rights. And in case of conflict between different interests. The director must prioritize the shareholder’s interests.

Section 172 of the 2006 act, promotes the success of the company for the benefit of its members as a whole, and the success of the company for the benefit of members is the ultimate goal. India’s situation and the UK’s ESV model are very similar as they both weigh shareholders’ and non-shareholder constituencies equally. Both India and the UK recognized stakeholder interests before the codification of directors’ duties.

India’s Context

The post-independence company law aimed to protect the shareholders, to attract capital and did not focus on the interests of non-shareholder constituencies. However, there was a change in philosophy post-1960. Which led to amendments in the 1956 Company law.

Company law in India encompasses the interests of employees who get some special rights under company law. Like preferential treatment for dues in case of winding up of a company, right to be heard. Under the company, law creditors get standard rights and remedies. Rights are provided to protect the interests of the creditors. Public Interest is an important element, parties can exercise remedies where affairs of the company are carried out in a prejudicial manner. Indian Company law recognized stakeholder interest under both common law and stakeholder interests even before the codification of the director’s duties.

If we compare the developments in the UK to Section 166 of the Indian Companies Act. We note that efforts to codify directors’ responsibilities have been made in both the UK and India. Particularly those pertaining to non-shareholder constituencies. Section 166(2) appears to cover non-shareholder constituents’ interests in relation to the obligations of directors.

Now the Irani committee report made some very important recommendations and observations.

Clause 147(2) of the Companies Bill, it was noted that the intent was to only codify the director’s duties and not the interests of employees and potential stakeholders. And there was the codification of existing common law. Another important aspect was that the director’s duty was simply toward the interests of the employees. This includes having special provisions to protect employees during winding-up proceedings or consulting employees in major decisions that might impact them, like mergers. Stakeholders other than employees who would be benefiting were not specified. Exercise of power should be in good faith and in the best interest of the company.

The Parliamentary Standing Committee makes specific references to be inserted for the duty of shareholders, employees, the environment, and the community. In view of the voluntary CSR norms, an enabling clause is added which allows directors to consider non-shareholder interests.

ICSI recommendations were accepted which basically meant that the directors are required to consider stakeholder interests and not be just an enabling provision allowing directors to consider stakeholder interests. Under Section 166 (2) there is a duty to act in good faith. Which includes promoting the objects for the benefit of its members as a whole. The best interests include the company, shareholders, employees, community, and the protection of the environment. India does often talk about the rights of stakeholders but in case of a breach of duty, the question of an enforceable right has not been answered. India has adopted a pluralist approach and distanced itself from the pluralist model. Overall though there is greater protection from stakeholders than in the UK.

There are some issues in implementation.

Section 166 does not cast a duty on the director to protect the rights of the shareholder therefore section 166 is consistent with English Law, Therefore in case of a breach of the director’s duty it’s only the company that can bring an action and neither the shareholder nor other stakeholders can directly seek remedies against the directors. 

Stakeholders frequently have no recourse if their obligations are broken. The conventional remedies, including class actions and derivative lawsuits, are exclusively open to shareholders, not to stakeholders. The pluralistic method is fraught with issues in and of itself, rendering section 166’s rights for stakeholders more rhetorical than legally enforceable. When section 166 and its clauses are closely examined, it becomes clear that stakeholders do not have any legal recourse. The class action provisions contained in section 245 entitle only members and depositors to file a class action. If they believe that the company is being managed in a way that harms the interests of the company or its members or depositors. The legislative contemplation did not extend to the interests of other stakeholders, which is reflected in the language of the section. 

When it comes to bringing a derivative action on behalf of a firm that has broken its obligations, the law recognizes that only shareholders may do so. Derivative actions are regulated in the UK and are only open to shareholders.

It is important to understand that putting a subjective duty on the director to consider the interests of all the parties and stakeholders relying on the pluralist approach can be a recipe for failure. As there would be a conflict of interest between the shareholder and stakeholder, there would be substantial discretion at the hands of the directors. Allowing directors to focus on their own self-interests and leaving little accountability for anyone else. 

Conclusion

With regard to stakeholders, the implementation and enforcement of the directors’ duties outlined in sections 166(2) of the Indian Companies Act and 172 of the UK Companies Act would be extremely challenging in both India and the United Kingdom. Because stakeholders in both jurisdictions lack access to effective remedies in the event that directors’ obligations are breached. Courts and tribunals are more likely to consider Section 166 (2) in the near future. However, it appears that a thoughtful legislative reevaluation would be necessary to address the issues with the current provision (some of which we have highlighted above).Which would be more suitable than creating impromptu legal responses? As we’ve seen, giving stakeholders actual ammunition based on the law is likely to be a double-edged sword, because any novel approach taken by the judiciary is likely to have effects on the common law system, which are better addressed by legislative than judicial measures. One issue that needs to be addressed head-on is what solutions should be offered to stakeholders. However, steps should be taken to set up avenues for stakeholders where they have an opportunity to get some remedy in case of breach of duty by the director.

Author’s Bio

Shreya Govil is a student at Jindal Global Law School. Their areas of interest are constitutional law, gender studies, and Human rights law.

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