Environmental, Social and Governance

Note what that sentence does. It makes the protection of the environment an interest a director is required to have regard to, so a decision taken in disregard of it is a breach of a statutory duty, not merely a bad decision.

In the CSR list: Schedule VII item (iv). Activities relating to ensuring environmental sustainability, ecological balance, protection of flora and fauna, animal welfare, agroforestry, conservation of natural resources and maintaining the quality of soil, air and water, including contribution to the Clean Ganga Fund.

In the Board's report: section 134(3)(m). The report must contain the conservation of energy, technology absorption, foreign exchange earnings and outgo, in such manner as may be prescribed.

That clause is older than the ESG vocabulary and was written when energy conservation was an industrial policy concern rather than a climate one, but it is where a company's energy disclosure sits in this Act.

And in the risk statement: section 134(3)(n). A statement of the development and implementation of a risk management policy, identifying elements of risk which in the Board's opinion may threaten the existence of the company. Where a company's existence is threatened by environmental exposure, that is where it must be said.

The social component

Corporate social responsibility: section 135 and Schedule VII. The obligation of a company above five hundred crore net worth, one thousand crore turnover or five crore net profit to spend two per cent of the average net profits of the three immediately preceding financial years, with preference to the local area, on the twelve heads of Schedule VII: hunger, poverty, malnutrition, health care, sanitation and safe drinking water; education and vocational skills; gender equality, women, orphans and senior citizens; environmental sustainability; national heritage, art and culture; armed forces veterans and war widows; sports; the Prime Minister's National Relief Fund and the PM CARES Fund; research and public funded universities; rural development; slum area development; and disaster management.

And since the 2019 and 2020 amendments the obligation has teeth, the unspent amount having to be transferred and the failure carrying a penalty: [Corporate Social Responsibility].

Employees, in the director's duty. Section 166(2) again, which names employees before shareholders in its list.

Employees, in a winding up. Section 326 puts workmen's dues, and two years of wages and holiday pay ahead of even secured creditors, which is the Act's strongest statement about whose interest survives a failure.

The woman director. The second proviso to section 149(1) requires prescribed classes of companies to have at least one woman director.

Security holders' grievances. Section 178(5) and (6), the Stakeholders Relationship Committee where there are more than a thousand security holders.

The whistleblower. Section 177(9) and (10), the vigil mechanism for directors and employees with safeguards against victimisation.

And pay equity, of a kind. Section 197(12) requires a listed company to disclose in the Board's report the ratio of the remuneration of each director to the median employee's remuneration, which is a comparison between the top and the middle of the company.

The governance component

This is the whole of [Corporate Governance], and in an answer on ESG it should be summarised rather than repeated: independent directors and their declaration, code and fixed term under section 149 and Schedule IV; the Audit, Nomination and Remuneration and Stakeholders Relationship Committees under sections 177 and 178; the Board's report and the Directors' Responsibility Statement under section 134; the statutory and secretarial audits under sections 143 and 204; and the control of managerial remuneration under sections 197 and 199.

Two of those carry a governance point that belongs here. The Directors' Responsibility Statement requires the directors to state that they devised proper systems to ensure compliance with all applicable laws, which includes environmental and labour law. And section 134(3)(p) requires a listed company to state the manner of the annual evaluation of the performance of the Board, its committees and individual directors.

Where the Act stops

It is as important to say what the Act does not do, because an answer that claims more than the statute contains is wrong on the law.

There is no statutory ESG report. The Act requires the Board's report under section 134(3), and within it the specific items listed above. A separate sustainability or ESG report is not required by the Companies Act.

There is no statutory ESG rating or assurance. The Act provides for a statutory audit of the accounts and a secretarial audit of compliance, and for nothing else.

And the listed-company reporting framework is not in this Act. Reporting obligations of that kind for listed entities are imposed under the Securities and Exchange Board of India Act, 1992 and the regulations made under it, and they change from time to time. A student answering this topic should say that the framework for listed companies is prescribed by the Securities and Exchange Board of India and state the position as it stands at the date of the paper, rather than reciting a framework from a textbook that may have been superseded.

That is not a gap in the answer; it is the answer. The Companies Act supplies the duty, the spending obligation and the governance machinery; the securities regulator supplies the reporting.

A worked example

Taloja Chemicals Limited has a net worth of six hundred crore rupees, a plant on a river, twelve hundred employees and a Board of ten.

Environmental. Its directors must, under section 166(2), act in the best interests of the company, its employees, the shareholders, the community and for the protection of the environment. A decision to save cost by discharging untreated effluent is not merely unlawful under environmental law; it is a breach of the statutory duty of a director.

Its Board's report must state the conservation of energy, technology absorption and foreign exchange earnings and outgo (section 134(3)(m)), and its risk management policy identifying risks that may threaten the company's existence (clause (n)), which for a chemical plant on a river includes the risk of closure on environmental grounds.

Its CSR. Crossing the five hundred crore net worth threshold, it must constitute a CSR Committee, adopt a policy on Schedule VII activities, and spend two per cent of the average net profits of the three immediately preceding financial years, preferring the local area. It funds effluent treatment for the village downstream and tree planting on the riverbank, both within Schedule VII item (iv), and a vocational training centre, within item (ii). Unspent money goes to a Schedule VII Fund within six months, or, for its ongoing water project, to the Unspent Corporate Social Responsibility Account within thirty days.

Social. Being within the prescribed class it has at least one woman director: second proviso to section 149(1). It has more than a thousand security holders, so it has a Stakeholders Relationship Committee with a non-executive chairperson. Its vigil mechanism lets an employee report the effluent discharge with direct access to the Audit Committee's chairperson and protection from victimisation. Being listed, it discloses the ratio of each director's remuneration to the median employee's remuneration.

Governance. Four independent directors, one third of ten rounded up; their annual declarations; an Audit Committee with an independent majority; a Nomination and Remuneration Committee of non-executive directors; the Board's report and the Directors' Responsibility Statement, in which the directors state that they devised proper systems to ensure compliance with all applicable laws, which covers the environmental statutes; a secretarial audit by a company secretary in practice; and the section 197 ceilings on managerial pay.

What it need not do under this Act. It need not publish a separate ESG or sustainability report, obtain an ESG rating, or have its environmental disclosures assured. Whether it must make a prescribed sustainability disclosure as a listed entity is a question under the Securities and Exchange Board of India Act, 1992 and the regulations made under it, and the answer should be stated as at the date of the question.

If it fails. The consequences come from the individual provisions, not from any general ESG provision: section 135(7) for the unspent CSR amount, section 134(8) for a defective Board's report, section 178(8) for the missing committee, and section 166(7) for the breach of a director's duty.

Distinctions that carry marks

What this does NOT mean

It does not mean ESG is a legal category in the Companies Act. The Act nowhere uses the expression; the components are found in provisions written for their own purposes.

It does not mean the environment is only a CSR matter. It is written into the director's duty in section 166(2), which applies to every company whether or not section 135 does.

It does not mean corporate social responsibility is voluntary. Since the 2019 and 2020 amendments the unspent amount must be transferred and the failure carries a penalty.

It does not mean the Act requires sustainability reporting. That obligation, for listed entities, comes from the securities regulator, not from this Act.

It does not mean the governance component is separate from the rest. The same Board that must have regard to the environment is the Board that the committees, the report and the audits are there to discipline.

Quick revision

• The expression "ESG" appears nowhere in the Companies Act, 2013. The topic is the location of its three components in provisions written for other purposes.
• Environmental: section 166(2), the duty to act in the best interests of the company, its employees, the shareholders, the community and for the protection of the environment; Schedule VII item (iv), environmental sustainability, ecological balance, flora and fauna, animal welfare, agroforestry, conservation of natural resources and the quality of soil, air and water, including the Clean Ganga Fund; section 134(3)(m), conservation of energy, technology absorption and foreign exchange; section 134(3)(n), the risk management policy identifying risks that may threaten the existence of the company.
• Social: section 135, the two per cent obligation on companies above five hundred crore net worth, one thousand crore turnover or five crore net profit, with preference to the local area and the twelve heads of Schedule VII; section 166(2), employees and community; section 326, workmen's dues and two years of wages and holiday pay ahead of secured creditors; the woman director; the Stakeholders Relationship Committee; the vigil mechanism with direct access to the Audit Committee's chairperson; and the pay ratio to the median employee's remuneration.
• Governance: the machinery of sections 134, 143, 149, 177, 178, 197, 199 and 204 and Schedule IV, including the Directors' Responsibility Statement's undertaking that proper systems to ensure compliance with all applicable laws were devised and are adequate and operating effectively, and the annual evaluation disclosure under section 134(3)(p).
• The limits: the Act requires no separate ESG or sustainability report, no ESG rating or assurance, and does not prescribe the listed-entity reporting framework, which is made under the Securities and Exchange Board of India Act, 1992; consequences flow from the individual provisions, such as sections 135(7), 134(8), 178(8) and 166(7).

Test yourself

1. Does the Companies Act, 2013 use the expression "ESG"? No. The expression appears in no section, Schedule or marginal note. The Act carries the three components separately: the environment and the community in the director's duty under section 166(2), the social and environmental heads of Schedule VII under section 135, and the governance machinery of sections 134, 149, 177, 178, 197 and 204.

2. Which single provision carries the environment into every company's law? Section 166(2): a director shall act in good faith 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 the environment.

3. Where do environmental matters appear in the Board's report? In section 134(3)(m), the conservation of energy, technology absorption and foreign exchange earnings and outgo; in clause (n), the risk management policy identifying elements of risk which in the Board's opinion may threaten the existence of the company; and in clause (o), the corporate social responsibility policy and the initiatives taken, which may include Schedule VII item (iv) activities.

4. Name four social provisions of the Act. Any four of: section 135 and Schedule VII, corporate social responsibility; section 166(2), employees and the community; section 326, workmen's dues and two years of wages and holiday pay in priority to secured creditors; the woman director under the second proviso to section 149(1); the Stakeholders Relationship Committee under section 178(5); the vigil mechanism under section 177(9) and (10); and the pay ratio disclosure under section 197(12).

5. Does the Act require a sustainability report? No. It requires the Board's report under section 134(3) with the items specified there, a statutory audit under section 143 and, for prescribed companies, a secretarial audit under section 204. Reporting obligations of a sustainability kind for listed entities are imposed under the Securities and Exchange Board of India Act, 1992 and the regulations made under it, and their content should be stated as at the date of the question.

6. What is the consequence of failing on an ESG obligation? There is no general consequence, because there is no general obligation. The consequences attach to the individual provisions: section 135(7) for a failure to transfer unspent corporate social responsibility money, section 134(8) for a defective Board's report, section 178(8) for the absence of a required committee, and section 166(7) for the breach of a director's duty.