In April 2022, António Guterres, United Nations Secretary-General, drew the world’s attention to the alarming findings of the Intergovernmental Panel on Climate Change in its third report. Concerned that major emitters were not taking requisite steps to fulfil their climate pledges, the Secretary-General warned that unless governments everywhere reassess their energy policies, the world would soon be uninhabitable.

Evidently, governments are responsible for framing and implementing policies for environmental conservation. However, large corporations controlling crucial sectors such as energy, minerals, and mining, hold the key to effectively reduce dependence on carbon fuels.

Corporations act through a board of directors and such boards, especially in these sectors, find themselves under increasing scrutiny for taking affirmative steps towards protection of the environment. In February 2023, ClientEarth, an environmental law charity, filed a derivative claim against the directors of Shell Plc (“Shell”), the oil and gas giant, before the High Court in London. ClientEarth claimed that, while formulating Shell’s climate change risk management strategy, Shell’s directors had breached their directorial duty to promote Shell’s success as well as their duty to exercise reasonable care, skill and diligence. Interestingly, ClientEarth’s grievance was not that the directors failed to take steps to reduce dependency on fossil fuels. It acknowledged Shell’s graded plan to eliminate carbon intensity of its products by 2050. However, ClientEarth argued that Shell’s directors were not acting fast enough as they had excluded short to medium-term targets to cut absolute emissions.

In May 2023, the High Court dismissed ClientEarth’s application. On 12 July 2023, ClientEarth has once again approached the High Court to reconsider its dismissal. However, this request was also declined.

While ClientEarth’s action may not have been successful, it raises interesting questions on the obligations and liability of directors in the context of protection of the environment. Specifically, we consider, in the Indian context, whether (a) commercial decisions taken by directors for the company can be challenged when they appear to be at the cost of the environment; and (b) refuge, if any, is provided by the ‘business judgment rule’ to directors facing such a challenge.

Statutory Framework under the Companies Act, 2013 (“Indian Companies Act”)

In India, the changing approach towards environment conservation is evident from section 166 of the Indian Companies Act which imposes a statutory duty upon directors to protect the environment [section 166(2)]. Prior to this change, a director’s fiduciary duty was limited to protecting and acting in the company’s best interests. The Indian Companies Act, while continuing to impose this directorial obligation to act in the best interests of the company, its employees and the shareholders, now also requires director to act “for the protection of environment” [section 166(2)].

The expansion of the ambit of a director’s duties in India was discussed by the Supreme Court in Tata Consultancy Services Ltd. vs. Cyrus Investments (P) Ltd. [(2021) 9 SCC 449] (“Tata Mistry Case”). The Court observed that “the history of evolution of the corporate world shows that it has moved from the: (i) familial to (ii) contractual and managerial to (iii) a regime of social accountability and responsibility. This is why Section 166(2) also talks about the duty of a Director to protect environment, in addition to his duties to: (i) promote the objects of the company for the benefit of its members as a whole; and (ii) act in the best interests of the company, its employees, the shareholders and the community”. [paragraph 19.23]

It is pertinent, however, that the term ‘environment’ is not defined under the Indian Companies Act. The Supreme Court in M.K. Ranjitsinh vs. Union of India [(2021) 15 SCC 1, paragraph 12] observed that the term has to be given the meaning assigned to it under the Environment (Protection) Act, 1986. Section 2(a) of the Environment (Protection) Act, 1986, defines the word ‘environment’ to include the “interrelationship which exists among and between water, air and land, and human beings, other living creatures, plants, micro-organisms and property”.

Section 166(7) of the Indian Companies Act provides that a failure to comply with the duties set out in section 166(2), including the duty to safeguard the environment, would attract a fine which may extend to INR 5,00,000/- (approximately USD 6000) [section 166(7)]. More importantly, and in addition to a monetary penalty, if a company’s shareholders believe that the directors’ decision(s) appears to tip towards promoting profits at the cost of environmental conservation, such shareholders would arguably have the right under section 241 of the Indian Companies Act to approach the National Company Law Tribunal (“NCLT”) and contend that the company’s affairs are being conducted in a manner prejudicial to public interest. The NCLT has wide powers in actions of oppression and mismanagement, which includes powers to suspend the board of directors of a company during the pendency of the proceedings [Union of India, MCA vs. Infrastructure Leasing & Financial Services Ltd. 2018 SCCOnline NCLT 8537, paragraph 8].

Faced with such an action, the directors may consider claiming protection under the ‘business judgment rule’.

Business Judgment Rule

The business judgment rule is a widely recognized protection available to directors, when their commercial decisions are put to test before a court of law. The principle entails that while making a commercial decision on the company’s behalf, the board would have acted in good faith, on an informed basis and with the honest belief that the action is in the company’s best interests [Aronson vs. Lewis, 473 A.2d 805 (1984)]. In the absence of any evidence of abuse of discretion, courts would typically refrain from second-guessing the decision of a properly functioning board of directors, even if it may not have been the best decision in the company’s interests [Fisher vs. Cadman [2005] EWHC 377 (Ch)].

The origins of the business judgment rule can be traced to the courts in the United Kingdom. As early as 1742, the Court of Chancery in the Charitable Corporation against Sir Robert Sutton and about Fifty Others [(1742) 26 ER 642] opined that “The events do often times shew, that the proceedings or omissions of persons acting in this capacity are of evil tendency; yet it would by no means be just in a Judge to determine from events that have happened that they might be foreseen, because if so, nobody would accept the direction of corporate affairs”.

Over time, this rule has been further developed and refined, particularly by the courts in Delaware, United States of America, making it an effective shield for directors who have acted in good faith while taking commercial decisions for the company.  The high standard for challenging a board’s decision was recently reaffirmed by the Delaware Court of Chancery in City of Coral Springs Police Officers’ Pension Plan vs. Jack Dorsey, Block, Inc., [C.A. No. 2022-0091-KSJM, judgment dated May 9, 2023] by holding that “…a board comprising of a majority of disinterested and independent directors is free to make a terrible business decision without any meaningful threat of liability, so long as the directors approve the action in good faith.”

In ClientEarth’s legal action against Shell’s directors, the High Court inter alia referred to the business judgment rule while dismissing ClientEarth’s application. Particularly, the High Court agreed with “…the well-established principle that it is for directors themselves to determine (acting in good faith) how best to promote the success of a company for the benefit of its members as a whole” [paragraph 19].

As can be seen, the presumption survives only in favor of independent/disinterested directors who have acted in good faith and on an informed basis. The principle would not aid directors who fail to exercise their fiduciary duties, namely due care, loyalty and/or good faith and consciously disregard their directorial duties.

In the Indian context, there have been a limited number of reported cases wherein this defense has been relied upon. However, a perusal of even these limited cases demonstrates that this rule is recognized by both adjudicating authorities such as the NCLT
(as seen in Fidaali Moiz Mithiborwala vs. Majolica Properties (P.) Ltd., 2017 SCC OnLine NCLT 20894, wherein the NCLT opined that every decision of the NCLT must be tested on the fulcrum of the business judgment rule] as well as regulatory authorities such as the SEBI (as seen in Franklin Templeton Mutual Fund, Adjudication Order No. PM/NR/2021-22/12225-12233, 2021 SCC OnLine SEBI 839, where the SEBI acknowledged that the genesis of business judgment rule can be traced to a Court’s “…respect for corporate self-governance, as well as their dislike for second-guessing the business decisions of corporate directors and officers”).

The question which arises is whether the business judgment rule can be an effective shield against allegations of breach of statutory directorial duties. Unfortunately, Indian case law does not shed light on this issue yet. We can, however, take guidance from the High Court’s position in the ClientEarth action. This action was premised on the purported violation by Shell’s directors of their statutory duties. Nonetheless, the High Court accepted the business judgment rule as a valid defense against the same.

Foreign courts, especially in common law jurisdictions, have taken a firm view in favour of application of the business judgment rule. In this context, it will be interesting to see the approach of Indian courts given their history of activism in environmental matters and how Indian courts balance environmental activism with established principles of limited directorial liability.

Conclusion

Since the Indian Companies Act came into force, the courts in India have not had the opportunity to consider any challenge to a board’s decision on the ground that the same is in violation of the director’s duty to protect the environment. As such, it remains to be seen the manner in which such a challenge would be analyzed by the Indian courts and the extent to which the business judgment rule would come to the aid of the directors facing such a challenge. Naturally, factors such as the diligence exercised by the board, vested interests, if any, of the directors, material considered by the board, the director’s independence, etc. would play a crucial role in determining the outcome of any such challenge. However, given the manner in which courts in the United Kingdom and the United States of America have dealt with such claims, particularly ClientEarth’s action, one can assume that the business judgment rule would be an important shield for directors facing prosecution.

– Abhijnan Jha & Urvashi Misra