ESG in IBC Over-Enthusiasm or the most Practical Approach: Critical Analysis
Vinit Bachwani & Arunima Sao
5th year, B.A. LL.B(Hons.), Hidayatullah National Law University
Introduction
The neo-classical concepts of economic development based on demand-supply theory are losing its relevance due to its short-sighted and corrective approach. There is rather significant focus on preventive approach driven by Ecological Economics which focuses on wellbeing and environmental decisions rather than correcting these decisions later. This Ecological model is at par with the communitarianism approach of Insolvency where focus is on reviving a business which is economically, socially and environmentally sustainable and benefits a wider range of stakeholders. The benefits of ecological economics in insolvency situations are yet underexamined.[1]
The macro-economic benefits of ecological economics cannot be denied. However individual firms Pressurizing corporates to contribute socio-environmental responsibilities to dress up it as business discipline has often distracted legislative and corporate policies from the main goal aligning social and environmental activities of business with its long-term purposes and goals. This is the reason why mandatory provisions of CSR and similar rules in China have often been termed as ‘forced philanthropy’ and ‘over-enthusiasm’ of corporate law makers.
There is a similar pitch to include Economic-Social Governance as a part of mandatory provisions of Insolvency laws. In a similar pattern to other economic laws Insolvency laws have also been formulated based on spectrum starting from creditor centric approach to a communitarianism approach. Where the neo-classical economic model can be said to be pari-passu centre-right capitalist approach or creditor’s bargain model[2]. On the other hand, Communitarianism approach includes the socialist and approach. Thus, this article is divided into two parts which analyses the extreme ends of the spectrum in an attempt to strike the fine balance between the two approaches. The first part deals the necessity of the resolution plan being included in the Resolution plan. The second part deals with the unanswered questions have always led the arguments against inclusion of ESG as mandatory provisions of Resolution plan in Insolvency laws.
Intersection of ESG and IBC
Insolvency and Bankruptcy code, 2016 was a major breakthrough contributing to one of the most important structural reforms as bragged by Finance Minister in her latest interim budget speech[3]. This Code is in line with objectives of UNCITRAL Model Law on Insolvency[4] of reorganization (revival) and time bound resolution process. It is indeed evident that IBC has provided a predictable and reliable framework for insolvency resolution and has made great strides. Though IBC may be the major structural reform in the words of Chief Economic Advisor “recent changes including GST, IBC Code and direct taxes, also needed a periodic review”[5]. And Recently There has been a strong pitch by the Insolvency law experts and higher IBBI professionals to include ESG into IBC Code, 2016.
The pitch to include ESG as a part of insolvency resolution is supported by the overall environment of integration of ESG in Corporate laws in India. Companies Act, 2013 under Section 135 makes it mandatory for some specific companies earning profit to contribute towards Corporate Social Responsibility (CSR)[6]. This expenditure as provided under Schedule VII of Companies Act includes various activities fulfilling ESG goals like activities relating to environment sustainability, Social Business projects etc. In a similar pitch Business Responsibility and Sustainability reporting, a step ahead of ESG Reporting, was made mandatory by SEBI for top 1000 companies[7]. Given the increasing alignment of economic activities with ESG the need for clarity is awaited. Indian Green Social and Sustainability bond has recorded a growth of 585% to reach $75 billion in 2021[8]. India’s sustainable funds in comparison to retail assets held amounts to Rs. 110 billion[9].
Thus, a strong pitch to include ESG as a mandatory component of the Resolution plan approved under section 31 of Insolvency and Bankruptcy code is justified. Even though the resolution plan does not expressly mandate ESG to be included in the resolution plan, its inclusion is always anticipated.
Lack of Clarity regarding ESG Principles under IBC
There are primarily two core principles where ESG may find its place in IBC. Firstly, promoting wider stakeholder’s interest through ESG provisions and secondly, reorganization of business i.e., through restructuring of ESG related liabilities under the code. It is evident from the existing provisions of IBC that it is mainly focused on debt restructuring process by inclusion of creditors in the process. But in the whole process, there is not mandate upon the resolution professional to follow ESG related principles. There is code of conduct by IBBI[10] which is mainly focused on better administration and fair play. Similarly, NCLT is not bound to observe ESG principles before approval of a resolution plan. This shows a gap from communitarianism approach which it seeks to follow. It is rather a creditor centric approach where creditors initiate a credit restructuring process which if fails leads to liquidation without taking into account the stakes of community involved in any business.
Promotion of wider stakeholders’ interest
Insolvency and Bankruptcy code is said to be resounding success because of the comprehensive procedure provided to remove a business from its insolvent state. But these comprehensive procedure fails to accommodate or provide a window for the wider stakeholders affected by the activities of the business. These stakeholders can include the environment advocacy groups, environmental authorities, labour authorities, and employee unions etc. The Insolvency and Bankruptcy code neither provides for any approval from environmental and labour authorities and nor provides any window to raise these concerns before the approval of resolution plan. The invocation of public interest concerns is also discretionary on the part of NCLT. The discretion of NCLT to reject the resolution plan has also been limited to two major reasons i.e., violation of any applicable law (which may include environment and labour laws) and adherence to broad payment principles as laid down under IBC.
Restructuring of ESG related liabilities
As far as restructuring of Environment related liabilities is considered under section 53 of IBC which provides for the Waterfall arrangement, ESG liabilities are not excluded as such. This means that Environmental liabilities can be restructured in ordinary manner equating these liabilities with other trade and statutory liabilities of the company. As per Section 53 of IBC Environmental and Social liabilities like CSR expenditure, Environmental penalties or compensation etc due to government could be recovered as operation dues under section 5 (21) defining ‘operation debt’ read with Section 53 (1) (e) (i) providing for the waterfall arrangement. Whereas environment compensation to any third party can be covered under section 53 (1) (f) as “any other debts or dues”. Considering the concept of ‘absolute liability’ laid down by Supreme Court in India which also led to the enactment of Public Liability Insurance Act 1991 can be applied to insolvency proceedings. But its application into insolvency law has not been supported by any precedent and is yet to be seen its development is still in its nascent stage.
Similarly, there is no clarity upon the treatment of social liabilities for example, health and safety related liabilities, civil claims of employees and fines for non-maintenance of occupational safety etc. These liabilities are unliquidated damages that may accrue in future arising out of any tortuous or product liability. Unlike other liabilities, social liabilities accrue in future and are unascertained. In Essar Steel India Limited[11], it was held that there should be no ‘hydra head’. Hydra heads here refer to the future uncertain liabilities which may arise out of any product liability, tort liability or asbestos claim. It is important to note resolution applicant can avail immunity from ‘an offence’ and not civil liabilities pursuant to section 32A. Generally, these liabilities may be provided in the resolution plan but there is high probability that such liability may arise in future and principle of ‘absolute liability’ may be applicable upon them. However, the manner of treatment of such liabilities by NCLT is yet to be seen.
Though Environmental and Social liabilities do not have clarity, Governance provisions are comprehensively dealt in the Code. It is evident from the fact that it is expressly provided in section 32A that ‘officers in default’ cannot enjoy the immunity provided under the same provision. Insolvency and Bankruptcy Board of India has also laid down code of conduct for insolvency professionals[12] which provides for objectivity, conflict of interest, and independence etc. The registration of insolvency professional with insolvency professional agency under section 206 of IBC is a pre-requisite to be classified as an insolvency resolution professional.
An inherent gap between the most widely accepted approach of insolvency i.e., communitarianism and Indian Insolvency and Bankruptcy code is visible. The introduction of ESG principles in IBC can fill this gap. It resonates the call by senior IBBI professionals to include ESG in insolvency law through amendment. But various insolvency law professionals have also expressed their concern regarding introduction of ESG in insolvency law. It always remains a question that whether increasing pressure on business to fulfil social obligations even after paying taxes leads to increased burden and distraction form the goals of the business leading to greater economic loss to the society. These arguments lead us to two contentions firstly being why ESG principles can be beneficial for Indian corporate culture and development of insolvency law in India and but there concerns expressed by the insolvency law professionals against the introduction of these principles in IBC. Thos concerns have been expressed below.
Is inclusion of ESG against the Basic Principles of IBC?
The principal objective of IBC as stated in the preamble is the reorganization of the business and insolvency resolution of the business to be achieved in a ‘time bound manner’. Whereas ESG compliance makes the process lengthy and affects the time boundedness of the resolution. At the same time forcing the ailing company to focus on ESG parameters can act as a pediment in achieving efficiency and profitability, promotion of entrepreneurship capabilities and loss of economic interests of the primary stakeholders of the company. This leads us primary objections regarding the inclusion of ESG in IBC. Those questions are:
- Whether inclusion of ESG defeats the objective of IBC?
- Whether ESG overburdens the financially ill company in a corporate environment which is already over-enthusiastic towards and ESG principles?
ESG vis-à-vis Basic Principles of IBC
A business environment with microscopic vision of corporate responsibility along with micro-management of business responsibilities could lead to over-regulation of the corporates leading to negative impact on the ease of doing purpose. And this overregulation could lead to defeating the primary objectives of the Insolvency Resolution under CIRP and over burdening the financially ill companies.
ESG against the Objectives of the IBC
Inclusion of ESG as a mandatory compliance under IBC can negatively impact all the objectives stated in the preamble of the code. As ESG, still regulatory framework of most of it is in grey area, directly affects the time boundedness of resolution and viability check of the business[13]. Firstly, incorporation of various regulatory checks and approvals from environment, social and other stakeholders before an approval of the resolution plan could lead to redundant and time-taking negotiation process with various stakeholders. Whereas the primary objective of the IBC is corporate resolution rather than corporate responsibility. There is a strict timeline of 330 days in which a CIRP has to be completed which usually gets extended due to overburdened tribunals and judicial system of the country. In Coc Essar Steel India v Satish Kumar Gupta[14], Supreme Court held that the “If the delay or a large part thereof is attributable to the tardy process of the AA and/or the NCLAT itself, it may be open in such cases for the AA and/or NCLAT to extend time beyond 330 days”. This shows that the resolution plan before its approval by the Adjudicating Authority takes time beyond timeline provided. Increased approvals to be taken from the environment tribunals or authorities could lead to increased disputes and fundamentally impracticable to complete the CIRP in the same time line.
Secondly, Mandatory ESG compliance in an approval of resolution plan can lead to increased pressure upon the distressed assets and limited financial space to adhere to the various environmental and social regulations. This leads to increased pressure on the assets, impacting its productivity and reduction in the overall value of the asset. Thirdly, ESG keeps the profitability and productivity on back foot and imparts greater value to the social and governance norms. This directly impacts the economic interests of the primary stakeholders of the company i.e., shareholders, creditors and even employees (employment continuity and job security). Assigning greater values or weights on the ESG norms and could automatically lead to a compromise with the primacy of the economic interests of the primary interests of the stakeholders. This would not only create imbalance in promoting stakeholder’s interest but may lead to defeating another objective of credit availability in the market.
Should a failing business be compelled to be socially responsible?
With a lot of fuss about ESG in the business practises, it has not served the desired results in the society. And this has led to the development of the complex regime where we have moved from simple Corporate Social Responsibility to complex ESG Reporting and ESG Compliances which require enough time and resources already scarce with a corporate entity under CIRP. Even the high profit-making entities are the worst performers as far as sustainability is concerned[15]. Thus, Mandatory inclusion of ESG can just be a mirage of increased corporate governance which may never lead to fruitful results as it may prove unviable business. There are various other theories which suggest that ESG can never be forcefully imposed upon business houses. Those theories argue that:
- Companies have purely profit motive – In this theory Friedman[16] argues that corporates advocating ESG are “dangerous wolf dressed in sheep’s clothing” as they preach ESG to earn profits. For Example, “For example, a company could be a significant source of emissions but still get a decent ESG score, if the ratings firm sees the pollutive behaviour as being managed well or as non-threatening to the company’s financial value”[17]. Thus, forcing ESG can lead the ‘dangerous’ turning into a ‘hazardous’ fox.
- Overburdened but Scarce resources – The business which is an ‘artificial person’ are being attached with social responsibilities. The corporates have to pay taxes which are soaring and India being the country with one of the highest rates of tax[18] across the globe. And Contribution to ESG and CSR have become a tool at the hands of the Government to fill the gap which they have not been able to.
- Half-Hearted Measures and distraction from the principal business activity – Over emphasis on ESG related responsibilities of the business leads to half-hearted efforts which reduce these ESG responsibilities to a mere tick the box exercise and shortcuts being adopted to “pretend” that business is fulfilling the ESG activities without actually working upon it. This can be proved from the fact that most of the businesses lack strategic ESG policy for value creation. But today’s concept of ESG has proved to be its dilution.
ESG’s role in development of Insolvency Resolution Landscape
There is increasing focus on value creation by the business in Indian Corporate culture. Integration of ESG principles as a part of corporate governance practise has been a major tool to achieve this aim. In the process of integration of these principles, Companies Act, 2013 and various disclosure requirements by SEBI like mandatory ESG reporting and BRSR reporting has given a kickstart to companies to adopt ESG practises. While reorganization of business is the prime objective of IBC code evident from supreme court’s judgement in Benani Industries[19] has held that objectives of IBC are sacrosanct in nature. In the process of reorganization of the business if we miss the opportunity to integrate the ESG activities in the business would not fulfil our strategic aim of value creation. Aligning ESG principles in business leads to creation of a complementary force to public administration. It provides a new stream of funding available for social welfare. Apart from this, companies in a long run integrate with the community to become the part of the community. Long term organizational goals of the management rise above profitability to become socially conscious of the impact business activities create in the society.
Fine Balance Between Overregulation & Value Creation By ESG
As discussed above that overregulation and mandatory imposition of the ESG related activities could prove to more problematic. It can convert a ‘dangerous’ into ‘hazardous’ fox. But without ESG activities business is driven without long term sustainability and value creation. And it is a challenge before the regulatory authorities to strike a fine balance between the two contradictory forces working against each other. This balance can be struck through two-pronged legislative approach. Firstly, Motivating the resolution professionals and Resolution Applicants towards voluntary adoption of ESG practises. Secondly, Incentivizing the resolution applicants and corporates from various procedural and tax exemptions to voluntary take part in ESG and value creation in the business.
Conclusion
The concerns about the potential burden and distraction from business goals exist, the strategic incorporation of ESG principles in the IBC can enhance the effectiveness of the insolvency resolution process, making it more comprehensive and aligned with the evolving expectations of corporate governance in the 21st century. As far as their positive inclusion is concerned, its role in the development of the insolvency resolution landscape goes beyond legal compliance; it becomes a strategic tool for value creation. Aligning ESG principles in business operations not only contributes to social welfare but also positions companies as integral parts of the community. But forcing these principles through mandatory enforcement could lead to negative impacts on viability, profitability and it may not serve the objectives of IBC. This long-term integration demands a conscious approach by the legislators, and strike a fine balance between ESG and IBC to lead towards its healthy adoption into the system.
References:
[2] “MOKAL, RIZWAAN JAMEEL, ‘The Creditors’ Bargain and the Collectivity of the Liquidation Regime’, Corporate Insolvency Law: Theory and Application (Oxford, 2005; online edn, Oxford Academic, 1 Jan. 2010), https://doi.org/10.1093/acprof:oso/9780199264872.003.0002, accessed 20 Feb. 2024.”
[3] “Press Release, Press Information Bureau, Ministry of Finance, May, 16, 2020, https://pib.gov.in/Pressreleaseshare.aspx?PRID=1624536”
[4]“ UNCITRAL MLCBI, United Nations Commission on International Trade Law, 1997.”
[5] The Hindu 05.02.24
[6] Act no. 18, Parliament of India (2013).
[7]“Business responsibility and sustainability reporting by listed entities, May 10 2021, SEBI Circular No. SEBI/HO/CFD/CMD-2/P/CIR/2021/562 https://www.sebi.gov.in/legal/circulars/may-2021/business-responsibility-and-sustainability-reporting-by-listed-entities_50096.html.”
[8]“Assets of ESG funds rise 5x in four years to Rs 12,450 crore, shows data, Chirag Madia, The Business Standard, April 24, 2022 https://www.business-standard.com/article/markets/assets-of-esg-funds-rise-5x-in-four-years-to-rs-12-450-crore-shows-data-122042400997_1.html”
[9]“Rejuvenating India’s ESG investment landscape, Prasad Thakur, The Economic Times, June 30, 2023, https://bfsi.economictimes.indiatimes.com/blog/rejuvenating-indias-esg-investment-landscape/103872998”
[10]“Insolvency Professionals and the Code of Conduct, Mukulita Vijayawargiya, IBBI, https://ibbi.gov.in/uploads/resources/85f8ee79409d33976f0badbc0bf62ad4.pdf”
[11] “Essar Steel India Limited v Satish Kumar Gupta, (2020) 8 SCC 531”
[12] “First Schedule, Insolvency and Bankruptcy Board of India (Insolvency Professionals) Regulations 2016. (https://ibbi.gov.in//uploads/legalframwork/213cd7f2c53374800f7cf1e881b58d51.pdf).”
[13] “Corey B Shapiro, Green Funds in a Gray Area, Vol. 48 No. 2 (2023), Columbia Journal of Environmental Law, https://journals.library.columbia.edu/index.php/cjel/article/view/11734”
[14] Coc Essar Steel India v Satish Kumar Gupta, [2019] ibclaw.in 07 SC.
[15] Naomi Buck, The Climate Blockers: BASF quietly lobbies against strong climate policy while talking a big game, (January 25, 2023), “https://www.corporateknights.com/category-climate/the-climate-blockers-basf-quietly-lobbies-against-strong-climate-policy-while-talking-a-big-game/”
[16] “Milton Friedman. (1970). A Friedman doctrine‐- The Social Responsibility of Business Is to Increase Its Profits. https://www.nytimes.com/1970/09/13/archives/a-friedman-doctrine-the-social-responsibility-of-business-is-to.html”
[17] “Taparia, H. (2021). The World May Be Better Off Without ESG Investing. Stanford Social Innovation Review. https://doi.org/10.48558/PC0C-TV52”
[18] “Are Indians paying more tax than those in other countries?, Samrat Sharma, June 16, 2023, The India Today, https://www.indiatoday.in/diu/story/are-indians-paying-more-tax-than-those-in-other-countries-2393897-2023-06-16 “
[19] “Binani Industries Ltd. v Bank of Baroda [2018] ibclaw.in 08 NCLT.”
