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This is an expert article by Mr. Souvik Ganguly, Managing Partner at Acuity Law. GNLU Centre for Corporate & Insolvency Law extends its gratitude for his expert opinion.
It is not that the company is a creation of our modern era. It has been recorded that Kongo Gumi[1] established in 548 A.D. in Japan, is the oldest company which continues to do business albeit as a subsidiary of Takamatsu Construction Group.
The company that we see today has these fundamental characteristics: (i) separate legal entity; (ii) perpetual succession; (iii) transferability of shares; (iv) ownership of property; (v) ability to sue and be sued; and (vi) separate governance structure. These fundamental characteristics have made the company, the ideal vehicle for owning businesses across continents. Typically, the key stakeholders intrinsically linked to the company are shareholders, directors, employees, suppliers / vendors, and customers. The Government may also be considered a stakeholder as it derives substantial revenues by taxing the profits of the company and taxing the stakeholders who financially benefit from the company.
Accordingly, the company is central to conducting economic activities for the financial benefit of its stakeholders. However, it may be argued that the company is not run for the good of all its stakeholders but for the good of only its shareholders, since it is because of the shareholder that the company exists. If the shareholder would not have contributed the capital, the company may not have existed. Accordingly, the benefits of the economic activity of the company should only be appropriated by the shareholder.
These premises and thoughts on the company and its social responsibility have been dealt with by Milton Friedman in an article published on 13 September 1970 in the New York Times[2] titled ‘A Friedman doctrine – The Social Responsibility of Business Is to Increase Its Profits’. In this article Friedman has denied any duty of the company to social responsibility and has extended his arguments to reflect that the corporate executive running the business should be strictly focussed on generating profits for the benefit of the shareholders. The corporate executive is not required to contribute to social activities by utilizing the resources of the company. Friedman concluded his thoughts in the said article as follows:
“That is why, in my book “Capitalism and Freedom,” … have said that in such a society, “there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud”.”
Thus, Friedman’s doctrine encourages the company to maximize creation of profits for the benefit of shareholders. This doctrine gives clarity to the role of the corporate executive in the management of the company. This doctrine propagated the involvement of the corporate executive to only focus on its core strength of running a company and not get involved in alleviating social problems of which the corporate executive may have little or no expertise.
Though Friedman’s doctrine influenced corporate behaviour significantly including establishing the primacy of the shareholder vis-à-vis the other stakeholders, the discontent of other stakeholders increased significantly in the decades that followed. This was especially visible in the way corporate America in an attempt to maximise shareholder’s value, would sell assets or businesses or retrench workers. This era of maximization of shareholder value at the cost of everything else is best summarised through the words of the fictional character Gordon Gekko played by Michael Douglas in the movie Wall Street (1987 release) when he says[3]:
“Well, in my book you either do it right or you get eliminated. In the last seven deals that I’ve been involved with, there were 2.5 million stockholders who have made a pretax profit of 12 billion dollars. Thank you. I am not a destroyer of companies. I am a liberator of them! The point is, ladies and gentleman, that greed, for lack of a better word, is good.”
However, it was not that all members of corporate America agreed with the above. There were many who were considering alternative discourses to humanise the company and evolve the company for the benefit of all stakeholders. This effort was vocalised by Lady Lynn Forester de Rothschild[4]. Lady Lynn Forester articulated that private enterprise, i.e., corporations would need to work towards inclusive growth which in the long run would benefit society as well as the corporations. Inclusive capitalism considers the interest of all stakeholders and not merely short-term shareholder interests. The basis being that long term economic growth distributed amongst more stakeholders will create sustainable growth which will not only benefit the individual but also the corporation.
Having shared the two contrasting approaches in America, it is time to deal with the situation in India.
India not only favours the inclusive capitalism model, that is, all stakeholders should benefit from the company, but goes beyond to extend the role of the company towards the community, that is for the greater good! In our laws, the role of the corporate executive, that is, a director, in governing the company has been incorporated in the statute. A director in a company in India is required to act in (i) good faith to promote the objects of the company for the benefit of its members as a whole; and (ii) the best interests of the company, its employees, the shareholders, the community and for the protection of environment.[5] This unambiguously imposes an obligation on a director to act not only in the interest of shareholders and the company but also that of the other stakeholders, namely, employees, the community, and the environment.
In addition to the above, Indian laws governing the company require certain types of companies[6] to mandatorily spend some part of their profits[7] for social schemes which should be independent of the business of the company and not solely for the business of the company.[8]
The above indicates that India has adopted an extreme form of ‘inclusive capitalism’ as Indian profit-making companies will need to work for the community which is not linked to the business of the company. For instance, a director of a profit-making company while implementing the social contribution scheme will need to look beyond its stakeholders’ interest while implementing social schemes. Interestingly, contributions towards enhancing the skills of its employees, developing healthcare facilities for its employees and their families, providing access to research and development centres to its suppliers, or providing better emission control technology to its suppliers, will not result in the said company contributing to social schemes. Though all the above benefits the company and the community.
Considering the potential to grow our GDP to INR 7.5 trillion[9]by 2030, and assuming that this growth will be as a result of increased economic activity by Indian companies, any burden imposed on our companies to contribute to social contributions which is not connected to the conduct of business activities may be detrimental to the growth of the company.
Social contributions as enumerated in our company law should be limited to activities which directly benefit all the stakeholders of the company. For instance, if educational institutions are established which benefit the employees and their families; emission control technologies are implemented for suppliers of the company; or healthcare facilities are made available to employees and families; it will benefit the company to attract better talent and suppliers, which in turn will provide a strong foundation for the further growth of the company. A growing company will benefit the larger ecosystem in a particular geography, which in turn will benefit the economic growth of the country.
On the other hand, if the company is required to implement social schemes for the wider community, the company may not be able to do it efficiently due to lack of expertise or due to the costs attached in getting the expertise.
As far as the role of director is concerned towards the community, it should be linked to agreed benchmarks provided in the law. If the company is compliant with the said benchmark, there should not be any additional obligations on the director towards the community. For instance, if environmental laws prescribe certain limits on emission and the company has taken measures to limit it within such norms, the director should be considered to be in compliance with the law. If there is sewage pipe leak close to the premises of the company, but such leak has nothing to do with the company, the director should not be accountable to discharge any duties in such a situation. If the director takes any action in such a situation it is not because he is a director of the company but because as member of that community, the director has the desire to help in his individual capacity and not as the representative of the company.
To conclude, as a country we need more private participation in creating global enterprises. Private enterprise taking social responsibilities for non-stakeholders is onerous. The role of a private enterprise in social responsibilities should be limited to the well-being of its stakeholders. It is not denied that Friedman’s doctrine may not work squarely in the Indian social context. Hence, doing ‘good’ by a company should not be limited only to its shareholder but should be also for other stakeholders. However, doing ‘greater good’ for the community in general, that is, who are not stakeholders in a company, should not be imposed by a statute. If at all, such actions should be governed by shareholders’ wisdom considering the community’s social requirements.
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The information contained in this document is not legal advice or legal opinion. The contents recorded in the said document are for informational purposes only and should not be used for commercial purposes. Acuity Law LLP disclaims all liability to any person for any loss or damage caused by errors or omissions, whether arising from negligence, accident, or any other cause.
[1]https://www.peterfisk.com/2020/08/the-worlds-oldest-companies-kongo-gumi-a-japanese-construction-company-founded-in-578-ad-to-build-the-shitenno-ji-buddhist-temple/
[2] https://www.nytimes.com/1970/09/13/archives/a-friedman-doctrine-the-social-responsibility-of-business-is-to.html
[3] https://www.imdb.com/title/tt0094291/characters/nm0000140
[4] Lynn Forester de Rothschild on Inclusive Capitalism | Time and Why companies must look long-term or get left behind Building a better working world (ey.com)
[5] Section 166(2) of the Companies Act, 2013
[6] Section 135(1) of Companies Act, 2013:(a) Net worth of INR. 5 billion or more; or (ii)Turnover of INR 1billion or more; or (iii) Net profit of INR 50 million or more. Net profit is calculated in accordance with the provisions of section 198 of Companies Act r/w Rule 2(1)(h) of Companies (Corporate Social Responsibility Policy) Rules, 2014
[7] Section 135(5) of Companies Act, 2013: The eligible company must spend, in every financial year, a minimum of:2% of average net profit during the 3 immediately preceding financial years or since its incorporation, in case where company has not completed 3 years since incorporation.
[8] General Circular No. 14/2021 dated 25th August 2021 clarified as response to question 4.2 appearing at Page 10 stating that “any activity which is not designed to benefit employees solely, but the public at large, and if the employees and their family members are incidental beneficiaries, then, such activity would not be considered as “activity benefitting employees” and will qualify as eligible CSR activity.”
[9] https://www.spglobal.com/marketintelligence/en/mi/research-analysis/indias-gdp-growth-remains-buoyant-in-2023-sep23.html
