| Reference Date | Version | July 11, 2024 | 1.0 |
| Keywords | Startups, environment, ESG reporting, technology, artificial intelligence |
| Legislation(s)/Policies |
|
| Jurisdiction | India |
Expert advice from corporate lawyers handling advisory to startups would be helpful to make the most of the benefits and exemptions offered under the regulatory regime, ensure compliance with law, and structure transactions and documents from a futuristic perspective while protecting legitimate business interests.
Introduction
Over the past two decades, the Environmental, Social, and Governance (‘ESG’) framework has transformed the business landscape.
The legal framework has evolved from voluntary guidelines such as National Voluntary Guidelines on Social, Environmental, and Economic Responsibilities of Business to mandatory disclosures under the Business Responsibility and Sustainability Report (‘BRSR’) for top 1000 listed companies.
One may argue that mandatory ESG disclosures are directed towards top companies due to the resource constraints that smaller companies may face.
However, provisions regarding ESG measures and reporting are embedded in corporate governance under the Companies Act, 2013 (‘Companies Act’), which applies to all companies.
It is important to understand the extent to which such ESG measures and reporting apply to startups and examine whether there is merit in exploring exceptions, if not a separate regime, for startups in this regard.
This article examines ESG measures and reporting under the Companies Act and their impact on startups.
Meaning of Startup
‘Startup’ as a concept was introduced under the ‘Startup India’ initiative launched in 2016 by the Government of India to create a conducive environment for young companies seeking to innovate and improve products, processes or services in India.
The Department of Promotion of Industry and Internal Trade (DPIIT), Ministry of Commerce, Government of India, issued eligibility criteria through notification dated February 17, 2016.
According to the notification:
“An entity shall be considered as a Startup:
i. Up to a period of ten years from the date of incorporation/registration if incorporated as a private limited company, partnership firm or LLP in India.
ii. Turnover for any financial year since incorporation has not exceeded one hundred crore rupees.
iii. Entity is working towards innovation, development or improvement of products or processes or services, or is a scalable business model with high potential of employment generation or wealth creation.
Provided that an entity formed by splitting up or reconstructing an existing business shall not be considered a Startup.”
It is relevant to note that the expression ‘startup’ has not been specifically used under the Companies Act.
The Startup Ecosystem
IT tools are often instrumental in achieving innovation, scalability and democratizing access to startup products and services.
Startups are typically heavily reliant on IT and Artificial Intelligence (AI) to harness the potential of big data and analytics.
Several benefits have been extended to startups to create a conducive ecosystem.
- Tax exemptions under Sections 80-IAC and 56(2)(viib) of the Income Tax Act, 1961.
- Relaxed foreign direct investment norms under FEMA (Non-debt Instruments) Rules, 2019.
- Permission to issue convertible notes by DPIIT-recognised startups.
- Rebates on trademark and patent filing fees.
- Ease of participation in Government procurement and tenders.
- Self-certification under certain labour and environmental laws.
- Faster exit mechanisms under the Insolvency and Bankruptcy Code, 2016.
Environmental law exemptions are available only to startups classified under the ‘White category’ industries.
The White category includes sectors such as air coolers, electrical items and organic manure manufacturing.
ESG and the Companies Act
The BRSR framework under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 mandates ESG disclosures only for top 1000 listed companies.
However, elements of ESG are embedded within the Companies Act itself.
- A director has a duty to act in the best interests of the company, employees, shareholders, community and environment.
- Board Reports are required to contain disclosures relating to energy conservation, technology absorption and corporate social responsibility initiatives.
Director’s Duties Towards Community and Environment
Section 166 of the Companies Act casts a positive obligation on directors.
Section 166 states:
“A director of a company shall act in good faith in order 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 environment.”
The provision effectively imposes duties toward:
- The Company
- Employees
- Shareholders
- The community
- The environment
The Hon’ble Supreme Court in Tata Consultancy Services Limited v. Cyrus Investments Pvt. Ltd. observed that corporate governance has evolved toward social accountability and responsibility.
The Court highlighted that Section 166(2) requires directors to protect the environment in addition to promoting company interests.
Similarly, in M.K. Ranjitsinh and Ors. v. Union of India and Ors., the Hon’ble Supreme Court reiterated that directors are obligated to act for protection of the environment.
The Court also clarified that the meaning of ‘environment’ should be interpreted in line with the Environment (Protection) Act, 1986.
The duties toward community and environment substantially capture the “Environmental” and “Social” pillars of ESG.
The duties toward company, employees and shareholders largely capture the “Governance” element of ESG.
Legislative History: Tracing the Intent
Section 166(2) can be traced to the 21st Report of the Standing Committee on Finance (2009-2010) on the Companies Bill, 2009.
The Institute of Company Secretaries of India (ICSI) suggested inclusion of director duties relating to employees, community and environment.
The Committee accepted the suggestion, particularly in light of the proposed Corporate Social Responsibility provisions.
The originally proposed provision focused on directors acting in good faith to promote company objects and act in the interests of the company, employees, community and environment.
The final provision under the Companies Act additionally incorporated duties toward shareholders and protection of the environment.
Arguably, the legislative intent behind extending duties toward community and environment was closely linked with Corporate Social Responsibility obligations under Section 135 of the Companies Act.
However, Section 166(2) operates independently of CSR obligations.
Directors’ Report
Section 134 of the Companies Act requires the Board of Directors’ Report to include disclosures relating to:
- Conservation of energy
- Technology absorption
- Foreign exchange earnings and outgo
- Corporate Social Responsibility initiatives
Rule 8 of the Companies (Accounts) Rules, 2014 prescribes detailed reporting requirements regarding:
- Energy conservation measures
- Use of alternate sources of energy
- Technology absorption
- Research and development expenditure
- Foreign exchange earnings and expenditure
However, qualitative reporting by many companies often remains inadequate and generic.
The article discusses examples of listed companies and private companies making broad statements without meaningful disclosures.
This highlights a disconnect between statutory director duties and actual reporting obligations.
Startups: ESG Considerations and Issues
Environment, sustainability and governance are important considerations for startups.
However, practical implementation challenges cannot be ignored.
Technology startups heavily depend upon computing hardware and AI systems, which contribute significantly toward carbon emissions.
Accurately determining environmental impact across the IT value chain remains extremely difficult.
Most early-stage startups lack the tools and financial capacity required to measure environmental impact effectively.
They are simultaneously under pressure to create commercial value while ensuring innovation.
The broad wording of Section 166(2) may therefore become onerous for startups because:
- The terms ‘environment’ and ‘community’ are extremely broad.
- There is no accurate method to measure the carbon footprint of IT usage.
- Competing business interests may require prioritisation of commercial objectives over environmental concerns.
The International Energy Agency projects that electricity consumption of data centres in 2026 may double compared to 2022 levels.
AI systems consume significantly higher energy than traditional computing systems.
Training a single AI model may consume more electricity annually than 100 US homes.
The development of AI therefore also creates responsibility toward addressing environmental impacts.
AI may simultaneously be leveraged by startups for:
- Resource management
- Energy optimisation
- Climate mitigation
- Sustainable operational practices
In the long run, startups may need to align AI adoption with ESG principles to create synergy between innovation and sustainability.
Viewpoint
In the context of startups, ESG compliance frameworks are likely to gain greater acceptance if they remain simple, measurable and economically viable.
Imposition of stringent environmental compliance requirements on startups may adversely impact growth and innovation.
Technology-based startups possess enormous potential to address environmental challenges through innovation.
The ESG framework in India must therefore strike a balance between innovation, community welfare and environmental protection.
The broad duty imposed under Section 166(2) is relevant but difficult to implement in practical terms.
The provision casts an expansive obligation upon directors to consider impacts upon the company, employees, shareholders, community and environment.
Board Report requirements under Sections 134(m) and 134(o) do not adequately correlate with directors’ statutory duties.
A more cohesive and practical framework may therefore be necessary to bridge the gap between legislative intent and implementation.
Legal Support in Corporate and Commercial Sector
Ashwini Panwar (Mr) and Rachit Singh (Mr)
Associate at Alaya Legal
