Interplay of ESG and Insolvency Laws in India: Navigating a New Era of Corporate Accountability

Introduction

The corporate landscape is undergoing a profound shift globally, with Environmental, Social, and Governance (ESG) factors taking center stage. In India, ESG is emerging as a critical framework for measuring and managing corporate responsibility, complementing traditional financial metrics. As the country increasingly integrates ESG criteria into corporate governance, the intersection of ESG and insolvency laws becomes an important area of focus. How companies are evaluated during financial distress, and the manner in which they are restructured, is now being influenced by ESG concerns. This article explores the interplay between ESG and insolvency laws in India, shedding light on how these seemingly separate domains are converging to shape the future of corporate accountability.

Understanding ESG in the Indian Context

ESG refers to the three core factors that measure the sustainability and societal impact of a company. These factors are increasingly used by investors to determine the long-term value and sustainability of a business:

1. Environmental (E): Focuses on how a company’s operations impact the environment, including resource management, carbon footprint, and waste production.
2. Social (S): Deals with a company’s relationships with stakeholders, including employees, suppliers, customers, and the communities in which it operates. It includes labor practices, human rights, and community engagement.
3. Governance (G): Relates to the way a company is managed, including board structure, executive compensation, transparency, and adherence to laws and ethical standards.

In India, ESG is not merely an emerging trend but is becoming institutionalized. The Securities and Exchange Board of India (SEBI) mandates the top 1,000 listed companies to file Business Responsibility and Sustainability Reports (BRSR) from the Financial Year 2022-23, a move aligned with global standards like the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB). Companies are expected to disclose their ESG practices, creating a transparent system that facilitates informed decision-making by investors.

Overview of Insolvency Laws in India

Insolvency laws in India are governed by the Insolvency and Bankruptcy Code, 2016 (IBC), which provides a streamlined process for resolving corporate insolvencies and bankruptcies. The IBC seeks to consolidate India’s previously fragmented insolvency regime and create a time-bound and creditor-friendly process. Under the IBC, when a company is unable to repay its debts, a creditor can initiate the Corporate Insolvency Resolution Process (CIRP). This process aims to either revive the company through a resolution plan or liquidate its assets if revival is not viable.

The IBC places significant emphasis on resolving insolvency efficiently, with strict timelines to minimize value erosion. Creditors, primarily financial institutions, play a pivotal role in deciding the future of the distressed company, determining whether the company should be restructured or liquidated. While financial viability remains the primary concern, the rise of ESG considerations is starting to impact this process, especially as investors and stakeholders prioritize sustainability and ethical governance.

ESG and Insolvency: Points of Convergence

1. Sustainability in Resolution Plans: Under the IBC, resolution applicants (usually investors or other companies) submit plans to revive financially distressed companies. Traditionally, these plans focus on financial restructuring, debt reduction, equity infusions, or operational turnarounds. However, as ESG becomes a more important metric, resolution plans are now increasingly incorporating sustainability considerations. Investors are likely to consider the long-term viability of the company in terms of its environmental and social impact, not just its financial health. For instance, a company with high environmental liabilities (such as those in polluting industries) may struggle to attract resolution applicants without substantial commitments to improve its ESG profile. This could involve addressing environmental non-compliance, investing in cleaner technologies, or improving labor practices; all factors that contribute to the overall viability of a resolution plan.
2. Inclusion of ESG Risk in Valuation: Valuation of distressed assets under the IBC has typically been based on financial metrics like debt-equity ratios, asset values, and future cash flows. However, the inclusion of ESG risks, such as pending environmental litigation, social unrest due to poor labour practices, or governance failures, could significantly affect a company’s valuation. These risks could lead to future liabilities, regulatory fines, or reputational damage, which investors and creditors need to account for during the insolvency process.
3. Impact on Creditors Decisions: Financial creditors, such as banks and Asset Reconstruction Companies, are the primary decision-makers in insolvency cases under the IBC. Traditionally, their focus has been on recovering as much of their dues as possible. However, global trends show that financial institutions are increasingly integrating ESG factors into their lending and investment decisions. Indian banks, especially those with global operations or foreign investment, are under growing pressure to consider ESG factors. This shift could influence how they assess the viability of resolution plans, with an increased preference for sustainable and ethically governed companies.
4. ESG Compliance and Liquidation: In cases where resolution plans are not viable and a company proceeds to liquidation, ESG considerations can still play a role. Liquidators may need to factor in the environmental impact of liquidating the company’s assets. For example, if the company holds contaminated land or hazardous materials, compliance with environmental laws will be critical in the liquidation process. This could result in higher liquidation costs or legal liabilities, which could reduce the recovery available to creditors.
5. Corporate Social Responsibility (CSR) and Insolvency: While not strictly part of ESG, the notion of Corporate Social Responsibility (CSR) overlaps significantly with social and governance issues. Under the Companies Act, 2013, Indian companies meeting certain financial thresholds are required to spend 2% of their net profits on CSR activities. When a company enters insolvency, its CSR obligations might be impacted. This raises ethical and legal questions about whether CSR obligations should be continued during the insolvency process, especially in light of the social impact on communities dependent on these companies’ operations.

Regulatory and Judicial Developments

While the IBC itself does not explicitly address ESG concerns, Indian regulators and courts are increasingly acknowledging the role of sustainability in corporate governance. The National Company Law Tribunal (NCLT), which oversees insolvency proceedings, has begun to see cases where ESG concerns have influenced decision-making. Furthermore, SEBI’s emphasis on ESG disclosures under the BRSR framework will inevitably impact insolvency proceedings, as distressed companies will likely face scrutiny for failing to meet ESG standards. This could also affect their ability to attract potential resolution applicants or investors who prioritize ESG-compliant companies.

Conclusion

The interplay between ESG and insolvency laws in India is still evolving, but it is clear that ESG factors are becoming increasingly relevant to the way insolvency processes are conducted. As Indian companies and financial institutions come under pressure to improve their ESG profiles, these considerations will play a larger role in the decision-making process of creditors, investors, and regulators. Incorporating ESG into insolvency frameworks is not merely a trend but a necessary evolution to ensure that corporate restructuring is aligned with the principles of sustainability, ethical governance, and social responsibility. This will not only protect the interests of creditors and stakeholders but also ensure that companies emerging from financial distress are better positioned to contribute to India’s broader goals of sustainable development and inclusive growth.

In the years to come, we can expect further integration of ESG criteria into Indian insolvency law, creating a more holistic approach to corporate distress that goes beyond financial recovery to include long-term sustainability and corporate responsibility.