Legal Business

Sponsored briefing: Evaluating sustainable investments in India: mitigating ESG risks through due diligence

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Deals Bharucha & Partners

Justin Bharucha and Vandana Pai examine how due diligence can be used to identify and address risks of non-compliance with ESG regulations

Investors the world over are increasingly structuring investments with lower environmental, social and governance (ESG) risks. One of the reasons for this is the growing regulatory scrutiny on ESG-related non-compliance. For instance, recently, the Securities and Exchange Commission fined BNY Mellon Investment Adviser for claiming that it had met all compliance requirements despite having failed to undertake an ESG quality review.

ESG is not an entirely new concept in India. There have been statutes on the books and bodies regulating ESG issues in India for decades – for instance, various environmental regulations, labour codes, corporate social responsibility (CSR) rules implemented in 20141 and quasi-judicial authorities like the National Green Tribunal.

Even the 2021 business responsibility and sustainability reporting (BRSR) issued by the Securities and Exchange Board of India (SEBI), India’s securities market regulator, is based on the principles set out in the National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business issued by the Ministry of Corporate Affairs (MCA) in 2011 (and updated in 2019), and has replaced the business responsibility report first introduced by the SEBI in 2012.

In the past, Indian regulators have taken enforcement action against companies for failing to comply with regulatory ESG requirements. For instance, the National Green Tribunal, by its order dated 10 September 2020, directed the Central Pollution Control Board to undertake an environmental audit of Amazon Retail India Private Ltd due to its excessive use of plastic as packaging material.

Similar scrutiny may also be expected from other Indian regulators in the coming years given India’s target of net zero greenhouse gas emissions by 2070.

ESG reporting metrics and scope of diligence

In India, ESG reporting is neither objective nor standardised. As of 1 April 2023, the SEBI’s BRSR requires the top 1,000 listed companies by market capitalisation to make ESG-related disclosures in their annual reports against nine principles, including accountability and transparency, provision of sustainable goods and services, and responsiveness to stakeholders. However, BRSR compliance is not mandated for unlisted entities or smaller listed companies, and there is no format for ESG reporting in India for such entities. The only guidance available is the BRSR lite version of the reporting format suggested by the MCA in the Report of the Committee on Business Responsibility Reporting, which recommended changes to the MCA’s National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business.

Given the above, diligence undertaken by the investors becomes a key measure to evaluate target companies’ ESG compliance and commitment. Akin to a legal due diligence, an ESG due diligence should be structured based on the sector in which the target is engaged, and involves the assessment of compliance and liability. For instance, a plastics manufacturer would be more susceptible to risks associated with waste management, as opposed to a target in the IT/ITES sector where risks pertaining to data protection norms may be more relevant. Additionally, the ESG due diligence may also take into account: (i) whether the target has a dedicated ESG policy; (ii) how the target chooses to respond to ESG-related risks; (iii) the target’s governance structure, including decision making at the board and shareholder levels; (iv) oversight models adopted by the target; (v) evaluation of the target’s supply chain, and, to the extent possible, whether the target’s suppliers are compliant with ESG requirements; and (vi) the energy sources used by the target.

Mitigating ESG risks and next steps

Fundamental ESG risks identified through due diligence must be addressed either through pre-closing conditions or conditions subsequent. ESG compliance is increasingly likely to be an extremely important issue that may impact whether a transaction will actually progress.

Investors may also consider including tailored representations and warranties in the transaction documents. These may include representations and warranties pertaining to compliance with regulatory disclosure requirements – including compliance by the target’s suppliers, maintaining adequate sectoral licences, and incorporating a defined metric to measure future ESG goals. To address the adverse impact of issues such as greenwashing and social-washing (essentially, artificially inflating ESG compliance or portraying a higher level of compliance), investors may consider building specific indemnities into the deal documentation. To that end, market practice has been to either negotiate to hold back a portion of the investment amount – which can then be set off against any losses arising from known ESG risks – or deferring that portion of the payment until ESG compliance requirements have been met.

Globally, insurance providers are coming up with assessment tools for ESG risks that can measure a target’s ESG performance in accordance with internationally recognised methodologies and provide a score based on 18 ESG themes. Essentially, these ESG scores allow underwriters to make decisions on whether there can be any incentives or dynamic pricing on insurance products, depending upon contingent events, for eg, installation of solar energy panels. Once these products and services – tailored to the nine principles under the BRSR and the MCA’s guidelines – are available in India, investors may opt for the same to measure the target’s ESG performance and manage risks2.

Post closing, investors may require the target to build and follow voluntary industry group standards and best practices, undergo voluntary social audits and assurance from time to time, and benchmark its ESG performance against its competitors.

Given the rise in ESG concerns and the lack of objective regulations, ESG-based due diligence has become an essential tool for investors to unlock value and protect themselves against potential risks. Targets that embrace regular ESG due diligence and take proactive initiatives are better positioned to build trust with their potential investors and adapt to the expectations of sustainability.

Authors


JUSTIN BHARUCHA
Managing partner
E: justin.bharucha@bharucha.in


VANDANA PAI
Partner, head – investment funds practice
E: vandana.pai@bharucha.in

  1. India was the first country to legislate mandatory CSR requirements and compliance, and penalties for failure to comply. A company that fails to make the mandatory CSR contribution is liable to a penalty of twice the amount that was not contributed for CSR purposes, and its officers in default are liable to a penalty of one tenth of the CSR amount that was not contributed or INR 10m, whichever is lower.
  2. Although ESG ratings services are available in India, the ratings are usually restricted to entities whose securities are listed on a stock exchange as the ratings providers rely on publicly available information to evaluate these entities.

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Legal Business

Sponsored briefing: Tackling recalcitrant parties and guerrilla tactics in arbitration – an Indian perspective

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Disputes Bharucha & Partners

Sneha Jaisingh discusses guerrilla tactics in Indian arbitral proceedings

Professor William Park compared arbitration to fine dining, which, unlike the messy hamburger of litigation, provides a balanced meal of efficiency, expediency, party autonomy and due process principles. Alas, today, arbitration in India is more messy mince and less fine dining, largely due to recalcitrant parties adopting guerrilla tactics.

‘Guerrilla tactics’ refers to deliberate attempts by certain parties – usually the respondents to arbitrations – to derail and obstruct arbitral proceedings, often as a ground to challenge the final award. While some argue that these tactics should not be categorised as guerrilla tactics as they are merely defensive in nature, one cannot deny their existence. Parties must, therefore, be mindful when dealing with counterparties in an arbitration. While there can never be a straitjacket formula to address guerrilla tactics, there are a few points that parties should bear in mind.

At the outset, to avoid a challenge to the existence of an arbitration agreement, when drafting and negotiating an arbitration clause or agreement, parties must ensure that the clause or agreement is easy to interpret and unambiguous. Where an institution is being chosen to administer the disputes and, or, govern the procedural law, parties must choose the institution that is most likely to suit their needs, and understand the nature of the potential disputes. The institution should also be cost effective. Next, when faced with a dispute, parties must exercise proper diligence when appointing arbitrators and ensure that relevant disclosures have been made with respect to any matters that may give rise to a justifiable doubt as to the independence or impartiality of an arbitrator.

Once the arbitral tribunal has been constituted, it must proceed with the first hearing and the first procedural order. This is particularly important as, under the Arbitration and Conciliation Act, 1996 (Act), a tribunal has wide discretion to determine how arbitral proceedings will be conducted, provided that each party is treated equally and given a full1 opportunity to present their case. Consequently, a robust first procedural order will likely pay dividends later. If issues such as place and applicable law of the arbitration have not already been agreed to, they must be addressed at the first hearing. Parties may also address whether there is any jurisdictional challenge, interim measure or other preliminary issue that needs to be determined. More procedural aspects such as length of pleadings, filing of documents, simultaneous exchanges of pleadings or documents, communications with parties and arbitrators, how to deal with impromptu applications, rules of evidence, costs including on account of adjournments should also be addressed. It is also good practice to try and obtain the consent of the counterparty on such issues so that the tribunal’s scope is narrow.

Guerrilla tactics often also include attempts to bring matters that are extraneous to the arbitration before the tribunal. Illustratively, a party may make allegations of oppression and mismanagement in the case of shareholder disputes, raise issues such as invalidity of patents in disputes pertaining to recovery of royalty fees, allege that the underlying agreement which is the subject matter of the dispute is anti-competitive, or is vitiated by fraud. As the same factual matrix may give rise to various causes of action, it is critical that parties ensure that the scope of the arbitration is well defined and that a party only raises claims which are arbitrable in nature. Equally, where a counterparty has sought to raise claims in respect of extraneous matters, a party may be able to establish that the extraneous proceedings filed by the counterparty are vexatious and designed to thwart the arbitration.

Other intimidation tactics may include the counterparty filing large volumes of pleadings or evidence which are irrelevant. In such cases the admission and denial of documents is crucial so that the onus of proving the existence and the relevance of extraneous documents is on the counterparty seeking to introduce them. To some extent, the filing of voluminous pleadings and, or, evidence may be obviated through the tribunal’s first procedural order.

Counterparties seeking to delay proceedings may also file for discovery or the production of documents as part of a fishing expedition or roving enquiry. Although the Act does not prescribe procedures for discovery and production of documents, Indian courts have held that principles of evidence and procedure for civil suits would apply to arbitral proceedings. Parties should, therefore, bear in mind that the discovery and production of documents sought must be relevant and material to the case. Discovery will not be allowed on matters which relate solely to a party’s own case. A party is entitled to inspection of all documents which do not constitute exclusively the other party’s evidence of their case.

Briefly, an arbitral tribunal has wide ranging powers to control proceedings. However, there is always a risk that, when faced with guerrilla tactics, the tribunal may fall prey to due process paranoia. It is, therefore, imperative that the party against whom such tactics are being employed provides the tribunal with adequate support to enable it to take takes steps against the recalcitrant party keeping in mind principles of equity and natural justice.

Authors


Sneha Jaisingh
Partner
E: sneha.jaisingh@bharucha.in

  1. Sohan Lal Gupta v. Asha Devi Gupta(2003) 7 SCC 492 holds that for a fair hearing each party must have: (i) notice of the hearing; (ii) a reasonable opportunity to be present at and throughout the hearing, together with advisers and witnesses; (iii) a reasonable opportunity to present evidence and arguments in support of its case and to test the opponent’s case by cross-examination, rebuttal evidence and oral arguments; and (iv) unless expressly agreed, presented the whole of their evidence and argument at the hearing.

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