While Section 135 of the constitution requires companies meeting certain thresholds to spend a part of their profits on corporate social responsibility (CSR) initiatives, this article seeks to find out if the section is violative of the rights conferred by Articles 14 and 19(1) (g) of the Constitution
Over the last two decades, the role of corporates in India's economic growth has witnessed a significant increase. More importantly, this period has seen the private sector entering several public utility industry sectors. Private companies are now present in sectors of critical national importance such as power, telecommunications, aviation, roads, insurance, mining and banking.
There is therefore a legitimate expectation now that, private businesses which have taken over the state's erstwhile role should be obligated to contribute to the cause of betterment of weaker sections of the society.It is perhaps to address this expectation that the Ministry of Corporate Affairs, Government of India has included Section 135 in the Companies Act, 2013 ("the Act") which requires companies meeting certain thresholds to spend a part of their profits on corporate social responsibility ("CSR") initiatives. The provisions of Section 135 are supplemented by the Companies (Corporate Social Responsibility Policy) Rules, 2014 ("CSR Rules") framed by the Ministry of Corporate Affairs, Government of India, which have become effective from 1st April, 2014.
This article is an attempt to analyse Section 135 in the light of certain provisions of the Constitution of India ("Constitution"). The principal questions which this article proposes to debate are as follows:
(1) Is Section 135 violative of the rights conferred by Articles 14 and 19(1)(g) of the Constitution?
(2) If yes, is Section 135 of the Act entitled to protection of Article 31C of the Constitution?
Salient Features Of Section 135
In a free enterprise, the community is not just another stakeholder in business, but is in fact the very purpose of its existence - Jamsetji Tata
As per Section 135, every company which has a net worth of '500 crores or more, or turnover of '1000 crores or more or a net profit of '5 crores or more during any financial year is required to:
(a) constitute a Corporate Social Responsibility Committee ("CSR Committee") of the board of directors, which should include at least one independent director;
(b) disclose the composition of the CSR Committee in the director's report, which is required to be sent to the shareholders every year;
(c) ensure that the CSR Committee formulates and recommends to the board, a Corporate Social Responsibility Policy ("CSR Policy") which should indicate the CSR activities to be undertaken by the company (these activities need to be from amongst the list of activities set out in Schedule VII to the Act);
(d) disclose the contents of the CSR Policy on its website and in the directors' report;
(e) spend, in every financial year, at least two per cent. of the average net profit of the company made during the three immediately preceding financial years, in pursuance of the CSR Policy; and
(f) specify in the directors' report, the reasons for not spending the amount referred to in (e) above, if such amount is not spent.
Though at first glance, Section 135 appears to have a restrictive field ofoperation, it's actual reach is quite expansive, as explained below:
(a) Each criteria stipulated in Section 135(1) is an independent threshold. Thus, a company which has suffered a loss during a particular financial year will nevertheless be covered within the scope of Section 135 if it meets the net worth or turnover criteria. Similarly a company which earns a profit of '5 crores or more in a financial year will be covered within the scope of Section 135 even if it does not meet the net worth or the turnover criteria.
(b) The phrase "during any financial year" implies that if a company has achieved any of the criteria set out therein even for one of the financial years, it becomes obligated to comply with Section 135 for all subsequent financial years, even where it may not meet the stipulated criteria during such years.
Possible Grounds For Challenging The Constitutional Validity Of Section 135
It is now well-settled that the judiciary can strike down laws made by the State as being unconstitutional only on two grounds viz.: (i) lack of legislative competence; and (ii) breach of fundamental rights granted under the Constitution. Section 135 is intended to regulate the CSR activities of companies and falls within the ambit of entries 43 and 44 of the Seventh Schedule to the Constitution read with Article 246(1) thereof, whereby the Parliament has been granted exclusive legislative power to make laws relating to, inter alia, incorporation, regulation and winding up on companies. Accordingly, the ground of lack of legislative competence would not be available in the case at hand.
Section 135 Whether Violative Of Article 14
Article 14 of the Constitution guarantees to every person, equality before law and equal protection of law within the territory of India.Article 14 however allows reasonable classification of the subjects of the legislation though it does not permit arbitrariness.
The Supreme Court has consistently ruled that classification is valid only if (i) it is founded on an intelligible differentia and (ii) the differentia has a rational relation to the object sought to be achieved by the statute in question.
There may be circumstances where the size of the business may be a reasonable index for classification. Thus, a by-law charging higher licence fee from wholesale traders as compared to retailers was upheld1.
Therefore, the mere classification of companies based on net worth, turnover and net profit for the purpose of Section 135 cannot be said to be violative of Article 14. However, Section 135 treats companies in different situations similarly, as follows:
As per Section 135(1), once a company has met any one of the thresholds relating to net worth, turnover or net profits, it comes within the purview of Section 135 for all future points in time (except to the extent exempted under rule 3(2) of the CSR Rules).Thus, a company which does not meet the thresholds at a future point in time would nevertheless continue to be obliged to spend on CSR activities.
On a separate note, the legal validity of the exemptions granted by rule 3(2) of the CSR Rules as above is doubtful since the CSR Rules have been framed under Section 469 of the Act which does not authorize the executive, acting under a delegated power, to grant any exemption.
The explanation to Section 135 states that ‘average net profits' shall be computed in accordance with the provisions of Section 198. Section 198 (4) (l) permits only accumulated losses incurred after the date of effectiveness of the said Section (but not for periods prior to such effectiveness) to be set-off against net profits for arriving at ‘average net profits' for the purposes of Section 135. Thus, a company which has earned profits during the preceding three financial years but is yet to recoup its carried forward losses relating to the period prior to effectiveness of Section 198 will be required to spend on CSR.
A loss-making company's obligation to contribute to CSR is the same as that of a profit-making company so long as the ‘average net profits' test is met.
Lastly, Section 135 also applies to companies registered under Section 8 of the Act, which are statutorily obliged to apply their profits only for promoting their objects.
In short, Section 135 treats unequals as equals and is therefore violative of Article 14.
Section 135 whether violative of Article 19(1)(g)
Samir Oak is General Manager - Legal Services, Tata Group Legal Dept. at Tata Services Limited. Currently, as a part of Tata Group Legal team with primary responsibilities being M&As, corporate restructuring, contract review and general corporate and mercantile law advisory. Prior to this, he was Sr. Manager - Legal & Secretarial at Tata Teleservices Limited and Manager - Legal & Secretarial at Hughes Tele.com (India) Limited. He is in-house corporate counsel with exposure to diverse industry sectors (including 9 years in telecom services) across the gamut of legal activities including compliance, contract review, corporate law advisory and litigation
The first issue to be answered here is whether Section 135 constitutes a restriction on the right to carry on trade or business. In the author's view, Section 135 constitutes such a restriction since it requires the company to divert the money which could have otherwise been reinvested into the company's business for incremental returns or paid as dividend to shareholder,for being spent on CSR activities.
The next question to be answered is whether the restrictions imposed by Section 135 are unconstitutional. Article 19(1) (g) is subject to the provisions of Article 19(2) to 19(6) which permit the state to make laws which impose reasonable restrictions on the exercise of the right granted by Article 19(1)(g), inter alia, ‘in the interests of the general public'. The Supreme Court has, by and large, given an expanded meaning to the language of Article 19(6). The fundamental principle that the Supreme Court has enunciated in the matter of interpreting Article 19(6) is that the reasonablenessof restriction is to be determined in an objective manner and from the standpoint of the interests of the general public and not from the standpoint of the persons upon whom the restrictions are imposed2.
Article 19 (6) has been instrumental in saving several social welfare laws from being rendered unconstitutional, such as Minimum Wages Act, 19483. In a recent case4, the Supreme Court, by a majority judgment, upheld the constitutional validity, in the face of Article 19 (1) (g), of the provisions of the Right of Children to Free and Compulsory Education Act, 2009 which obliged private unaided schools to reserve 25% seats for admitting students from scheduled castes, scheduled tribes and other disadvantaged sections of the public.
The principal arguments,on merits, in favour of striking of Section 135 as unconstitutional vis-à-vis Article 19(1) (g) would be as follows:- (i) Section 135 is nothing but the outsourcing by the Government of its duty to provide its citizens with health care, education, housing and other basic life-sustaining amenities. (ii) Section 135 is not intended to limit the adverse impact of business on the public. It applies to companies carrying on all types of businesses and not necessarily those which are harmful to the health and/or well-being of the society.(iii) Section 135 is not intended to help achieve the fulfilment of fundamental rights of citizens which, in the absence of it, would be defeated. (iv)There has been no study or empirical evidence to suggest that the benefits of mandating a CSR spend as stipulated in Section 135 will outweigh the benefits of not mandating such spend at all.
The author however believes that the state has strong arguments supporting the validity of Section 135 vis-à-vis Article 19(1) (g), as follows:- (i) Section 135 is an enabling provision as the state has chosen to permit companies to spend on causes of their choice, rather than levy a separate tax. (ii) Section 135 has been legislated for the benefit of the general public, and is therefore permissible under Article 19(6). (iii) Only large well-capitalized and profitable companies are required to undertake CSR activities. (iv) The minimum prescribed CSR spend is only 2% and if this is not complied with, then the only consequence is that the company needs to disclose reasons thereof in the annual report. (v) A citizen has no legal obligation to carry on a business through the instrumentality of a company. A person choosing the company form of organization, with all its attendant benefits, should be prepared to comply with the restrictions that come with it.
On balance therefore, it seemshighly unlikely that the court would be persuaded to strike down Section 135 on the ground of being violative of the rights conferred by Article 19 (1) (g).
Section 135 whether protected by Article 31C
The Supreme Court has consistently refrained from laying down hard and fast rules in the matter of stipulating parameters as to what constitutes a reasonable restriction and what does not. The case at hand would therefore need to be decided based on merits.
Having concluded that Section 135 is violative of Article 14, it is necessary to ascertain whether it is protected by Article 31C of the Constitution.Article 31C validates laws made by the state for giving effect to the directive principles of state policy set out in Part IV of the Constitution, even where such laws infringe fundamental rights granted under Part III of the Constitution. The relevant extract of Article 31C reads as follows:
"31C. Notwithstanding anything contained in Article 13, no law giving effect to the policy of the state toward securing all or any of the principles laid down in Part IV shall be deemed to be void on the ground that it is inconsistent with, or takes away or abridges any of the rights conferred by Article 14 or Article 19 [and no law containing a declaration that it is for giving effect to such policy shall be called in question in any court on the ground that it does not give effect to such policy]."
This Article however does not provide a carte blanche to the state in the matter of law-making and, in the KeshavanandBharti case, the Supreme Court ruled that the courts are entitled to review whether a law purporting to be made pursuant to the directive principles does, in fact, further the cause of the directive principles set out in Part IV of the Constitution. The Supreme Court accordingly held to be invalid, the words appearing in square brackets in the extracts of Article 31C reproduced above.
The Supreme Court has held that the courts will look at the preamble and other provisions of the law as prima facie evidence as to whether a particular provision seeks to implement the directive principles of state policy.5 Viewed in this context, in the present case, neither the Act nor the Statement of Objects and Reasons to the Companies Bill, 2012 (based on which the Act was passed) clarify as to whether Section 135 seeks to implement any directive principles of state policy.
Further, as held in the case of Minerva Mills6, in order to come within the protective shield of Article 31C, it is necessary that the dominant object of the legislation should be to give effect to the directive principles of state policy. The Supreme Court held in this case that even in a statute enacted for giving effect to a directive principle, if the Court finds a provision which is not essentially and integrally connected with implementation of a directive principle or the dominant purpose whereof is to achieve an unauthorised purpose, it would be outside the protection of Article 31C.
It can be nobody's argument that the Companies Act, 2013 has been promulgated for giving effect to any of the directive principles of state policy. Accordingly, Section 135 does not qualify for protection under Article 31C.
The foregoing analysis leads to the following conclusions:-
(1) In the event of a legal challenge, Section 135, as currently drafted, is likely to be struck down by the judiciary as being in breach of Article 14 of the Constitution, but is unlikely to be found violative of Article 19(1)(g).
(2) Section 135 is not entitled to protection of Article 31C of the Constitution
It would therefore be advisable for the Government to bring in suitable amendments to Section 135 so as to bring it in line with Article 14 of the Constitution, to obviate the risk of a constitutional challenge being initiated against this positive and noble initiative.
Footnote: 1 Muhammadbhai Khudabux Chhipa v. State of Gujarat (AIR 1962 SC 1517).
2 Krishnan Kakkanth v. Govt. of Kerala (AIR 1997 SC 128).
3 Bijay Cotton Mills Ltd. v. The State of Ajmer (AIR 1955 SC 33)
4 Society for Un-aided Private Schools v. Union of India & Anr. (AIR 2012 SC 3445)
5 Confederation of Indian Industry (CII) - Desirable Corporate Governance - A Code, 1998; 3 Committee on Corporate Governance, chaired by Kumar Mangalam Birla appointed
Disclaimer - The views expressed in this article are the personal views of the author and are purely informative in nature.