Comply-Or-Explain Principle.
Comply-or-Explain Principle
Meaning and Origin
The Comply-or-Explain Principle is a cornerstone of modern corporate governance. It requires companies to either comply with prescribed governance norms (such as a Corporate Governance Code) or explain clearly and transparently why they have not complied.
Instead of strict legal enforcement, this principle relies on:
Transparency
Market discipline
Shareholder scrutiny
The concept originated in the UK Corporate Governance framework and has since been adopted in many jurisdictions, including India (SEBI regulations), EU, and OECD frameworks.
Core Objectives of the Principle
Flexibility – Allows companies to deviate where strict compliance is impractical
Accountability – Forces boards to justify governance decisions
Transparency – Shareholders receive full disclosure
Investor Protection – Enables informed decision-making
Avoids box-ticking – Focuses on substance over form
How the Principle Works
A company must:
Comply with governance provisions
OR
Explain:
Which provision is not complied with
Reasons for non-compliance
Whether the deviation is temporary or permanent
Alternative governance measures adopted
A vague or boilerplate explanation is treated as non-compliance.
Legal Nature
The principle is not mandatory law
It operates through:
Stock exchange listing requirements
Regulatory guidelines
Shareholder enforcement
Courts usually do not punish deviation, but they scrutinize disclosure quality
Case Laws on Comply-or-Explain Principle
1. Cadbury Committee Report Case (UK – Foundational Authority)
Principle Established:
The Cadbury Committee introduced the Comply-or-Explain approach, emphasizing that governance codes should not be rigid laws.
Significance:
Companies must justify deviations
Shareholders decide whether explanations are acceptable
Laid foundation for judicial acceptance of flexible governance
2. Hutton v. West Cork Railway Co. (1883)
Principle Applied:
Corporate decisions must be justified as being in the interest of the company, not directors personally.
Relevance:
Boards explaining non-compliance must demonstrate bona fide intent
Explanations lacking business rationale may be rejected by courts/shareholders
3. Regentcrest plc v. Cohen (2001)
Held:
Directors’ decisions must be made in good faith and for proper purpose.
Relevance to Comply-or-Explain:
Explanations for non-compliance must be honest and rational
Courts will not interfere if directors acted bona fide, even if governance codes were not strictly followed
4. People’s Insurance Co. Ltd. v. Akbar Ali (India)
Held:
Directors occupy a fiduciary position and must act with utmost good faith.
Relevance:
Indian courts expect transparent reasoning when corporate standards are deviated from
Supports the “explain” limb of the principle
5. N. Narayanan v. Adjudicating Officer, SEBI (2013)
Held:
Disclosure and transparency are fundamental to corporate governance.
Significance:
Failure to give proper explanation for governance deviations can attract regulatory penalties
Reinforces that explanation must be full, fair, and truthful
6. SEBI v. Sahara India Real Estate Corporation Ltd. (2012)
Held:
Corporate disclosures must be substantive, not cosmetic.
Relevance:
Boilerplate explanations defeat the purpose of Comply-or-Explain
Regulators can intervene where explanations are misleading or incomplete
7. Needle Industries (India) Ltd. v. Needle Industries Newey (India) Holdings Ltd.
Held:
Corporate actions must be fair, transparent, and equitable to all shareholders.
Relevance:
Deviations from governance norms must not prejudice minority shareholders
Explanations are subject to fairness scrutiny
8. Union of India v. Azadi Bachao Andolan
Held:
Substance prevails over form in corporate and tax matters.
Relevance:
Reinforces the philosophy behind Comply-or-Explain
Mere formal compliance or empty explanation is insufficient
Indian Regulatory Recognition
In India, the principle is embedded in:
SEBI (LODR) Regulations
Clause 49 (earlier)
Annual Corporate Governance Reports
Companies must:
Disclose deviations
Provide reasons
Face market and regulatory consequences for poor explanations
Advantages of the Principle
✔ Encourages innovation
✔ Avoids rigid legal compliance
✔ Strengthens board accountability
✔ Enhances investor confidence
Criticism
✖ Risk of boilerplate explanations
✖ Weak enforcement
✖ Shareholders may lack power to penalize poor explanations
Conclusion
The Comply-or-Explain Principle strikes a balance between regulation and flexibility. Courts and regulators consistently emphasize that:
Compliance is ideal, but explanation must be genuine, transparent, and reasoned.
Poor explanations are treated as effective non-compliance, attracting shareholder distrust and regulatory scrutiny.
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