In the complex world of corporate governance, the role of board observers has emerged as a key component, especially in the wake of increased investor scrutiny, particularly in the private equity (PE) and venture capital (VC) sectors. With growing financial uncertainty, investors are looking for ways to maintain a closer watch on companies without assuming directorial risks. One such method is by appointing a board observer, a role that, although devoid of statutory voting power, can wield significant influence.
A board observer’s position in the intricate realm of corporate governance is crucial and varied. With increased distress particularly in the private equity sector, we may see investors deploying various tools to keep a closer eye on the company’s financial performance. Appointing a board observer is one such tool.
Despite not having statutory authority or the ability to vote, board observers have a special position of influence and can provide productive insights.
Board observers quite literally are individuals who are fundamentally appointed with the task to ‘observe’. They act as representatives typically from major investors, strategic partners, or key stakeholders, and are granted access to board meetings.
Understanding the Role of Board Observers
Board observers are not formal members of the board, nor do they hold the power to vote on corporate decisions. However, their presence in board meetings is a tool used primarily by major investors, strategic partners, and other key stakeholders to monitor the company’s strategic direction and financial health. These individuals are entrusted with providing valuable insights without the direct legal responsibilities that directors typically face.
Although board observers do not have a formal vote, their influence can shape company strategies. This unique role enables them to represent the interests of investors or stakeholders while remaining free from the direct obligations of fiduciary duties.
Board Observer Rights – How does it work?
Investors involved in the venture capital (VC) and private equity (PE) spaces often negotiate for a board seat with the intent to contribute to the decision-making process and protect their interests by having representation on the board. A recent trend, however, indicates that these investors are reluctant to formally exercise their nomination rights owing to the possible risks/liabilities associated with directorships, such as fiduciary duties and vicarious liability that is often intertwined in the acts and omissions of the company, which can lead to such directors being identified as “officers in default”.
The rights and responsibilities of a board observer are distinct from those of a nominee director, primarily due to the lack of formal voting authority. Accordingly, board observers are relieved from the direct fiduciary duties that are normally connected with board membership since their position is specified contractually rather than by statutory board responsibilities.
Is a Board Observer an officer in default?
The Act provides a definition for the term “Officer” which inter alia includes any person in accordance with whose directions or instructions the board of directors of the company or any one or more of the directors are accustomed to act. Additionally, the term “Officer in Default” states that an Officer of the company who is in default will incur liability in terms of imprisonment, penalties, fines or otherwise, regardless of their lack of an official position in the company.
Accordingly, any person who exercises substantial decision-making authority on the board of the company may be covered as an Officer in Default.
While board observers may not be equivalent to formal directors, the litmus test lies in determining where the decision-making power truly resides, leading to potential liabilities that may surpass the protections sought by investors.
Observers are not subject to a company’s breach of any statutory provisions because their appointment is based on a contractual obligation rather than a statutory one, unlike nominee directors who are permitted to participate in board meetings.
Even though board observers are not designated as directors, they run the risk of being seen as “Shadow Directors” if they have a significant amount of authority or influence over the decisions made by the company.
The Legal Perspective on Board Observers
Unlike nominee directors, who are formally appointed and legally bound to fulfill statutory responsibilities, board observers are appointed through contractual obligations. This shields them from liabilities tied to breaches of statutory provisions. However, as their influence grows, so does the risk of being classified as shadow directors, particularly if they are perceived as playing a significant role in decision-making.
Conclusion
Corporate Governance is an evolving concept, especially in the context of active investor participation. In order to foster a corporate environment that is legally robust, it will be imperative to strike a balance between active investor participation and legal prudence. That being said, as businesses continue to navigate complex and evolving landscapes, the value of a well-integrated board observer cannot be overstated. A board observer can bring clarity to the business and operations of an investee company without attaching the risk of incurring statutory liability for acts/omissions by the company. This is a significant factor that makes the option of a board observer nomination more attractive to PE and VC investors, vis-a-vis the appointment of a nominee director.
FAQs on Board Observers
What is a board observer in corporate governance? A board observer is an individual appointed by investors or key stakeholders to attend board meetings without having formal voting power. They offer insights and monitor the company’s performance, primarily to protect the interests of those they represent.
How do board observers differ from directors? Unlike board directors, board observers do not have the authority to vote on decisions or take on fiduciary duties. Their role is more about observation and providing feedback rather than participating in the decision-making process.
What are the rights of a board observer? A board observer has the right to attend board meetings and access key company information, but they do not hold any voting rights. Their responsibilities and rights are typically outlined in a contractual agreement between the company and the observer’s appointing party.
Can board observers influence corporate decisions? Yes, board observers can provide valuable insights and advice that may influence corporate decisions, but they do not have direct decision-making power. Their influence comes from their ability to offer expert advice and represent investors’ interests.
Are board observers liable for company decisions? Generally, board observers are not legally liable for company decisions as they are not formal board members. However, if their influence over board decisions becomes significant, they could be viewed as shadow directors, which might expose them to certain legal liabilities.
Why do investors appoint board observers instead of directors? Investors often prefer appointing board observers because it allows them to monitor company performance and offer guidance without taking on the fiduciary duties and potential liabilities associated with being a formal board member.
What is the risk of being considered a shadow director as a board observer? If a board observer has significant influence over board decisions, they could be classified as a shadow director. Shadow directors can be held liable for the company’s actions, similar to formally appointed directors, especially in cases of misconduct or financial mismanagement.
How does a board observer benefit private equity and venture capital investors? Board observers allow PE and VC investors to maintain oversight of their portfolio companies, ensuring the company’s strategic direction aligns with their interests. This role provides investors with valuable insights without the risk of statutory liabilities that come with directorship.
In the ever-evolving landscape of the SaaS industry, understanding the various types of agreements is crucial for businesses to operate effectively and legally. From customer contracts to partner agreements, these legal documents form the backbone of SaaS operations. By navigating the intricacies of these agreements, businesses can protect their intellectual property, establish clear terms of service, and mitigate potential risks. In this comprehensive guide, we will explore the key types of agreements used in the SaaS industry, providing valuable insights for both established companies and startups.
What is SaaS?
Software as a Service (“SaaS”), is a way of delivering software applications over the internet. Instead of purchasing and installing software on your computer, you access it online through a subscription. This makes it easier to use and manage, as updates, security, and maintenance are handled by the service provider. Examples of SaaS include tools like Google Workspace or Microsoft 365, where everything is accessible from a web browser. This model is convenient for businesses because it reduces upfront costs and offers scalability based on their needs.
What are SaaS Agreements?
However, beneath the surface of this convenient access lies a complex web of agreements that govern the relationship between SaaS providers and their customers, which are essential to ensuring a smooth and secure experience for all parties involved. These agreements outline the terms of using a cloud-based software service. These agreements specify the rights and responsibilities of both parties, covering aspects such as subscription fees, data privacy, service availability, support, and usage limitations.
This article delves into the various types of agreements that form the backbone of the SaaS industry and it will explore their key components, importance, and how they work together to create a win-win situation for both SaaS providers and their subscribers.
What are the types of Agreement in SaaS Industry
In the SaaS industry, various types of agreements are commonly used to establish the terms of service, licensing, and other legal arrangements between the SaaS provider and its customers. Here are some key types of agreements used in the SaaS industry:
Terms of Service (ToS) or Terms of Use (ToU)
These agreements outline the terms and conditions under which users are allowed to access and use the SaaS platform. They typically cover aspects such as user obligations, limitations of liability, intellectual property rights, privacy policies, and dispute resolution procedures. Key Components: User obligations, limitations of liability, intellectual property rights, privacy policies, dispute resolution procedures. Importance: Provides clarity and sets apt expectations for users regarding acceptable use of the SaaS platform, protecting the provider from misuse and establishing guidelines for resolving disputes.
Service Level Agreement (SLA)
SLAs define the level of service that the SaaS provider agrees to deliver to its customers, including uptime guarantees, response times for support requests, and performance metrics. SLAs also often outline the remedies available to customers in the event that service levels are not met. Key Components: Uptime guarantees, response times for support requests, performance metrics, remedies for breaches. Importance: Defines the quality of service expected by customers, establishes accountability for the SaaS provider, and offers assurances to customers regarding system reliability and support responsiveness
Master Services Agreement (MSA)
An MSA is a comprehensive contract that governs the overall relationship between the SaaS provider and the customer. It typically includes general terms and conditions applicable to all services provided, as well as specific terms related to individual transactions or services. Key Components: General terms and conditions, specific terms related to individual transactions or services, payment terms, termination clauses. Importance: Forms the foundation of the contractual relationship between the SaaS provider and the customer, streamlining the process for future transactions and ensuring consistency in terms across multiple agreements.
Subscription Agreement:
This agreement outlines the terms of the subscription plan selected by the customer, including pricing, payment terms, subscription duration, and any applicable usage limits or restrictions. Key Components: Pricing, payment terms, subscription duration, usage limits, renewal terms. Importance: Specifies the terms of the subscription plan selected by the customer, including pricing and payment obligations, ensuring transparency and clarity in the commercial relationship.
Data Processing Agreement (DPA)
DPAs are used when the SaaS provider processes personal data on behalf of the customer, particularly in relation to data protection regulations such as GDPR. These agreements specify the rights and obligations of both parties regarding the processing and protection of personal data. Key Components: Data processing obligations, data security measures, rights and responsibilities of both parties regarding personal data as laid down in India’s Digital Personal Data Protection Act 2023, and GDPR compliance. Importance: Ensures compliance with data protection regulations, establishes safeguards for the processing of personal data, and defines the roles and responsibilities of each party in protecting data privacy.
Non-Disclosure Agreement (NDA)
NDAs are used to protect confidential information exchanged between the SaaS provider and the customer during the course of their relationship. They prevent either party from disclosing sensitive information to third parties without consent. Key Components: Definition of confidential information, obligations of confidentiality, exceptions to confidentiality, duration of the agreement. Importance: Protects sensitive information shared between parties from unauthorized disclosure, fostering trust and enabling the exchange of confidential information necessary for business collaboration.
End User License Agreement (EULA)
If the SaaS platform includes downloadable software or applications, an EULA may be required to govern the use of that software by end users. EULAs specify the rights and restrictions associated with the use of the software. Key Components: Software license grant, permitted uses and restrictions, intellectual property rights, termination clauses. Importance: Establishes the rights and obligations of end users regarding the use of software, ensuring compliance with licensing terms and protecting the provider’s intellectual property rights.
Beta Testing Agreement
When a SaaS provider offers a beta version of its software for testing purposes, a beta testing agreement may be used to outline the terms and conditions of the beta program, including feedback requirements, confidentiality obligations, and limitations of liability. Key Components: Scope of the beta program, feedback requirements, confidentiality obligations, limitations of liability. Importance: Sets the terms for participation in beta testing, manages expectations regarding the beta software’s functionality and stability, and protects the provider from potential risks associated with beta testing activities.
These are some of the most common types of agreements used in the SaaS industry, though the specific agreements required may vary depending on the nature of the SaaS offering and the requirements of the parties involved.
Conclusion
In conclusion, the Software as a Service (SaaS) industry relies on a variety of agreements to establish and govern the relationships between SaaS providers and their customers. Each agreement plays a crucial role in defining the terms of service, protecting intellectual property, ensuring data privacy and security, and mitigating risks for both parties involved. From Terms of Service outlining user responsibilities to Service Level Agreements guaranteeing performance standards, and from Data Processing Agreements ensuring compliance with regulations like GDPR to Non-Disclosure Agreements safeguarding confidential information, these agreements collectively form the legal backbone of the SaaS ecosystem. By clearly delineating rights, obligations, and expectations, these agreements promote transparency, trust, and effective collaboration in the dynamic landscape of cloud-based software delivery. As the SaaS industry continues to evolve, these agreements will remain essential tools for fostering mutually beneficial partnerships and driving innovation in the digital economy.
FAQs on Types of SaaS Agreements
Q. What is the significance of agreements in the SaaS industry?
Agreements play a crucial role in defining the legal relationships between SaaS providers and their customers, outlining rights, obligations, and terms of service.
Q. What are the key types of agreements used in the SaaS industry?
Common agreements in the SaaS industry include Terms of Service (ToS), Service Level Agreements (SLAs), Master Services Agreements (MSAs), Subscription Agreements, Data Processing Agreements (DPAs), Non-Disclosure Agreements (NDAs), End User License Agreements (EULAs), and Beta Testing Agreements.
Q. What is the purpose of a Terms of Service (ToS) agreement in the SaaS industry?
ToS agreements establish the rules and guidelines for using the SaaS platform, including user responsibilities, intellectual property rights, and dispute resolution procedures.
Q. How do Service Level Agreements (SLAs) benefit customers in the SaaS industry?
SLAs define the level of service that the SaaS provider commits to delivering, including uptime guarantees, support response times, and performance metrics, offering assurances to customers regarding service quality.
Q. What does a Master Services Agreement (MSA) encompass in the SaaS industry?
MSAs serve as comprehensive contracts governing the overall relationship between SaaS providers and customers, covering general terms, specific transaction details, payment terms, and termination clauses.
Q. What is the purpose of Non-Disclosure Agreements (NDAs) in the SaaS industry?
NDAs protect confidential information exchanged between parties during the course of their relationship, preventing unauthorized disclosure and fostering trust in business collaborations.
Q. How do End User License Agreements (EULAs) affect users of SaaS platforms?
EULAs define the terms of use for software provided by SaaS platforms, including permitted uses, restrictions, and intellectual property rights, ensuring compliance and protecting the provider’s interests.
Q. What is the role of Beta Testing Agreements in the SaaS industry?
Beta Testing Agreements establish terms for participating in beta programs, outlining feedback requirements, confidentiality obligations, and limitations of liability for both parties involved in testing new software releases.
Q. How can businesses ensure they are effectively using these agreements in the SaaS industry?
Businesses should carefully review, customize, and regularly update these agreements to reflect evolving legal requirements, industry standards, and the specific needs of their SaaS offerings and customer base.
In the accounting realm, there are two primary types of audits: internal audits and statutory audits. Both audits are essential for reviewing an organization’s financial records, but they differ significantly in their objectives, scope, and target audience.
While we all know about Internal and Statutory audit, understanding the difference between internal audit and statutory audit is important because they serve different purposes and are crucial for businesses aiming to enhance their financial transparency and compliance. Internal audit is a form of assurance to the board and management of a company that the company’s processes, systems, operations, and financials are in compliance with the company’s policies and procedures. Statutory audit, on the other hand, is conducted to ensure that the company’s financial statements are true and fair, and comply with the relevant statutes and regulations. This article further elaborates the Difference between Statutory Audit and Internal Audit
Internal Audit: Key Features and Importance
An internal audit involves a thorough examination of an organization’s financial records and internal controls by an independent entity, typically an internal audit department. The primary aim of an internal audit is to provide an unbiased evaluation of an organization’s operations, helping management pinpoint areas for improvement. Here’s a closer look at the key features of internal audits:
Objectives of Internal Audits
The main goal of an internal audit is to ensure that an organization’s internal controls and risk management processes are operating effectively. These audits assess the efficiency, effectiveness, and economy of an organization’s operations, offering valuable insights into potential enhancements.
Scope of Internal Audits
The scope of an internal audit is defined by the organization’s internal audit department and can encompass all aspects of operations, including financial, operational, and compliance areas. This comprehensive approach ensures that all relevant risks and controls are evaluated.
Frequency of Internal Audits
Internal audits are generally conducted on a regular schedule, such as quarterly, semi-annually, or annually. This consistent oversight helps organizations maintain robust internal controls and adapt to changing risks.
Reporting of Internal Audits
After the audit is completed, reports are generated for management, outlining findings and recommendations. These insights are crucial for driving improvements in the organization’s operations, ensuring ongoing compliance and operational excellence.
By understanding the significance of internal audits, organizations can better leverage these evaluations to enhance their financial integrity and operational efficiency.
Statutory Audits: Key Features and Importance
A statutory audit is a mandatory examination of an organization’s financial records conducted by an independent auditor appointed by a government or regulatory body. The primary goal of a statutory audit is to provide assurance that an organization’s financial statements present a true and fair view. Here’s an overview of the key features of statutory audits:
Objectives of Statutory Audits
The main objective of a statutory audit is to deliver an independent opinion on the organization’s financial statements. This opinion assures stakeholders—including shareholders, investors, and lenders—that the financial statements are accurate and reliable.
Scope of Statutory Audits
The scope of a statutory audit is defined by the relevant regulatory body or government agency that mandates the audit. Typically, it encompasses a thorough review of the financial statements and accompanying notes, ensuring comprehensive scrutiny of the organization’s financial health.
Frequency of Statutory Audits
Statutory audits are generally conducted annually, although the frequency can vary based on specific regulatory requirements or the nature of the organization’s operations.
Reporting of Statutory Audits
After the audit is complete, the auditor prepares a report intended for stakeholders such as shareholders, investors, and lenders. The auditor’s opinion is included in the organization’s annual report, which is made publicly available, enhancing transparency and accountability.
By understanding the importance of statutory audits, organizations can ensure compliance with regulatory standards and build trust with their stakeholders.
This guide provides an overview of the differences between the two types of audits, including the scope and objectives of each.
Internal Audit vs. Statutory Audit: Comparative Table
Sr No.
Particulars
Internal Audit
Statutory Audit
1
Meaning
Internal Audit is carried out by people within the Company or even external Chartered Accounts (CAs) or CA firms or other professionals to evaluate the internal controls, processes, management, corporate governance, etc. these audits also provide management with the tools necessary to attain operational efficiency by identifying problems and correcting lapses before they are discovered in an external audit
Statutory Audit is carried out annually by Practising Chartered Accountants (CAs) or CA Firms who are independent of the Company being audited. A statutory audit is a legally required review of the accuracy of a company’s financial statements and records. The purpose of a statutory audit is to determine whether an organization provides a fair and accurate representation of its financial position
2
Qualification
An Internal Auditor need not necessarily be a Chartered Accountant. It can be conducted by both CAs as well as non-CAs.
Statutory Audits can be conducted only by Practising Chartered Accountants and CA Firms.
3
Appointment
Internal Auditors are appointed by the management of the Company. Form MGT-14 is to be filed with ROC
Statutory Auditors appointed by the Shareholders of the Company in its Annual General Meeting. Form ADT-1 is to be filed with ROC.
4
Purpose
Internal Audit is majorly conducted to review the internal controls, risk management, governance, and operations of the Company and to try and prevent or detect errors and frauds.
Statutory Audit is conducted annually to form an opinion on the financial statements of the Company i.e whether they give an accurate and fair view of the financial position and financial affairs of the Company.
5
Reporting Responsibilities
Reports are submitted to the management of the Company being audited.
Reports are submitted to the shareholders of the Company being audited.
6
Frequency of Audit
Conducted as per the requirements of the management.
Conducted annually as per the statute.
7
Independence
An internal auditor may or may not be independent of the entity being audited.
A statutory auditor must always be independent.
8
Removal of auditor
Internal auditors can be removed by the management
Statutory Auditors can be removed by shareholders in an AGM only.
9
Regulatory requirements
Internal audit is not a regulatory requirement for all private limited companies. The requirements for internal audits are prescribed in Section 138 of the Companies Act, 2013.
All Companies registered under the Companies Act are required to get Statutory audits done annually.
Key Difference Between Internal Audit And Statutory Audit
Similarities Between Internal Audit And Statutory Audit
Having discussed the differences between internal audit and statutory audit, let’s now take a look at the similarities between the two.
The primary similarity between internal audit and statutory audit is that they both require an independent area of operation that should, ideally, be free from any sort of managerial interference or organizational control.
Both internal and statutory audits follow the same procedural path—planning, research, execution, and presentation. These paths may vary slightly from one auditor to another, but they largely stick to the same pattern.
Be it an internal audit or a statutory audit, both types are dependent on the availability and access of clear, reliable, and accurate data. If an organization offers its resources in a transparent manner, the audit would be fair and just.
The long-term purpose of internal and statutory audits is to prevent mistakes, maintain clarity, enhance efficiency, and present a precise snapshot of the firm’s financial position.
When should you conduct Statutory Audit?
Statutory audits are essential for ensuring financial transparency and compliance with regulatory standards. Here are the key circumstances under which statutory audits should be conducted:
Annually: Statutory audits are generally required on an annual basis to verify the accuracy of financial statements and ensure compliance.
At Year-End: Conduct audits at the end of the financial year to evaluate the organization’s overall financial health and performance.
Regulatory Mandates: Whenever dictated by government regulations or industry standards, statutory audits must be performed to meet compliance obligations.
Following Significant Changes: Initiate audits after major organizational changes, such as mergers, acquisitions, or restructuring, to assess financial impacts.
In Response to Stakeholder Concerns: If shareholders, investors, or lenders express concerns regarding financial accuracy, a statutory audit should be conducted without delay.
Before Major Financial Transactions: Conduct statutory audits prior to significant financial activities (e.g., IPOs, large loans) to provide assurance to stakeholders.
When Compliance Issues Arise: If there are signs of non-compliance with laws or regulations, initiate an audit to investigate and address potential issues.
At the Start of New Financial Periods: Audits can help establish a clear financial baseline when entering a new financial period.
When Planning for Expansion: Before expanding operations or entering new markets, a statutory audit can assess financial readiness and compliance.
When should you conduct Internal Audit?
Internal audits are vital for evaluating an organization’s internal controls and operational efficiency. While Statutory Audit is compulsorily required to be conducted annually, as an organization you should choose to conduct an Internal Audit if you want to:
Analyze the fairness of your firm’s internal controls, processes, and operations
Compare your actual performance with budgets and estimates
Evaluate policies, strategies, and compliances
Devise appropriate measures to meet organizational objectives
Identify risks within the organization, focusing on high-risk areas that require closer examination
Conduct audits prior to launching new projects or initiatives to ensure that appropriate controls and procedures are in place
Identify concerns or areas for improvement
Identify and report errors, frauds, wastage, or embezzlement, if any.
Conclusion
Wrapping up, Internal Audit vs. Statutory Audit serves distinct yet complementary roles in ensuring organizational integrity. While internal audit helps the management in ensuring operational efficiency, controls, corporate governance etc. are working effectively in their organization , statutory audit ensures that their financial statements give a true and fair view and are compliant with all applicable laws and regulations. Internal Audit focuses on improving internal controls and risk management, providing ongoing insights for management. In contrast, Statutory Audit is an external, legally required review of financial statements, ensuring compliance and accuracy. Both are essential for effective governance, with Internal Audit being proactive and Statutory Audit providing independent assurance.
Treelife’s multidisciplinary team has the right domain expertise in the startup ecosystem and can provide you with the necessary insights and guidance to make the right decisions for your business and auditing requirements.
Frequently Asked Questions (FAQs)
1. Can an Internal Auditor and Statutory Auditor be the same?
A statutory auditor of the Company cannot be its internal auditor
2. Can a statutory auditor rely on an internal auditor?
A statutory auditor can use the report of an internal auditor in a meaningful manner to identify key risk areas and key internal controls in place and accordingly plan their statutory audit procedures. The Standards on Auditing applicable in India (SA-610) also prescribes the extent and manner in which a statutory auditor can use the work of an internal auditor.
3. Can the Board of Directors appoint a statutory auditor of the Company?
Only the first statutory auditor of the Company can be appointed by the board of directors within 30 days from the date of incorporation. In the first Annual General Meeting (AGM) of the Company, the shareholders are required to appoint the statutory auditor of the Company and thereafter statutory auditors can only be appointed in the AGM of the Company by shareholders.
4. What is the difference between an internal and external auditor?
An internal auditor is someone who is appointed by the management of the Company and might also be an employee of the Company. An external auditor can never be an employee of the Company and should be independent of the Company/entity they are auditing.
5. Why Are Audits Important for Organizations?
Organizations require audits for various reasons, including compliance with regulatory requirements, attracting investors, securing loans, and enhancing internal controls.
6. Who Conducts Audits?
Audits are typically carried out by certified public accountants (CPAs) or other qualified auditors trained to evaluate financial records and operational processes.
7. What Does the Audit Process Involve?
The audit process generally consists of four main stages: planning, fieldwork, reporting, and follow-up. During planning, auditors define the scope and objectives. In the fieldwork stage, they examine financial records and operations. The reporting phase involves issuing a report with findings and recommendations, while follow-up ensures that any suggested improvements are implemented.
8. What Is the Purpose of an Audit Report?
The primary purpose of an audit report is to provide stakeholders—such as shareholders, investors, and lenders—with assurance that an organization’s financial statements are accurate and complete.
9. What Is an Audit Trail?
An audit trail is a comprehensive record of all transactions and activities within an information system. It serves to track changes, identify errors, and maintain the integrity of the system.
10. What Is a Management Letter?
A management letter is a report issued by an auditor to management, detailing findings and offering recommendations for enhancing internal controls and operational efficiency.
11. How Frequently Should Organizations Conduct Audits?
The frequency of audits varies based on organizational needs and regulatory requirements. Internal audits may be conducted regularly—quarterly, semi-annually, or annually—while statutory audits are usually performed on an annual basis.
As India marches towards its goal of becoming a $5 trillion economy, innovation and global connectivity in finance have become critical components of this journey. At the heart of this transformation lies the Gujarat International Finance Tec-City (GIFT City)—India’s first operational International Financial Services Centre (IFSC). Launched in 2007, GIFT City is not just a hub for international finance; it represents India’s vision of becoming a leader in global finance, technology, and innovation. GIFT IFSC provides a comprehensive platform for financial activities, including banking, insurance, capital markets, FinTech, and Fund Management Entities (FMEs). Its attractive tax incentives and solid regulatory framework make it a gateway for both inbound and outbound global investments, drawing businesses and investors from around the world.
At Treelife, we are excited to present “Navigating GIFT City: A Comprehensive Guide to India’s First International Financial Services Centre (IFSC).” This guide offers insights into the current legal, tax, and regulatory framework within GIFT IFSC, highlighting the strategic advantages of establishing a presence here, with a focus on the FinTech and Fund Management sectors. Whether you’re an investor, financial institution, or corporate entity exploring opportunities, we believe this guide will be a valuable resource in navigating the exciting prospects within GIFT IFSC.
What Does GIFT City Offer?
GIFT City is positioned as a global hub for financial services, offering a range of services across banking, insurance, capital markets, FinTech, and Fund Management Entities (FMEs). By combining smart infrastructure and a favorable regulatory environment, GIFT City is becoming the go-to destination for businesses seeking ease of doing business, innovation, and access to global markets.
Here are some key takeaways from the guide:
1. Introduction to GIFT City and IFSCA
GIFT City is the epitome of India’s ambition to establish a world-class international financial center. The International Financial Services Centres Authority (IFSCA) is the primary regulatory body that oversees operations within GIFT City, ensuring a seamless and globally competitive financial environment. IFSCA’s unified framework offers businesses ease of compliance and flexibility, making it an attractive hub for both domestic and international entities.
2. Regulatory Framework for Permissible Sectors with Treelife Insights
Our guide provides an in-depth look at the regulatory landscape governing GIFT City’s key sectors, including banking, insurance, capital markets, and many more, with a special focus on FinTech, and Fund Management Entities (FMEs). Alongside Treelife insights, we highlight how the city’s regulatory framework promotes innovation, offering businesses a fertile ground for growth.
3. Setup Process
Our guide walks you through the step-by-step setup process for entities looking to establish operations. Whether you are a startup, a financial institution, or a multinational company, guide through GIFT City’s infrastructure and compliance processes.
4. Tax Regime
One of the standout advantages of operating within GIFT City is its favorable tax regime. Businesses enjoy significant tax exemptions, including a 100% tax holiday on profits for 10 out of 15 years, exemptions on GST, and capital gains tax benefits. These incentives are designed to attract global businesses and investors, positioning GIFT City as a competitive alternative to other international financial hubs. Our guide details these tax benefits and how businesses can leverage them for maximum advantage.
Why This Guide is Essential
Our guide provides a comprehensive overview of the opportunities within GIFT City, focusing on FinTech and Fund Management sectors. It also includes a detailed analysis of the tax incentives, setup processes, and regulatory requirements that make GIFT City an attractive destination for global financial institutions.
Whether you’re an investor looking to tap into India’s expanding economy, or a business exploring new markets, this guide will serve as your roadmap to success within GIFT City.
Download the Guide
Discover how GIFT City is shaping the future of finance and how you can be part of this exciting journey. Download our guide to learn more about the opportunities, regulatory framework for the permissible sectors, incentives, and innovations that await in India’s first IFSC.
For any questions or further information, feel free to reach out to us at [email protected].
In the contemporary competitive job market, companies are constantly seeking innovative ways to attract and retain top talent. Employee Stock Option Plans (hereinafter ESOPs) have emerged as a popular tool, offering employees a stake in the company’s success and fostering a sense of ownership. ESOPs have become a game-changer, offering employees a chance to foster a sense of ownership in the company and to partake in its success. But ESOPs are more than just a fancy perk in a landscape where talent reigns supreme; understanding how the process flow works, the tax implications involved in India, and the factors that influence the exercise price – the price employees pay for the stock – is crucial for both employers and employees.
What are ESOPs?
Simply put, ESOPs are financial instruments that grant employees the right to purchase company shares at a predetermined price (also known as the exercise price) within a specified period (also known as the vesting period). These are typically structured as a performance-based equity incentive program, where employees are granted stock options as part of their compensation package.
ESOPs serve as a means to align the interests of employees with those of the company’s shareholders and can play a significant role in driving employee engagement, productivity, and long-term company performance. Additionally, ESOPs can be used as a tool for attracting and retaining top talent, as well as incentivizing employees to contribute to the company’s growth and success.
Benefits of ESOPs
ESOPs serve as a means to align the interests of employees with those of the company’s shareholders and can play a significant role in driving employee engagement, productivity, and long-term company performance. Additionally, ESOPs can be used as a tool for attracting and retaining top talent, as well as incentivizing employees to contribute to the company’s growth and success.
How do ESOPs Work?
The ESOPs work in following manner, primarily Finalizing Terms, ESOP Policy Adoption, Grant of ESOPs, Vesting of ESOPs, Exercise of ESOPs, Payment and Allotment of Shares.
Finalizing Terms: The company agrees on terms of ESOP policy such as grant, vesting, exercise, etc.
Adoption of ESOP policy: The company through board and shareholder resolutions, adopts the ESOP policy.
Grant of ESOPs: The eligible employees (as determined by the ESOP policy and/or the board of the company) will be granted options through issue of grant letters.
Vesting of ESOPs: In accordance with the vesting schedule set out in the ESOP policy/grant letter issued by the company, and upon completion of the milestones thereunder, the employees will be eligible to purchase the ESOPs.
Exercise of ESOPs: In accordance with the procedure set out in the ESOP policy and the grant letter, the employee will exercise the ESOP options.
Payment of Exercise Price: In accordance with the conditions set forth in the grant letter and the ESOP policy, the employee will pay the exercise price to purchase the vested ESOP options.
Allotment of Shares: Upon receipt of the exercise price, the company will allot the relevant shares to the name of the employee. It is important to note here that the shares given to the employees will be within the ESOP pool. Any proposed ESOPs that exceed the available pool will require that the pool first be increased.
Please see the image below describing the process flow of ESOPs:
We have provided a brief description of the important terms used in the ESOP process flow below:
Term
Brief description
Grant date
Date on which agreement is entered into between the company and employee for grant of ESOPs by issuing the grant letter
Vesting period
The period between the grant date and the date on which all the specified conditions of ESOP should be satisfied
Vesting date
Date on which conditions of granting ESOPs are met
Exercise
The process of exercising the right to subscribe to the options granted to the employee
Exercise price
Price payable by the employee for exercising the right on the options granted
Exercise period
The period after the vesting date provided to an employee to pay the exercise price and avail the options granted under the plan
What is the eligibility criteria for the grant of ESOPs?
The grant of ESOPs by a publicly listed company is governed by the Securities and Exchange Board of India, which prescribes strict conditions within which such public companies can reward their employees with stock option grants.
However, private companies are governed within the limited purview of the Companies Act, 2013 and the corresponding Companies (Share Capital and Debenture) Rules, 2014. Under this, the ESOPs can be granted to:
a permanent employee of the company who has been working in India or outside India; or
the director of the company including a whole-time director but not an independent director; or
a permanent employee or a director of a subsidiary company in India or outside India or of a holding company.
However, the legal definition of an employee excludes the following categories of “employees”:
an employee who is a promoter or a person belonging to the promoter group; or
a director who either himself or through his relative or through any body corporate holds more than 10% of the outstanding equity shares of the company, whether directly or indirectly.
Note: These exceptions are not applicable to start-ups for a period of 10 years from the date of their incorporation/registration.
Tax Implication of ESOPs – Explained through an Example
Employee Mr. A is granted ESOP of Company X (not assumed to be an eligible startup as per Section 80-IAC of Income Tax Act, 1961), which entitles him to get 1 equity share per option:
No. of Options = 100
Exercise Price = INR 10
Fair market value (FMV) of the share on exercise date = INR 500
FMV of share on the date of sale = INR 600
Assuming that all options have vested to Mr. A and are exercised in the same year, the tax liability would be as below:
On Exercise of ESOPs
On Sale of ESOPs
Number of shares = 100
Number of shares = 100
FMV = INR 500 per share
FMV = INR 600 per share
Exercise price paid by employee = INR 10 per share
FMV on date of exercise of option = INR 500 per share
Gain to employee = INR 490 per share
Gain to employee = INR 100 per share
Taxable income = INR 4,90,000 (taxable as salary income)
Taxable income = INR 1,00,000 (taxable as capital gains)
Deferred Tax Liability for Startups
In order to ease the burden of payment of taxes, employees of “eligible startups” (i.e., startups fulfilling eligibility criteria as specified under Section 80-IAC of the Income Tax Act, 1961 and obtaining an Inter-Ministerial Board Certificate) can defer the payment of tax or employers can defer the deduction of TDS for employees arising at the time of exercise of ESOPs. In other words, there is no taxable event for eligible startups on the date on which the employee exercises the options.
The tax liability will arise within 14 days from the earliest of any of the following events : (a) after completion of 48 months from the end of relevant accounting year; or (b) date of sale of shares by the employee; or (c) date from when the assessee ceases to be an employee of the ESOP-allotment company.
Determining the exercise price of a stock option
The exercise price is a crucial element of a stock option and denotes the predetermined rate at which an employee can procure the company’s shares as per the ESOP agreement. This price is established at the time of granting the option and remains fixed over the tenure of the option.
Factors Influencing Exercise Price
Fair Market Value (FMV): This is a key benchmark. Ideally, the exercise price should be set close to the FMV of the stock on the grant date. However, there can be variations depending on the company’s life stage, liquidity, and overall ESOP strategy. The exercise price is often tethered to the prevailing market value of the company’s shares. If the existing market value exceeds the exercise price, the option is considered “in the money,” rendering it more lucrative for the employee. Conversely, if the market value falls below the exercise price, the option is “out of the money,” potentially reducing its attractiveness.
Company Objectives: The ESOP policy outlines the rationale behind granting stock options and the intended benefits for employees. A lower exercise price can incentivize employees and align their interests with the company’s growth.
Dilution Impact: Granting options increases the company’s outstanding shares. The exercise price should consider the dilution impact on existing shareholders. The inherent volatility in Indian stock markets significantly impacts the exercise price. Heightened volatility tends to inflate option premiums, including the exercise price, owing to the increased likelihood of significant price fluctuations in the underlying shares.
Accounting and Legal Considerations: Indian Accounting Standards (Ind AS) and tax implications need to be factored in to ensure proper financial reporting and tax treatment. Tax consequences can vary based on the timing of the exercise and the type of ESOP.
Conclusion
In a nutshell, ESOPs have emerged as a significant instrument in India’s corporate landscape, fostering a sense of ownership and alignment between employees and companies. Understanding the key features including the process flow, tax implications and exercise price determination associated with ESOPs is paramount for companies to highlight maximized potential benefits to employees.
Frequently Asked Questions (FAQs) about ESOPs in India
Q. How is Exercise Price determined? A. Exercise Price can be whatever price the Company chooses at the time of issuing the grant letter. Some firms use a minimal exercise price (for example, INR 10) while others choose an exercise price depending on the company’s latest round value. The greater the difference between FMV and exercise price at the time of ESOP sale, the more money you create.
Q. How is a Vesting Schedule fixed? A. The most typical vesting plan is uniform yearly vesting over four years, which means that after the first year of mandatory ‘cliff’ vesting, you will get 25% of the total ESOPs guaranteed to you every year for the next four years.
Q. What happens to the ESOPs when an employee leaves the Company? A. This is typically governed by the ESOP Policy adopted by the Company. In short, unvested ESOPs are returned to the ESOP pool when an employee leaves and the employee may exercise the vested options in accordance with the ESOP Policy.
Q. Can ESOPs be subject to transfer restrictions? A. This would again be subject to the ESOP Policy but yes, a Company can subject these shares to restrictions such as Right of First Refusal or Right of First Offer, in order to create visibility on any transfers for the Company.
Q. How is ESOP liquidity made available to employees? A. This is again, subject to the ESOP Policy. It is important to note that employees can only profit from the ESOPs if a liquidity event (such as secondary transaction, repurchase or IPO) occurs.
Q. What are the tax benefits of ESOP for the employer?
A. ESOPs amount treated as a perquisite upon exercise of the option is considered a salary cost and is an allowable expenditure in the company’s hands. However, the company must deduct TDS on the same as per the provisions for TDS on salary.
Q. Are ESOPs part of CTC?
A. Yes, ESOPs may be included in the Cost to Company (CTC) of an employee.
Q: What is the tax treatment for ESOPs in the hands of the employee at the time of exercise?
A: The difference between the Fair Market Value (FMV) of the shares on the date of exercise and the exercise price (amount paid by the employee) is taxed as a perquisite or a part of the employee’s salary income at the time of exercise.
Q: What is the tax treatment when the employee sells or transfers the shares later on?
A: When the employee subsequently sells or transfers the shares, the difference between the actual sale considerations realized and the FMV considered at the time of exercise is treated as capital gain.
Q: Can the Fair Market Value be adjusted for indexation during subsequent sale or transfer?
A: Yes, the Fair Market Value can be adjusted for indexation if the holding period of the shares is more than 12 months for shares of listed companies and more than 24 months for shares of unlisted companies.
Q. How do I defer tax on ESOP?
A. One way to defer tax liability on perquisites related to ESOPs is to opt for an Inter-ministerial Board Certificate and defer the tax liability on perquisites till 14 days from earlier of the below events instead of date of exercise of option: (i) expiry of five years from the end of year of allotment of shares under ESOPs; (ii) date of sale of the such shares by the employee; or (iii) date of termination of employment.
Q. Is TDS applicable on ESOP?
A. Yes, the employer must deduct TDS as per the provisions for TDS on salary on the perquisite amount at the time of exercise of the option.
As part and parcel of a transaction, companies seeking investment provide their investors with certain rights, which are contractually negotiated. These range from receiving periodic reports on the business and financials of the company to representation on the board of directors and the right to be involved in certain key decisions required to be taken by the company in the course of their growth. Such rights are typically requested by investors based on factors such as the nature of the investment (i.e., financial or strategic) and the level of insight into the business, operations and management of the company required. In such transactions, these rights (and the extent) are agreed upon and captured in a shareholders’ agreement (“SHA”) between the parties, whereas the rights and obligations pertaining to the fundraising itself are governed by the investment agreement.
Typically, investors (especially foreign) and companies/founders agree to arbitrate any disputes arising from the investment agreement or the SHA. However, referring a dispute to arbitration is often not as clear-cut as a contractual agreement between parties. Indian courts have repeatedly been required to provide rulings on whether or not arbitration can be invoked by the parties to a SHA. This issue is complicated further by conflicting judicial precedents which have ultimately resulted in an unclear understanding of the law forming the basis of how parties can agree to arbitrate any disputes.
In this article Dispute Resolution in the Articles of Association (AOA), we have provided an overview of the contested legal position and our suggestions for navigating the murky landscape, with the fundamental goal of ensuring the parties’ contractually documented intent is protected and legally enforceable.
Relationship between a Shareholders’ Agreement and the Articles of Association (‘AOA’)
What is the AOA?
Similar to how the constitution of India forms the basis of Indian democracy, the memorandum of association (‘MOA’) and AOA form the basis for a company’s legal existence. The MOA can be seen as the constitutional document that lays down the fundamental elements and broad scope within which the company, business, and operations will typically operate. However, it is the AOA that puts in place a ‘rulebook’, prescribing the regulations and by-laws that govern the company and in effect, enshrining and giving effect to the principles of the MOA.
It is crucial to understand that because a company is seen as a separate legal person, the AOA is a critical document that establishes the legal relationship between the shareholders of the company inter se and with the company. In order to lay the framework for the operations of the company, an AOA will include provisions (in accordance with applicable laws) that:
(i) regulate internal affairs and operations of the company;
(ii) provide clarity on procedures the company must follow;
(iii) govern the issue/buyback of securities and clarify the legal rights and obligations of shareholders holding different classes of securities; and
(iv) legitimize the authority of the board of directors and their functions.
It is, therefore, a reasonable presumption that any action undertaken by a company must be authorised by the AOA/MOA. Any amendment or alteration to these documents would not only require the assent of the board, but also of the shareholders (i.e., members of the company), and requires filing with the competent Registrar of Companies under the Companies Act, 2013. While these procedures are in place primarily to protect the shareholders from mischief by the company, the lengthy process involved in altering the AOA serves to highlight how essential a document it is for a company’s action to hold legal justification.
How does the shareholders’ agreement typically become enforceable?
Often in transaction documents, a critical mechanism that enables the enforcement of the investor rights agreed in the SHA is captured in the investment agreement, where as part of the conditions required to be satisfied upon receipt of the investment amount by the company, the company, and founders must also ensure that the AOA is suitably amended to codify the investor rights.
However, the legal justification for this action in itself finds a conflict between two different schools regarding the enforceability of provisions from the SHA that have not been incorporated into the AOA:
(i) The “incorporation” view – the prominent authority for this view is the ruling of the High Court of Delhi in World Phone India Pvt. Ltd. & Ors. v. WPI Group Inc. USA (the “World Phone Case”)[1], where it was held that a board resolution passed without considering an affirmative voting right granted to a shareholder under a joint venture agreement, was legally valid in light of the company’s AOA, which contained no such restriction. Relying on the decision of the Supreme Court in V.B. Rangaraj v. V.B. Gopalakrishnan (the “Rangaraj Case”)[2] and subsequent decision of the Bombay High Court in IL&FS Trust Co. Ltd. v. Birla Perucchini Ltd. (the “Birla Perucchini Case”)[3], the Delhi High Court was of the view that the joint venture agreement could not bind the company unless incorporated into the AOA.
The Rangaraj Case is of particular interest in this school of thought because while the issue dealt with share transfer restrictions, the Supreme Court held that it was evident from the provisions of the erstwhile Companies Act, 1956 that the transfer of shares is a matter regulated by the AOA of the subject company and any restriction not specified in the AOA was not binding on the company or its shareholders. Crucially, the World Phone Case poses a problem in the legal interpretation of the “incorporation” view because the Delhi High Court has carried the ratio of the Rangaraj Case to a logical conclusion and observed that even where the subject company is party to an SHA, the provisions regarding management of affairs of the company cannot be enforced unless incorporated into the AOA.
(ii) the “contractual” view – the prominent authority for this view is the ruling of the Supreme Court in Vodafone International Holdings B.V. v Union of India (the “Vodafone Case”)[4], where the Supreme Court disagreed with the ratio in the Rangaraj Case, without expressly overruling it, and held that freedom of contract includes the freedom of shareholders to define their rights and share-transfer restrictions. This was found to not be in violation of any law and therefore not be subject to incorporation within the AOA. This has also been supported by the Delhi High Court in Spectrum Technologies USA Inc. v Spectrum Power Generation[5]and in Premier Hockey Development Pvt. Ltd. v Indian Hockey Federation[6]. In fact, in the latter case, the Delhi High Court was of the view that the subject company, being party to both an SHA and a share subscription and shareholders agreement containing an obligation to modify the AOA to incorporate the SHA, was conclusive in binding the subject company to the same despite an absence of incorporation into the AOA.
How can this fundamental disagreement be reconciled?
It is difficult to reconcile the issues caused by conflicting rulings from the same judicial authority. Given that the circumstances of each case provide scope for situation-specific reasoning, we cannot conclusively say one view is preferred, or more appropriate, over the other. Further, where the courts have stopped short of conclusively overruling previous judgments (for instance the Supreme Court on the Vodafone Case only disagreed with the ratio of the Rangaraj Case), the result is an unclear understanding of the legal position regarding the enforceability of SHA without incorporation in the AOA.
It is also pertinent to note that the issues in the above rulings also deal with the enforceability of certain shareholder rights that have been contractually agreed upon (such as affirmative votes or share transfer restrictions). By contrast, dispute resolution is a mechanism contractually agreed upon between the parties in the event of any dispute/breach of the SHA and cannot be characterized as a “right” of any shareholder(s), in the true sense of the word. However, in light of the conflicting principles guiding the “incorporation” and “contractual” views, the lack of clarity extends to the inclusion of dispute resolution in the AOA simply to make the intent of parties to approach arbitration, enforceable.
Incorporation of arbitration clauses
Flowing from the “incorporation” view, the Delhi High Court, relying on the Rangaraj Case, World Phone Case, and the Birla Perucchini Case, held in Umesh Kumar Baveja v IL&FS Transportation Network[7] that despite the subject company being a party to the SHA, it was the AOA that governed the relationship between the parties and that since they did not contain any arbitration provision, the parties could not be referred to arbitration. A similar ruling was passed by the Company Law Board, Mumbai in Ishwardas Rasiwasia Agarwal v Akshay Ispat Udyog Pvt. Ltd.[8], where it was held the non-incorporation of the arbitration clause into the AOA of the subject company was fatal to the request for a reference to arbitration, despite findings that the dispute was contractual in nature and arbitrable.
A second line of reasoning flowing from the “contractual” view has attempted to uphold the contractual intent of the parties reflected in an SHA. In Sidharth Gupta v Getit Infoservices Pvt. Ltd.[9], the Company Law Board, Delhi was required to rule on the reference to arbitration. Relying on the facts that the SHA had been incorporated verbatim into the AOA and the subject company was a party to the SHA, the Company Law Board rejected the argument from an “incorporation” view and remarked on the importance of holding shareholders “to their bargain” when significant money had been invested on the basis of the parties’ understanding recorded in the SHA. It is pertinent to note in this case, that the Company Law Board had been directed by the Supreme Court to dispose of the case without being influenced by the decisions of the Delhi High Court. This led the Company Law Board to not consider the ruling of the Delhi High Court in the World Phone Case as binding.
An unusual third line of reasoning has also been provided by the High Court of Himachal Pradesh in EIH Ltd. v State of Himachal Pradesh & Ors.[10]. In this case, a dispute regarding a breach of AOA was referred to arbitration under the arbitration clause of the constitutive joint venture agreement to which the resultant company was not a party. The High Court held that the joint venture agreement and the AOA of the subject company were part of the same transaction, where the primary contractual relationship was contained in the joint venture agreement, and that the AOA functioned as a “facilitative sister agreement” to the same. Given the critical nature of the AOA to the internal governance of the subject company as a juristic person however, this line of reasoning where the AOA is relegated to a “sister agreement” is likely to not stand the test of a comprehensive judicial review of this issue.
Navigating the landscape and concluding thoughts
The startup growth trajectory continues to contribute significantly to the Indian economy, with funding crossing USD 5.3 billion in the first six months of 2024 and over 915 investors participating in funding deals[11]. This will see a proportional rise in investor-company disputes, and when reference to arbitration is contractually agreed but not enshrined in the SHA, this can lead to further delays at the stage of dispute resolution, where the competent court would be required to first rule on whether the reference to arbitration can even be enforced. However, the conflicting judicial precedents are only the tip of this murky iceberg; party autonomy is a fundamental guiding principle to any reference to arbitration. Where judicial precedent sets the grounds for formal incorporation into the AOA as a condition to enforcing this party intent, however, a question of whether the parties’ contractually documented intent is being ignored, is raised.
Further, the legal basis for the “incorporation” view is itself under question. A key component from the Rangaraj Case is that the Supreme Court based its ruling on the issue of share transfer restrictions and basis the provision of Companies Act, 1956 that stated a company’s shares are “transferable in the manner provided by the articles of the company”. This position has also been questioned by a larger bench of the Supreme Court in the Vodafone Case and by academics and has been distinguished and disregarded by lower High Courts on slim grounds. Consequently, the judicial precedent has been applied to a non-share transfer context as well, forming the basis for the incorporation view on arbitration clauses.
In conclusion, while it is our opinion that a contract-centric approach is more reflective of party intent, especially with reference to arbitration, the insistence on incorporating provisions of the SHA into the AOA would pose a potential roadblock in the event the parties are required to approach dispute resolution. Pending clarity from the judiciary on this issue, the best approach to dealing with this situation is adopting a conservative approach of incorporating dispute resolution provisions within the AOA, preventing delays in the event of a dispute between the parties.
[1] World Phone India Pvt. Ltd. v. WPI Group Inc. USA 2013 SCC OnLine Del 1098.
[2] V.B. Rangaraj v. V.B. Gopalakrishnan (1992) 1 SCC 160.
[3] IL&FS Trust Co. Ltd. v. Birla Perucchini Ltd. 2002 SCC OnLine Bom 1004
[4] Vodafone International Holdings B.V. v. Union of India (2012) 6 SCC 613.
[5] Spectrum Technologies USA Inc. v. Spectrum Power Generation, 2000 SCC OnLine DEL 472
[6] Premier Hockey Development Pvt. Ltd. v. Indian Hockey Federation, 2011 SCC OnLine Del 2621
[7] Umesh Kumar Baveja v. IL&FS Transportation Network, 2013 SCC OnLine Del 6436
[8] Ishwardas Rasiwasia Agarwal v. Akshay Ispat Udyog Pvt. Ltd., C.A. 328/2013 in CP 117/2013 (Compay Law Board, Mumbai Bench) (Unreported).
[9] Sidharth Gupta v. Getit Infoservices Pvt. Ltd., C.A.128/C-II/2014 in CP No. 64(ND)/2014 (Company Law Board, New Delhi Bench) (Unreported).
[10] EIH Ltd. v. State of Himachal Pradesh, Arb Case 60/2005 (H.P. H.C.) (Unreported).
Equity dilution is a critical concept in the realm of finance, particularly in the context of corporate structures and investments. In the dynamic landscape of India’s burgeoning economy where businesses constantly seek avenues for growth and expansion, understanding the intricacies of equity dilution becomes paramount for entrepreneurs, investors, and stakeholders alike.
This article delves into the multifaceted aspects of equity dilution providing a comprehensive overview of its definition, mechanics, underlying causes, and real-life examples. By unraveling the complexities surrounding this phenomenon, the article will give valuable insights into its implications for companies, shareholders, and the broader market dynamics.
What Is Equity Dilution?
Equity dilution refers to the reduction in ownership percentage and/or value of existing shares in a company as a result of any circumstance resulting in either a drop in the valuation of the shares itself or upon new securities being issued, causing a decrease in the overall stake. Equity dilution is a mathematical consequence of commonly undertaken corporate decisions such as raising funding, incentivizing employees through stock options, or acquisition/liquidation of any businesses. While equity dilution is a common phenomenon in corporate finance, its implications can be far-reaching and have significant effects on the company’s stakeholders.
In the context of India, where innovation, entrepreneurship and investment in the startup ecosystem are thriving, equity dilution plays a pivotal role in shaping the trajectory of businesses across industries. Founders often resort to equity dilution as a means to access much-needed capital for growth and expansion. By selling a portion of their ownership stake to investors, founders can infuse funds into the business, fueling innovation, scaling operations, and penetrating new markets.
However, equity dilution is not without its challenges. For existing shareholders, the prospect of their ownership stake being diluted can be concerning, as it can dilute not only the impact of their voting rights and stake on future earnings, but also the value of the shares themselves, potentially triggering disagreements between shareholders and founders regarding the company’s worth.
When Does Equity Dilution Happen?
Equity dilution or share dilution is a is caused by any of the following actions:
Conversion by holders of optionable securities: Holders of optionable securities (i.e., securities they have a right to purchase and hold title in their name once successfully purchased) may convert their holdings into common shares by exercising their stock options, which will increase the company’s ownership stake. This includes employees, board members, and other individuals.
Mergers and acquisitions: In case of a merger of corporate entities or amalgamation/acquisition thereof, the resultant entity may buy out the existing shareholders or have a lower valuation, leading to a lower price per share and an economic dilution of the equity stake.
Issue of new stock: A company may issue new securities as part of a funding round. Where any equity shares or equity securities are issued, the existing shareholders’ would see a dilution to their shareholding on a fully diluted basis (i.e., all convertible securities are converted into equity shares for the purpose of calculation).
Working of Equity Dilution
Given the nuanced commercial terms involved, a company may opt to pursue any of the following in the ordinary course of business, and as a result experience equity dilution:
Issuing New Shares for Capital: This is the most common cause of dilution. Companies raise capital by issuing new securities to investors. The more shares issued, the smaller the percentage of ownership held by existing shareholders ultimately becomes. Economic dilution happens here when the shares are issued at a lower price than the one paid by the existing shareholders.
Employee Stock Options (ESOPs): When companies grant employees stock options as part of their compensation package, they are essentially creating a pool of shares that will only be issued in the future to employees. The right to purchase these securities (at a discounted price) is first granted to an employee, creating an option. Upon fulfillment of the conditions of the ESOP policy, employees exercise their options and purchase these shares in their name. The creation or increase of an ESOP pool will lead to a mathematical dilution in the overall percentage distribution, affecting a shareholder’s individual stake in the company.
Convertible Debt: Some debt instruments, such as convertible notes or compulsorily convertible debentures, can be converted into equity shares at a later date and on certain predetermined conversion terms. This conversion leads to an increase in the total number of equity shares, leading to dilution of the individual percentage stakes. Depending on the terms of the convertible debt securities, there could also be an economic dilution of the value of the equity shares held by existing shareholders.
Stock Splits: While a stock split doesn’t technically change the total value of a company’s equity, it does increase the number of outstanding shares. For example, a 2-for-1 stock split doubles the number of shares outstanding, which dilutes ownership percentages without affecting the overall company value.
Acquisitions Using Shares: When a company acquires another company using its own shares as currency, it issues new shares to the acquired company’s shareholders. This increases the total number of outstanding shares and dilutes existing shareholders’ ownership. This is commonly seen with schemes of arrangement between two sister companies under common ownership and control.
Reacquired Stock Issuances: If a company repurchases or buys back its own shares (reacquired stock) and then issues them later, it can dilute the existing shareholders’ ownership. This impact can be both stake-wise and economic, especially if the shares are essentially reissued at a lower price than the original price.
Subsidiary Formation: When a company forms a subsidiary and issues shares in that subsidiary, it technically dilutes its own ownership stake. However, this is usually done for strategic reasons and doesn’t necessarily impact the value of the parent company.
Example of Equity Dilution
Infographic Illustration
Fundamentally, each company is made of 100% shares (remember the one whole of something is always 100%). Let’s understand this with an example to get clarity.
2 Founders viz. A and B are holding 5,000 shares each with 50% of ownership in the Company.
An investor, C comes with an investment of 1Mn dollars considering the valuation of 3Mn dollars
Now have a look at the figures in below table to understand this quickly:
Here, the number of shares has been increased basis the ratio to post investment i.e. 25% (1Mn/4Mn). The investor can keep any ratio post investment basis the agreement.
We can understand that post investment round, the holding % of founders are getting diluted and their controlling interest has been reduced from the original scenario.
There are various types of dilution, including dilution of shares in a private company. It’s also important to know the equity dilution meaning and examples of equity dilution in startups.
There is no exact solution to how much equity to dilute; it depends on the stage of the business you are at. Too much dilution can be of concern to a future incoming investor and too little dilution concerns investors as they should have skin in the game. The ultimate goal is to grow the business. So even if the dilution numbers are skewed from the expected dilution you have in mind, the growth of the business is primary, and investment helps you get closer to that goal.
Pre-money valuation is the value of the company prior to receiving the investment amount. It is derived through various internationally accepted valuation methods like the discounted cash flow method. Investors offer equity based on pre-money valuation; however, the percentage sought is based on post-money valuation.
Understanding dilution and cap tables are pertinent metrics for fundraising and talking to investors. Founders often neglect it due to a lack of clarity of these concepts. A grasp on concepts like dilution and the cap table enables the founder to have better control of the startup equity.
Effects of Equity Dilution
During share dilution, the amount of extra shares issued and retained may impact a portfolio’s value. Dilution affects a company’s EPS (earnings per share) in addition to the price of its shares. For instance, a company’s earnings per share or EPS could be INR 50 prior to the issuance of new shares, but after dilution, it might be INR 18. However, if the dilution dramatically boosts earnings, the EPS might not be impacted. Revenue may rise as a result of dilution, offsetting any increase in shares, and earnings per share may remain constant.
Public companies may calculate diluted EPS to assess the effects of share dilution on stock prices in the event of stock option exercises. As a result of dilution, the book value of the shares and earnings per share of the company decline.
Equity dilution, a fundamental consequence of issuing new shares, is a double-edged sword for companies. While it unlocks doors to growth capital, it also impacts existing shareholders’ ownership and potential control. Understanding the effects of dilution is crucial for companies navigating fundraising rounds and strategic decisions.
Example: If a company having 100 shares issued, paid up and subscribed, each representing 1% ownership, issues 20 new shares, the total number of issued, paid up and subscribed shares becomes 120. Consequently, the existing shareholders’ ownership stake is diluted post-issue, as each share now represents only 0.83% (100/120) of the company. This translates to a decrease in:
Ownership Percentage: Existing shareholders own a smaller portion of the company.
Voting Power: Their voting rights are proportionally reduced, potentially impacting their influence on company decisions.
Earnings Per Share: If company profits remain constant, EPS might decrease as profits are spread over a larger number of shares. This can affect short-term stock price performance.
How to minimize equity dilution?
Companies can employ various strategies to minimize dilution and maximize the benefits of issuing new shares:
Strategic Valuation: A higher valuation during fundraising allows the company to raise the target capital while offering fewer shares. However, maintaining a realistic valuation is crucial to attract investors without inflated expectations.
Debt Financing: Exploring debt options like loans or convertible notes can provide capital without immediate dilution. However, debt carries interest payments and other obligations.
Structured Equity Instruments: Utilizing options like preferred shares can offer different rights and value compared to common shares, potentially mitigating the dilution impact on common shareholders.
Phased Funding with Milestones: Structuring investments in tranches tied to achieving milestones allows the valuation to climb incrementally, reducing dilution in later rounds.
Focus on Organic Growth: Prioritizing revenue and profit growth naturally leads to higher valuations. This requires less equity dilution to raise capital in the future.
Pros of Equity Dilution:
Equity dilution, while often viewed with apprehension by existing shareholders, can also bring several advantages to a company. By issuing new shares and thereby diluting existing ownership, companies can access capital and unlock opportunities for growth and expansion:
Access to Capital: Equity dilution allows companies to raise funds by selling shares to investors. This infusion of capital can be instrumental in financing expansion projects, funding research and development initiatives, or addressing financial challenges.
Diversification of Shareholder Base: Bringing in new investors through equity dilution can diversify the company’s shareholder base. This diversification can enhance liquidity in the stock, broaden the investor pool, and potentially attract institutional investors or strategic partners.
Alignment of Interests: Equity dilution can align the interests of shareholders and management, particularly in startups or early-stage companies. By offering equity stakes to employees, management can incentivize them to work towards the company’s long-term success, fostering a culture of ownership and commitment.
Reduced Financial Risk: Diluting ownership through equity issuance can reduce the financial risk for existing shareholders. By sharing the burden of ownership with new investors, shareholders may benefit from a more diversified risk profile, particularly in cases where the company’s prospects are uncertain.
Cons of Equity Dilution:
While equity dilution offers certain advantages, it also presents challenges and drawbacks that companies and shareholders must carefully consider. From the perspective of existing shareholders, dilution can erode ownership stakes and diminish control over the company. Let’s delve into some of the key drawbacks of equity dilution:
Loss of Ownership and Control: One of the primary concerns associated with equity dilution is the loss of ownership and control for existing shareholders. As new shares are issued and ownership is spread among more investors, the influence of individual shareholders over corporate decisions may diminish.
Dilution of Earnings Per Share: Equity dilution can lead to a reduction in earnings per share for existing shareholders. This dilution occurs when the company’s profits are spread across a larger number of shares, potentially decreasing the value of each share and impacting shareholder returns.
Potential for Share Price Decline: The issuance of new shares through equity dilution can signal to the market that the company is in need of capital or that its growth prospects are uncertain. This perception may lead to a decline in the company’s share price, adversely affecting shareholder wealth.
Strain on Shareholder Relations: Equity dilution can strain relations between existing shareholders and management, particularly if the dilution is perceived as unfair or detrimental to shareholder interests. Managing investor expectations and communicating the rationale behind equity issuances is crucial to maintaining trust and credibility.
Conclusion
Equity dilution poses a significant impact on the ownership stakes of founders and investors alike. Whether you are already implementing a corporate equity plan or considering setting one up, equity dilution is a critical aspect to consider. Understanding the fundamentals of equity dilution and how it functions, particularly in the context of stock option dilution, is essential for informed decision-making.
Share dilution, occurring whenever a corporation issues new shares to investors, can significantly affect the value of your financial portfolio. During this process, the corporation must adjust its earnings-per-share and share price ratios accordingly. While share dilution is often viewed unfavorably, it can also signify potential acquisitions that may enhance stock performance in the future. To mitigate any potential surprises, it is prudent to remain vigilant for indicators of stock dilution. By staying informed and proactive, stakeholders can navigate the complexities of equity dilution with confidence and clarity.
Frequently Asked Questions (FAQs) on Equity Dilution in India
1. What is equity dilution?
Equity dilution refers to the reduction in ownership percentage of existing shareholders in a company due to the issuance of new shares. This dilution can occur during fundraising rounds, employee stock option plans (ESOPs), mergers, acquisitions, or other corporate actions.
2. How does equity dilution work in Indian companies?
Equity dilution typically occurs when a company issues additional shares, either through primary offerings to raise capital or secondary offerings for employee incentives or acquisitions. This issuance increases the total number of shares outstanding, reducing the ownership percentage of existing shareholders.
3. What are the primary causes of equity dilution in India?
Equity dilution in India can be caused by various factors, including fundraising activities such as initial public offerings (IPOs), follow-on offerings, private placements, or debt conversions. Additionally, the implementation of ESOPs, mergers, acquisitions, and convertible securities can also contribute to equity dilution.
4. Can you provide examples of equity dilution in Indian companies?
Examples of equity dilution in India include IPOs of startups or established firms where new shares are issued to the public, leading to dilution for existing shareholders. Similarly, when companies offer ESOPs to employees or acquire other businesses through stock issuance, equity dilution occurs.
5. What are the implications of equity dilution for shareholders in India?
Equity dilution can impact shareholders in India by reducing their ownership percentage and voting rights in the company. It may also lead to dilution of earnings per share (EPS) and share price, potentially affecting shareholder value and returns on investment.
6. How can companies minimize equity dilution in India?
Companies in India can minimize equity dilution by carefully managing their capital structure, negotiating favorable terms during fundraising rounds, implementing efficient ESOP schemes, and exploring alternative financing options such as debt financing or strategic partnerships.
7. Are there any regulatory considerations related to equity dilution in India?
Yes, companies in India must comply with regulatory requirements set forth by the Securities and Exchange Board of India (SEBI) and other relevant authorities when issuing new shares or implementing equity-related transactions. Compliance with disclosure norms and corporate governance standards is essential to ensure transparency and accountability.
IFSCA listing regulations requires debt securities to adhere to international standards/principles to be labelled as “green,” “social,” “sustainability” and “sustainability-linked” bond.
As of September 30, 2024, the IFSC exchanges boasted a listing of approximately USD 14 billion in ESG-labelled debt securities, a significant chunk of the total USD 64 billion debt listings in a short period. This rapid growth highlights the growing appetite for sustainable investments among global investors.
Certain investors, particularly institutional ones like pension funds and socially responsible investment (SRI) funds, explicitly state in their investment mandates that they can only invest in ESG-labeled securities. To encourage and promote ESG funds, the IFSCA has waived fund filing fees for the first 10 ESG funds registered at GIFT-IFSC, to incentivize fund managers to launch ESG-focused funds.
However, this rapid growth also comes with a significant risk of “greenwashing” where companies or funds exaggerate or falsely claim their environmental and sustainability efforts.
What is “Greenwashing”?
However, with this rapid growth comes a significant risk: greenwashing. Greenwashing occurs when companies or funds exaggerate or fabricate their environmental and sustainability efforts to project a greener image and attract investors. It’s essentially a deceptive marketing tactic that undermines the true purpose of sustainable investing.
Recognizing the threat of greenwashing, the IFSCA has released a consultation paper seeking public comment on a draft circular titled “Principles to Mitigate the Risk of Greenwashing in ESG labelled debt securities in the IFSC.” This circular outlines principles that companies and funds issuing ESG-labelled debt securities on the IFSC platform must adhere to.
Karnataka, a state in India known for its vibrant tech industry, has recently unveiled its Global Capability Centres (GCC) Policy 2024-2029. This ambitious policy aims to solidify Karnataka’s position as a leading hub for GCCs in India and propel the state’s tech ecosystem to even greater heights.
What are Global Capability Centres (GCCs)?
For those unfamiliar with the term, GCCs are specialized facilities established by companies to handle various strategic functions. These functions can encompass a wide range of areas, including:
Information Technology (IT) services
Customer support
Research and development (R&D)
Analytics
By setting up GCCs, companies can streamline operations, reduce costs, and tap into a pool of talented professionals. This allows them to achieve their global objectives more efficiently.
Why is Karnataka a Major Hub for GCCs?
India is a powerhouse for GCCs, boasting over 1,300 such centers. Karnataka takes the lead in this domain, housing nearly 30% of India’s GCCs and employing a staggering 35% of the workforce in this sector. Several factors contribute to Karnataka’s attractiveness for GCCs:
Vast Talent Pool: Karnataka is home to some of India’s premier educational institutions, churning out a steady stream of highly skilled graduates in engineering, technology, and other relevant fields.
Cost-Effectiveness:India offers a significant cost advantage for setting up and operating GCCs, compared to other global locations.
Key Highlights of Karnataka’s GCC Policy 2024-2029
The recently unveiled GCC Policy outlines a series of ambitious goals and initiatives aimed at propelling Karnataka to the forefront of the global GCC landscape. Here are some of the key highlights:
Establishment of 500 New GCCs: The policy sets a target of establishing 500 new GCCs in Karnataka by 2029. This aggressive target signifies the government’s commitment to significantly expanding the state’s GCC footprint.
Generating $50 Billion in Economic Output: The policy envisions generating a staggering $50 billion in economic output through GCCs by 2029. This substantial economic contribution will be a boon for Karnataka’s overall development.
Creation of 3.5 Lakh Jobs: The policy aims to create 3.5 lakh (350,000) new jobs across Karnataka through the establishment and operation of new GCCs. This significant job creation will provide immense opportunities for the state’s workforce.
Centre of Excellence for AI in Bengaluru: Recognizing the growing importance of Artificial Intelligence (AI), the policy proposes establishing a Centre of Excellence for AI in Bengaluru. This center will focus on driving research, development, and innovation in the field of AI, fostering a robust AI ecosystem in Karnataka.
AI Skilling Council: The policy acknowledges the need to equip the workforce with the necessary skills to thrive in the AI-driven future. To address this, the policy proposes the creation of an AI Skilling Council. This council will be responsible for developing and delivering AI-related training programs, ensuring Karnataka’s workforce is well-prepared for the jobs of tomorrow.
INR 100 Crore Innovation Fund: The policy establishes an INR 100 crore (approximately $12.3 million) Innovation Fund. This fund will support joint research initiatives between academia and GCCs, fostering a collaborative environment that fuels innovation and technological advancements.
The GCC Policy has a clear and ambitious goal: for Karnataka to capture 50% of India’s GCC market share by 2029. Read more about the policy here.
“Vesting” is a contractual structure to facilitate gradual transfer of ownership. It is a legal term referring to the process in which a person secures his ownership of (legally referred to as “title to”) certain assets over a period of time.
What is a Vesting Period?
Vesting is a typical construct built around ownership of shares, and also refers to the process by which conditional ownership of such shares is converted to full ownership (including rights of transferability) over a fixed period of time. A critical feature of vesting is that the person will only have conditional ownership of such shares until the fixed period (legally referred to as the “Vesting Period”) is completed.
What are Vesting Schedules?
Depending on the needs of the contractual relationship and subject to applicable laws, vesting can adopt many forms. However, a common element found in most forms of vesting is the “Vesting Schedule”, i.e., the breakdown showing how the relevant assets/shares will be transferred to the ownership of the person over the Vesting Period.
Types of Vesting Schedules
(i) Uniform or Linear Vesting – a simple process through which the person receives a percentage of their shares over a fixed period of time. Eg: if an employee is granted 10,000 options with 25% of them vesting per year for 4 years, then the employee will have vested 2,500 shares after 1 year and can exercise the rights to the same in accordance with the applicable policies.
(ii) Bullet Vesting – usually employed on a need-based circumstance in the event of any operational delay impacting the Vesting Schedule, bullet vesting works in one shot, completing the vesting in one instance.
(iii) Performance-based Vesting – tied typically to the performance of an employee in relation to stock option grants, performance based vesting will depend on the satisfaction of a performance condition. This can be in the nature of milestones to be achieved by the employee or revenue goals to be achieved by the company. The critical feature here is that there is no fixed Vesting Period in such a model, and the vesting is instead directly tied to the achievement of performance goals.
(iv) Hybrid Vesting – usually a combination of linear and performanced-based vesting, this type of vesting will often require the fulfillment of tenure and performance requirements. Eg: an employee is required to complete a four year tenure in addition to satisfying certain key performance indicators in order to receive the full set of options/benefits.
(v) Cliff Vesting – in such a model, no benefits are vested in a person until a certain predetermined point in time is reached. Once that time is met, all options/benefits become fully vested at once. Eg: if a 1-year cliff vesting is employed for grant of employee stock options, the employee will receive 100% of the options only once the full year has been completed with the company.
Examples of Vesting: Employee Stock Option Plans and Founder Vesting – Explained:
Vesting is largely relevant to startups in two main areas: (i) employee stock option plans (“ESOP”); and (ii) lock-in of founder shares:
1. Employee Stock Option Plans:
ESOPs are a vital component of modern employee compensation structures and prove a great tool for employee motivation and retention. Through an ESOP scheme, an employee is: (i) given the right to purchase certain shares in his name through the ESOP pool formulated by the employer company (“Grant of Option”); (ii) required to complete the Vesting Period during which the shares will vest in his name; and (iii) exercise the right to purchase the shares upon completion of the Vesting Schedule at a predetermined price (as per terms of the ESOP scheme).
It is important to note here that under Indian law, the Securities Exchange Board of India (Share Based Employee Benefits) Regulations, 2014 (applicable to listed public companies) and the Companies (Share Capital and Debentures) Rules, 2014 (applicable to private and unlisted public companies) both prescribe a mandatory minimum Vesting Period of 1 year from the date of Grant of Option. As such, any ESOP scheme formulated by an Indian company will need to comply with this requirement.
ESOPs typically see use of any of the above described Vesting Schedules. This is because Vesting Schedules primarily serve as a great tool to employee motivation and retention, as when ESOPs are granted to employees, they become part owners of the company and consequently, aligning their performance and goals with those of the company over the Vesting Schedule proves beneficial for overall growth. Further, employee turnover is a huge cost incurred by a company and grant of ESOPs acts as a means to dissuade employees from leaving until their options/grants have fully vested.
2. Founder Vesting:
In a funding round – especially where an institutional investor is brought onto the capitalisation table of a company for the first time, much of the trust forming the basis of the investment is rooted in the demonstrated results, passion, experience and skillset of the founders. Consequently, in order to secure the investment for a minimum period and to ensure the founders do not exit the company prematurely, the parties will typically agree to a lock-in of the founders’ shares, which will give them conditional ownership until completion of a Vesting Schedule, at which point in time the unconditional ownership of all their shares is restored to the founders.
Founder Vesting typically sees use of linear, bullet or cliff vesting. Given that the founders are originally shareholders of the company who voluntarily accept restrictions on their shares for a fixed period of time, performance-based or hybrid vesting would not typically be accepted for release of these locked shares. Consequently, a clear Vesting Schedule that employs the linear, bullet or cliff vesting options provides greater clarity to the parties and offers a modicum of flexibility when determining the Vesting Schedule.
Frequently Asked Questions (FAQs) on Vesting in India:
How long does a typical Vesting Period last?
According to the Securities Exchange Board of India (Share Based Employee Benefits) Regulations, 2014 (applicable to listed public companies) and the Companies (Share Capital and Debentures) Rules, 2014 (applicable to private and unlisted public companies) both prescribe a mandatory minimum Vesting Period of 1 year from the date of Grant of Option and consequently companies/parties are free to determine the upper limit. However, we see that Vesting Periods typically last between 3 and 5 years.
Can a Vesting Schedule be accelerated?
Yes, however this would be possible in limited, predefined circumstances. For example, in the event that an employee is permanently incapacitated or dies during the Vesting Period, companies will typically accelerate the Vesting Period in order to ensure that the employee (or their legal heirs/executors of estate) is able to exercise the rights on the options that would have otherwise vested in accordance with the schedule, but for the extenuating circumstance. Similarly, the same principle can be applied to vesting of founders’ shares, in the event of the mutually agreed departure of a founder (also known as a good leaver situation). This is ultimately dependent on the terms of the applicable policy/agreement between the parties.
Can a Vesting Schedule be changed?
Generally, altering a Vesting Schedule is not permitted, but there are specific situations where changes can be made. For example, in the case of ESOPs, if the company must amend its ESOP policy to comply with applicable laws, the Vesting Schedule can be modified accordingly. Additionally, if the alteration benefits the employee or enhances the effectiveness of the ESOP scheme, changes may be allowed, provided they comply with legal guidelines.
For founder shares, where the Vesting Schedule is part of a contractual agreement, modifications can be made if they adhere to applicable laws and are mutually agreed upon by all parties involved.
How does ESOP vesting work for a startup?
For example, if a startup employee is granted 10,000 stock options with a 4-year vesting schedule and a 1-year cliff, the employee must remain employed with the company for at least 1 year before any options vest. After the cliff period (i.e., once the 1-year mark is reached), 25% of the options (2,500 shares) will vest. The remaining options will then vest evenly at a rate of 25% per year over the next 3 years.
How does vesting work in case of lock in of founder shares?
For example, according to the contractual agreement between the parties, 80% of the founders’ shares will be locked in for a period of 4 years, allowing the founders to retain 20% of their shares for immediate liquidity. The locked-in shares will then vest at a rate of 20% per year over the 4-year period, meaning the founders will achieve full (100%) ownership of their shares only at the end of the fourth year.
As we are witnessing NIFTY 50’s 52-week high, it’s a moment to reflect on the extraordinary journey this index has taken since its inception in 1996. Launched with an index value of 1000, NIFTY 50 has steadily grown, reaching an impressive 25,940.40 by September 2024—marking a growth of approximately 2,494%. This performance solidifies its place as a cornerstone of the Indian stock market.
A Benchmark of Indian Financial Growth
The NIFTY 50 index, short for National Stock Exchange Fifty, represents the performance of the top 50 companies listed on the NSE. It serves as a key benchmark for mutual funds, facilitates derivatives trading, and is a popular vehicle for index funds and ETFs. Over the last 28 years, it has been a testament to the robustness of the Indian economy, demonstrating the potential of long-term investment in the stock market.
A Comparison Across Asset Classes
Over the years, NIFTY 50 has outshined other traditional asset classes like gold, silver, and real estate. While these assets have held their value, particularly in times of economic volatility, NIFTY 50 has consistently delivered superior returns.
NIFTY 50: A ₹1000 investment in NIFTY 50 in 1996 would have grown to ₹25,790.95 by 2024, reflecting a 12.31% CAGR.
Gold: A similar investment in gold would have appreciated to ₹14,193.80, giving a 10.72% CAGR.
Silver: Investing ₹1000 in silver in 1996 would be worth ₹12,591.89 today, with a 10.30% CAGR.
Real Estate: A standard 9.3% CAGR would take ₹1000 to ₹10,903, reflecting real estate’s slower but steady growth in India.
These figures showcase how NIFTY 50 has not only matched but outpaced traditional safe-haven assets. While gold and silver offer reliability during economic uncertainty, they cannot compete with the compounding returns offered by the stock market.
Sectoral Shifts Reflecting India’s Growth
The sectoral composition of NIFTY 50 has evolved significantly. In 1995, Financial Services contributed just 20% of the index. Fast forward to 2024, and they now dominate with 32.6%. The rise of Information Technology, which was non-existent in 1995, grew to 20% by 2005 but has slightly reduced to 14.17% today. This shift from manufacturing and resource-based sectors to services and technology highlights India’s transformation into a modern, service-driven economy.
Resilience Through Market Challenges
NIFTY 50’s journey has not been without challenges. The index has weathered multiple crises, including the Dot-com bubble (2000-2002), Sub-prime crisis (2007-2008), Demonetization (2016), and the COVID-19 pandemic (2020). Despite these hurdles, NIFTY 50 has shown resilience, rebounding stronger each time and proving to be a robust long-term investment option.
Conclusion
As NIFTY 50 celebrates 28 years of excellence, its consistent returns and ability to outperform other asset classes make it a dominant force in India’s financial markets. For investors looking to balance risk and reward, NIFTY 50 remains a reliable choice, reflecting the strength and potential of India’s growing economy.
The cornerstone of any commercial agreement is a contract that has been validly executed in writing. They are critical to business relationships and provide a legal framework that captures the rights and obligations of the signatory parties. Consequently, commercial contracts can be complex and with exhaustive detail, capturing the parties’ agreement on various issues that can arise in the contract lifecycle. Further to the parties’ intent, contracts that satisfy the requirements of the Indian Contract Act, 1872 are therefore binding and can be legally enforced through a court of law.
One key component of a contract is the termination clause, which outlines how and when the contract can be legally “ended”. These clauses are critical because they define the conditions under which a party can walk away from the binding nature of the contract, without breaching the terms thereof. Whether due to non-performance, changes in business needs, or unforeseen events, contracts may need to be terminated in the course of business and thus, having a clear termination clause in place protects a party from potential risks and ensures they are not locked into unfavorable situations.
Based on the nature of the commercial relationship between the parties, there are several types of termination clauses which can be agreed, each serving a unique purpose. Termination clauses can allow for a party to end the agreement if the other fails to meet their obligations or breaches the contract, or even for termination by both parties on the basis of mutual convenience. Understanding termination clauses in a contract helps businesses avoid disputes and protect their interests when a contract must end.
What is a Termination Clause?
A termination clause is a critical provision in a contract that outlines the conditions under which one or both parties can end the agreement before its natural conclusion. It specifies the events or circumstances that allow for contract termination and often includes guidelines on the notice period, reasons for termination, and any potential penalties or obligations upon termination. Typically, termination clauses do not automatically end all obligations between the parties, and certain legal provisions (such as governing law and dispute resolution) would survive the termination of the agreement.
Definition of a Termination Clause
A termination clause legally defines how a contractual relationship between parties can be ended, by setting out pre-defined terms and conditions to be satisfied such that the termination itself does not amount to a breach of the contract. Depending on the nature of the underlying commercial relationship, termination clauses can be linked to performance, force majeure conditions that render performance impossible, mutual convenience, or even a unilateral right retained by one party (such as in investment agreements).
Purpose of Including Termination Clauses in Contracts
The primary purpose of a termination clause is to offer clarity on how the parties can end their contractual relationship and (to the extent feasible) protection from any claims of breach. It safeguards both parties by:
Managing Risks: Helps to limit financial or operational damages if the business relationship is no longer viable.
Ensuring Flexibility: Provides a means to break the contractual binds if the conditions become unfavorable, without triggering a dispute for breach of contract.
Defining Responsibilities: Clearly outlines post-termination duties, such as settling payments or returning property.
General Impact on Contractual Relationships
Termination clauses have a significant impact on contractual relationships by:
Fostering Accountability: Parties are aware of the consequences of failing to meet contractual obligations, promoting a higher standard of performance.
Reducing Uncertainty: Pre-defined termination conditions prevent conflicts, ensuring both sides know the terms of disengagement.
Enabling Smooth Transitions: When included, these clauses ensure that relationships can end in a structured manner, reducing the risk of disputes.
Relevance of Termination Clauses in Contracts
Termination clauses play a vital role in ensuring clarity on how and when a contract can be legally ended, thus preventing misunderstandings and disputes.
How Termination Clauses Prevent Disputes
A well-structured termination clause helps prevent disputes by clearly outlining the conditions under which the contract can be terminated. By establishing specific scenarios such as non-performance, breach of contract, force majeure or for mutual agreement, both parties understand their rights and obligations, reducing the risk of legal battles. This clear guidance helps avoid confusion and ensures that the end of a contract is handled fairly and predictably.
Importance in Managing Risks and Obligations
Termination clauses are essential to manage risks in contracts. They protect both parties from being locked into unfavorable agreements or suffering financial losses due to unforeseen circumstances. For example, if one party fails to meet their obligations, the termination clause offers a legal avenue to separate from the commercial relationship without breaching the contract. This minimizes potential damage to the business, whether by way of financial loss or reputational harm.
Influence on Contract Flexibility and Exit Strategies
A termination clause provides much-needed flexibility in contracts by offering a clear exit strategy. Businesses can adjust or end their contractual relationships without fearing legal consequences, provided the termination aligns with the agreed-upon terms. This flexibility is crucial in dynamic business environments where conditions can change quickly, and the ability to terminate a contract allows companies to adapt without long-term obligations.
Types of Termination Clauses in Contracts
Termination clauses in contracts provide clear terms for ending an agreement, protecting both parties from legal issues. There are several types of termination clauses, each with specific purposes and implications. Here are the most common types:
a. Termination for Convenience
Explanation: This clause allows one party to terminate the contract without providing a specific reason or cause. It is often used to offer flexibility in long-term contracts.
Typical Usage: Commonly found in government contracts, large-scale business agreements, and long-term partnerships where conditions may change over time.
Benefits: Provides flexibility for businesses to exit a contract when needs or priorities shift, allowing them to avoid being bound to unfavorable terms.
Challenges: Can be misused, leading to one-sided terminations or potential unfair treatment of the other party, especially if compensation for early termination is not properly addressed.
b. Termination for Cause
Explanation: Triggered when one party fails to meet specific contractual obligations, such as a breach of terms, non-performance, material issues such as negligence, gross misconduct or fraud, or other agreed-upon criteria.
Examples: Common triggers include non-payment, failure to deliver goods or services, breach of confidentiality provisions, failure to satisfy the terms of an employment relationship.
Importance of Defining “Cause”: Clarity in what constitutes “cause” leading to a breach or failure is critical to avoid disputes. Vague definitions can lead to legal battles and delays in enforcing the termination.
Legal Implications: The party terminating the contract must prove that “cause” was present, leading to the breach. Proper documentation and a clear process for addressing the breach are essential to avoid litigation.
c. Termination by Mutual Agreement
Explanation: Both parties agree to end the contract on terms that are mutually acceptable, often because the agreement is no longer necessary or beneficial.
Common Use: This is frequently used when both parties realize the business relationship is no longer advantageous and prefer to part ways amicably. A common example of such a clause is often seen in investment agreements, where the parties will typically agree to terminate the contract basis mutual agreement in the event that certain conditions cannot be fulfilled.
Benefits: A simplified and non-contentious process that allows the parties quick solution and where the costs and complications of dispute resolution can be avoided.
d. Automatic Termination Clauses
Explanation: The contract terminates automatically when specific predefined events occur without the need for further action by either party.
Examples: These events may include the death of a party, the dissolution of a company, or the completion of the contract’s objectives/duration of the contract.
Importance of Defining Triggering Events: Clearly specifying the events that will lead to automatic termination is essential to prevent confusion or disputes over whether the contract has ended.
Benefits: Such clauses ensure that once the objective/term of the contract has been achieved/completed, the parties do not need to take further steps to record their intent to terminate their arrangement.
e. Termination Due to Force Majeure
Explanation: This clause allows the termination of a contract when unforeseen or uncontrollable events prevent one or both parties from fulfilling their obligations.
Common Events: Natural disasters, war, pandemics (such as COVID-19), or significant government actions that impact the performance of the contract itself, are typical triggers for force majeure.
Significance: Including a force majeure clause in contracts is crucial for managing risks during global crises. It allows parties to exit contracts without penalties when extraordinary events make performance impossible.
Key Considerations When Drafting a Termination Clause
When drafting a termination clause in a contract, several critical factors must be carefully considered to ensure clarity, legal enforceability, and risk management. Here are the key considerations:
Clarity in Defining the Grounds for Termination
One of the most important aspects is clearly outlining the specific grounds for termination. Whether it’s termination for cause, convenience, or due to force majeure, the conditions must be unambiguous to prevent disputes. Clearly defining terms such as “material breach” or “failure to perform” will help both parties understand when termination is justified.
Notice Periods Required Before Termination
Including a well-defined notice period is essential. This provides the other party with sufficient time to rectify the issue or prepare for the termination. The notice period can vary depending on the type of contract and the reason for termination (e.g., 30 days’ notice for termination for cause, which may or may not include a timeline to cure the breach, or immediate termination for mutual convenience).
Consequences of Termination
Termination can lead to various consequences that should be addressed within the clause:
Compensation: Specify whether any financial compensation is due upon termination, particularly in cases of early termination.
Return of Goods: Include provisions for the return of physical goods, assets, or property that were exchanged during the contract.
Intellectual Property Rights: Clearly outline what happens to any intellectual property created or shared during the contract term.
Legal Enforceability and Compliance with Local Laws
It is vital to ensure that the termination clause complies with local laws and regulations, as termination rights can vary significantly across jurisdictions. Contracts must be legally enforceable in the applicable region to avoid issues in the event of a dispute. In India, this requires that the elements of a legally valid and binding contract as set out in the Indian Contract Act, 1872 must be satisfied.
Handling Disputes Arising from Termination
Even with a well-drafted termination clause, disputes can arise. This can typically be around the circumstances of the termination itself and consequently, provisions such as governing law and dispute resolution are deemed to survive the termination of the contract, in order to permit the parties to resolve the dispute and avoid prolonged legal battles.
Termination Clauses in a Contract Examples
Sample Image of Termination Clause
The Legal and Financial Implications of Contract Termination
Termination clauses in contracts come with significant legal and financial implications. Understanding these aspects is crucial to avoid costly disputes and ensure compliance with the terms of the agreement.
Legal Obligations of Both Parties After Termination
Once a contract is terminated, both parties have specific legal obligations they must fulfill. These may include the return of property, settling outstanding payments, or maintaining confidentiality. Failing to meet these obligations can result in legal action and penalties. It’s essential for contracts to outline post-termination duties clearly to ensure both parties comply with their legal responsibilities.
How Termination Clauses Impact Damages or Penalties
Termination clauses often address the potential for damages or penalties. For instance, if a party terminates the contract without meeting the agreed conditions, they may be liable for compensatory damages. Additionally, contracts may include penalty clauses for early or improper termination, which can lead to significant financial losses if not followed correctly. Clear language regarding these penalties helps mitigate financial risks and also aids in determining the liability of the parties vis-à-vis the termination of the contract.
Real-World Examples of Improper Termination Leading to Lawsuits or Financial Losses
Improper termination of contracts can lead to lawsuits, significant financial penalties, or reputational damage. For example, if a party terminates a contract without just cause or fails to follow the notice period, they can be sued for breach of contract. Real-world cases have shown that businesses that do not adhere to the terms of their termination clauses may face substantial financial losses, including compensating the other party for lost profits or operational disruption. This also presents a reputational risk, where the non-justifiable failure to honour the contract is seen as grounds for distrust in future dealings.
How to Handle Contract Termination Effectively
Handling contract termination effectively is essential for minimizing disruption to your business and maintaining good relationships with other parties. Here are key tips to ensure a smooth termination process:
Tips for Businesses to Navigate Contract Termination with Minimal Disruption
To avoid potential pitfalls, businesses should follow a structured approach when terminating a contract. Begin by reviewing the termination clause to ensure all conditions are met. Provide the required notice to the other party and plan for any transitional measures to minimize operational disruptions. Clear communication throughout the process helps prevent misunderstandings and maintains professionalism.
Importance of Consulting Legal Experts Before Terminating
Consulting a legal expert is crucial before terminating any contract. Legal advisors can help ensure compliance with the termination clause and local laws, preventing unintended breaches or legal challenges. They can also assist in understanding the financial and legal implications, such as penalties, compensations, or intellectual property rights, safeguarding your business from unnecessary risks.
Documentation and Communication During the Termination Process
Proper documentation is essential when handling contract termination. All communications related to the termination should be documented, including notices, emails, and formal letters. This ensures that you have a record of compliance with the terms of the contract. Clear and timely communication with the other party is key to preventing disputes and ensuring that both sides understand their responsibilities during and after termination.
Ensuring Smooth Transitions for Parties Involved After Contract Ends
A well-planned transition ensures minimal disruption after the contract ends. This may involve transferring responsibilities, returning assets, or settling outstanding payments. Businesses should coordinate with the other party to ensure a seamless handover of any obligations. Setting a clear timeline for post-termination tasks helps to ensure that both parties fulfill their remaining duties without delay.
Termination clauses are an essential component of any contract, providing clarity and security for both parties involved. By defining the conditions under which a contract can be legally ended, these clauses help prevent disputes, manage risks, and offer flexibility in evolving business relationships. Whether it’s termination for convenience, cause, or due to unforeseen events, well-drafted termination clauses ensure that the rights and obligations of each party are protected, allowing for smooth transitions when the contractual relationship comes to an end.
Ultimately, the importance of termination clauses lies in their ability to safeguard businesses from legal and financial repercussions. By working with legal experts to craft clear and enforceable termination provisions, businesses can avoid costly litigation, protect intellectual property, and ensure compliance with local laws. In today’s dynamic business environment, termination clauses offer a crucial exit strategy that maintains the integrity of both the contract and the business relationship.
Frequently Asked Questions (FAQs) on Termination Clauses in a Contract
What is a Termination Clause in a Contract? A termination clause defines the conditions under which a contract can be ended by either party. It outlines the grounds for termination, the required notice period, and any consequences that may arise.
Why is a Termination Clause Important in a Contract? A termination clause provides clarity and certainty for both parties, preventing disputes and ensuring that the contract can be ended legally and fairly if necessary.
What are the Most Common Grounds for Terminating a Contract? Common grounds for termination include:
Breach of Contract: If one party fails to fulfill their obligations under the contract.
Force Majeure: If an unforeseen event beyond the parties’ control makes it impossible to perform the contract.
Material Adverse Change: If a significant event occurs that negatively impacts the contract’s viability.
Insolvency: If one party becomes bankrupt or insolvent.
Mutual Consent: If both parties agree to terminate the contract.
What is a Notice Period in a Termination Clause? A notice period specifies the amount of time one party must give the other before terminating the contract.
What are the Consequences of Terminating a Contract? Consequences can vary depending on the specific circumstances, but they may include:
Payment of Termination Fees: If specified in the contract.
Return of Property: If property was transferred under the contract.
Confidentiality Obligations: If sensitive information was shared.
Dispute Resolution: If there is a disagreement about termination.
How Can a Termination Clause Protect Intellectual Property? A termination clause can include provisions to protect intellectual property rights, such as ownership, confidentiality, and non-compete agreements.
What is a Survival Clause in a Termination Clause? A survival clause specifies which provisions of the contract will continue to apply even after termination, such as confidentiality obligations or dispute resolution procedures.
How Can a Termination Clause Address Force Majeure Events? A termination clause can define what constitutes a force majeure event and outline the steps that must be taken by the affected party to mitigate the impact.
When Should I Consult a Lawyer About a Termination Clause? It’s always advisable to consult a lawyer when drafting or reviewing a contract, especially if the contract involves complex terms or significant financial stakes.
Can a Termination Clause Be Modified After the Contract is Signed? Yes, similar to how any contractual provision can be amended, a termination clause can be modified through a written amendment to the contract, but this requires mutual agreement from both parties.
In a significant development for foreign investors, the Delhi High Court recently delivered a landmark judgment in favor of Tiger Global, a Mauritius-based investment firm. The case centered around the sale of Tiger Global’s shares in Flipkart Singapore to Walmart and the applicability of tax benefits under the India-Mauritius Double Taxation Avoidance Agreement (DTAA).
The crux of the matter revolved around the Indian tax authorities’ attempt to deny Tiger Global treaty benefits by invoking the General Anti-Avoidance Rule (GAAR). This raised a critical question: can GAAR be used to negate treaty benefits for shares acquired before April 1, 2017, a date that marked significant changes to the India-Mauritius DTAA?
Background: The India-Mauritius DTAA and GAAR
The India-Mauritius DTAA is a tax treaty aimed at preventing double taxation on income earned by residents of either country in the other. This treaty provides benefits such as reduced or no withholding tax on capital gains arising from the sale of shares.
The General Anti-Avoidance Rule (GAAR), introduced in India in 2013, empowers tax authorities to disregard arrangements deemed to be artificial or lacking genuine commercial substance. The purpose is to prevent tax avoidance schemes that exploit loopholes in the tax code.
The Dispute: GAAR vs. Treaty Benefits
In this case, Tiger Global had acquired shares in Flipkart Singapore before April 1, 2017. This was crucial because the India-Mauritius DTAA offered more favorable tax benefits for pre-2017 acquisitions. However, when Tiger Global sold its shares to Walmart, the Indian tax authorities sought to apply GAAR, arguing that the investment structure was merely a tax avoidance scheme.
The Delhi High Court’s Decision
The Delhi High Court ruled in favor of Tiger Global, upholding its entitlement to treaty benefits under the DTAA. The Court’s reasoning rested on several key points:
Tax Residency Certificate (TRC): The Court acknowledged the Tax Residency Certificate (TRC) issued by the Mauritian government as sufficient proof of Tiger Global’s tax residency in Mauritius. This reaffirmed the importance of TRCs as evidence of tax residency in India.
Corporate Veil Principle: The Court recognized the legitimacy of complex corporate structures and upheld the “corporate veil principle.” This principle acknowledges that a company is a separate legal entity from its owners.
Beneficial Ownership: The Court examined the concept of “beneficial ownership” and concluded that Tiger Global, not a US-based individual, held the beneficial ownership of the shares. This countered the argument that Tiger Global was merely a “see-through entity” established solely for tax avoidance.
“Grandfathering Clause”: The Court considered the “grandfathering clause” within the DTAA, which protected pre-2017 investments from changes introduced after that date. This clause played a significant role in securing treaty benefits for Tiger Global.
Implications of the Decision
This landmark judgment has several significant implications for foreign investors in India:
Clarity on GAAR and Treaty Benefits: The Delhi High Court ruling provides much-needed clarity on the applicability of GAAR in relation to pre-2017 treaty benefits.
Importance of Tax Residency Certificates: The emphasis on TRCs as reliable evidence of tax residency reinforces the importance of obtaining these certificates from the relevant authorities.
Scrutiny of Complex Structures: While the Court upheld the “corporate veil principle,” it highlights that complex structures may still face scrutiny from tax authorities.
Looking Forward
The Delhi High Court’s decision is a positive development for foreign investors. It reinforces the sanctity of tax treaties and provides greater clarity on the role of GAAR in such scenarios. However, it is crucial to note that this is a single court judgment, and its interpretation by other courts and tax authorities remains to be seen.
Foreign investors operating in India should stay informed of evolving tax regulations and seek professional advice to ensure their investments comply with all applicable tax laws.
In recent years, a significant number of Indian startups have chosen to incorporate their businesses outside India, primarily in locations like Delaware, Singapore and other global locations. This trend, known as “flipping,” offered advantages like easier access to foreign capital and tax benefits. However, the tide is starting to turn. We’re witnessing a growing phenomenon of “reverse flipping,” where these startups are now shifting their bases back to India.
This shift back home is driven by several factors, including a booming Indian market, attractive stock market valuations, and a desire to be closer to their target audience – Indian customers. To further incentivize this homecoming, the Ministry of Corporate Affairs (MCA) has recently introduced a significant policy change.
MCA Streamlines Cross-border Mergers for Reverse Flipping
The MCA has amended the Companies (Compromises, Arrangements, and Amalgamations) Rules, 2016, to streamline the process of cross-border mergers. This move makes it easier for foreign holding companies to merge with their wholly-owned Indian subsidiaries, facilitating a smooth transition for startups seeking to return to their roots.
Key Takeaways of the Amended Rules
Here’s a breakdown of the key benefits for startups considering a reverse flip through this streamlined process:
Fast-Track Mergers: The Indian subsidiary can file an application under Section 233 read with Rule 25 of the Act. This rule governs “fast-track mergers,” which receive deemed approval if the Central Government doesn’t provide a response within 60 days.
RBI Approval: Both the foreign holding company and the Indian subsidiary need prior approval from the Reserve Bank of India (RBI) for the merger.
Compliance with Section 233: The Indian subsidiary, acting as the transferee company, must comply with Section 233 of the Companies Act, which outlines the requirements for fast-track mergers.
No NCLT Clearance Required: This streamlined process eliminates the need for clearance from the National Company Law Tribunal (NCLT), further reducing time and complexity.
The Road Ahead
The MCA’s move represents a significant positive step for Indian startups looking to return home. This policy change, coupled with a thriving domestic market, is likely to accelerate the trend of reverse flipping. This not only benefits returning companies but also strengthens the overall Indian startup ecosystem, fostering innovation and entrepreneurial growth within the country.
Prime Minister Narendra Modi’s recent launch of the IFSCA’s Single Window IT System (SWIT) marks a significant milestone for businesses looking to set up operations in India’s International Financial Services Centre (IFSC) at GIFT City. This unified digital platform promises to revolutionize the ease of doing business in this burgeoning financial hub.
What is the IFSC and Why is SWIT Important?
The International Financial Services Centres Authority (IFSCA) was established to develop a world-class financial center in India. Located in Gujarat’s GIFT City, the IFSC aims to attract international financial institutions and businesses by offering a global standard regulatory environment. However, setting up operations in the IFSC previously involved navigating a complex web of approvals from various regulatory bodies, including IFSCA itself, the SEZ authorities, the Reserve Bank of India (RBI), the Securities and Exchange Board of India (SEBI), and the Insurance Regulatory and Development Authority of India (IRDAI). This process could be time-consuming and cumbersome for businesses.
SWIT: Streamlining the Application Process
The SWIT platform addresses this challenge by creating a one-stop solution for all approvals required for setting up a business in GIFT IFSC. Here’s how SWIT simplifies the process:
Single Application Form: Businesses no longer need to submit separate applications to various authorities. SWIT provides a unified form that captures all the necessary information.
Integrated Approvals: SWIT integrates with relevant regulatory bodies – RBI, SEBI, and IRDAI – for obtaining No Objection Certificates (NOCs) seamlessly.
SEZ Approval Integration: The platform connects with the SEZ Online System for obtaining approvals from the SEZ authorities managing GIFT City.
GST Registration: SWIT facilitates easy registration with the Goods and Services Tax (GST) authorities.
Real-time Validation: The system verifies PAN, Director Identification Number (DIN), and Company Identification Number (CIN) in real-time, ensuring data accuracy.
Integrated Payment Gateway: Applicants can make payments for various fees and charges directly through the platform.
Digital Signature Certificate (DSC) Module: The platform enables users to obtain and manage DSCs, a crucial requirement for online submissions.
Benefits of SWIT for Businesses
The introduction of SWIT offers several advantages for businesses considering the IFSC:
Reduced Time and Cost: By consolidating the application process into a single platform, SWIT significantly reduces the time and cost involved in obtaining approvals.
Enhanced Transparency: SWIT provides a transparent and user-friendly interface that allows businesses to track the progress of their applications in real-time.
Improved Ease of Doing Business: This makes GIFT City a more attractive proposition for global investors and businesses.
Looking Ahead: The Future of GIFT City
The launch of SWIT is a significant step forward in positioning GIFT City as a leading international financial center. By streamlining the application process and promoting ease of doing business, SWIT paves the way for increased investment and growth in the IFSC. This, in turn, will contribute to India’s ambition of becoming a global financial hub.
The Indian startup ecosystem is a vibrant space brimming with innovation and potential. Fueling this growth engine are angel investors and angel funds, who provide crucial seed capital to early-stage startups. This article dives into the key regulations laid out by the Securities and Exchange Board of India (SEBI) for angel fund investments in India.
Eligibility for Angel Fund Investments
SEBI guidelines specify the kind of startups that are eligible for angel fund investments. Here are some key points:
Independent Startups: The company must not be promoted or sponsored by, or related to, an industrial group with a group turnover exceeding INR 300 crore.
Avoiding Familial Conflicts: Angel funds cannot invest in companies where there’s a family connection between any of the investors and the startup founders.
Investment Thresholds, Lock-in Period, Restrictions and Global Investment
SEBI regulations further outline the minimum and maximum investment amounts, along with a lock-in period:
Minimum Investment: Angel funds must invest a minimum of INR 25 lakhs (INR 2.5 million) in any venture capital undertaking.
Maximum Investment: The investment in any single startup cannot exceed INR 10 crore (INR 100 million). This encourages diversification across various promising ventures.
Lock-in Period: Investments made by angel funds in a startup are locked-in for a period of one year.
Restrictions on Investments: To ensure responsible investment practices, SEBI imposes specific restrictions:
Investing in Associates: Angel funds are not permitted to invest in their associates.
Concentration Risk: Angel funds cannot invest more than 25% of their total corpus in a single venture.
Global Investment Opportunities:While the focus remains on nurturing Indian startups, SEBI allows angel funds to invest in the securities of companies incorporated outside India. However, such investments are subject to conditions and guidelines stipulated by RBI (Reserve Bank of India) and SEBI. This flexibility allows angel funds to explore promising global opportunities while adhering to regulatory frameworks.
Unlisted Units: It’s important to note that units of angel funds are not permitted to be listed on any recognized stock exchanges. This is because angel investments are typically illiquid, meaning they are not easily tradable like publicly traded stocks.
SEBI regulations play a critical role in fostering a healthy and transparent environment for angel fund investments in India. These regulations attract investors, protect startups, and ultimately contribute to the growth of the Indian startup ecosystem.
In recent years, the global investment landscape has shifted dramatically, with sustainability becoming a central theme in financial markets. As nations and corporations commit to net-zero emissions, innovative financial instruments are emerging to facilitate this transition. One of the most promising of these instruments is Sovereign Green Bonds (SGrBs). Recently, the International Financial Services Centres Authority (IFSCA) in India introduced a scheme for trading and settlement of SGrBs in the Gujarat International Finance Tec-City International Financial Services Centre (GIFT IFSC), marking a significant step towards attracting foreign investment into the country’s green infrastructure projects.
Understanding Sovereign Green Bonds
SGrBs are debt instruments issued by a government to raise funds specifically for projects that have positive environmental or climate benefits. The proceeds from these bonds are earmarked for green initiatives, such as renewable energy projects, energy efficiency improvements, and sustainable infrastructure development. As global awareness of climate change grows, SGrBs are gaining traction as a viable investment option for those seeking to align their portfolios with sustainable development goals.
The Role of IFSCA
The IFSCA’s initiative to facilitate SGrBs in the GIFT IFSC is a strategic move that aligns with India’s commitment to achieving net-zero emissions by 2070. The GIFT IFSC has been designed as a global financial hub, offering a regulatory environment that supports international business and financial services. By introducing SGrBs, the IFSCA aims to create a robust platform for sustainable finance in India.
Key Features of the IFSCA’s SGrB Scheme
1. Eligible Investors
The IFSCA’s scheme allows a diverse range of investors to participate in the SGrB market. Eligible investors include:
Non-residents investors from jurisdictions deemed low-risk can invest in these bonds.
Foreign Banks’ International Banking Units (IBUs): These entities, which do not have a physical presence or business operations in India, can also invest in SGrBs.
2. Trading and Settlement Platforms: The IFSCA has established electronic platforms through IFSC Exchanges for the trading of SGrBs in primary markets. Moreover, secondary market trading will be facilitated through Over-the-Counter (OTC) markets.
3. Enhancing Global Capital Inflows: One of the primary objectives of introducing SGrBs in the GIFT IFSC is to enhance global capital inflows into India. With the global community increasingly prioritizing sustainable investment opportunities, India stands to benefit significantly from the influx of foreign capital. The availability of SGrBs provides a unique opportunity for investors looking to contribute to environmental sustainability while achieving financial returns.
The IFSCA’s introduction of SGrBs in the GIFT IFSC is a forward-thinking initiative that aligns with global sustainability goals. By facilitating access for non-resident investors and creating robust trading platforms, India is positioning itself as a leader in sustainable finance. As the world moves toward a greener future, the role of SGrBs will become increasingly important. For investors, these bonds not only represent a chance to achieve financial returns but also to make a meaningful impact on the environment.
The Department for Promotion of Industry and Internal Trade (DPIIT), Ministry of Commerce and Industry, is all set to unveil a revolutionary digital platform – Bharat Startup Knowledge Access Registry (BHASKAR) under the flagship Startup India program.
BHASKAR aims to bring together key stakeholders and address challenges in the entrepreneurial ecosystem.
With over 1,46,000 DPIIT-recognized startups in India, BHASKAR seeks to harness the potential by offering access to resources, tools, and knowledge.
It bridges the gap between startups, investors, mentors, and stakeholders, promoting interactions and collaborations.
By providing a centralized platform, BHASKAR facilitates quicker decision-making, scaling, and personalized interactions through unique BHASKAR IDs.
The platform is pivotal in driving India’s innovation narrative and fostering a more connected, efficient, and collaborative environment for entrepreneurship.
Key Features of BHASKAR
Networking and Collaboration: BHASKAR bridges the gap between startups, investors, mentors, and various stakeholders, enabling seamless interactions and collaborations across different sectors.
Centralized Access to Resources: By consolidating resources, BHASKAR provides startups with immediate access to essential tools and knowledge, facilitating faster decision-making and scaling.
Personalized Identification: Each stakeholder is assigned a unique BHASKAR ID, promoting personalized interactions and tailored experiences across the platform.
Enhanced Discoverability: With powerful search functionalities, users can effortlessly locate relevant resources, collaborators, and opportunities, leading to quicker decision-making and action.
BHASKAR: Pioneering the Future of India’s Startups
BHASKAR is poised to reshape India’s startup arena, fostering a more efficient, connected, and collaborative environment for entrepreneurship. The launch of BHASKAR underscores the Government of India’s commitment to catapulting India as a leader in global innovation, entrepreneurship, and economic growth.
Mumbai-based brand ‘Shaadi.com’ was launched in 1997 by Anupam Mittal and cousins, founders of People Interactive (India) Private Limited (“Company”). Since its introduction into the “matrimonial market”, the brand has become a prominent online matchmaking platform with international repute and presence. However, in early 2024, news broke about a messy legal battle between Anupam Mittal (by this time, serving as managing director for over 15 years) and WestBridge Ventures II Holdings, a Mauritius-based private equity fund (“WestBridge”), from whom the Company had secured funding in 2006. Spanning proceedings before courts in India and Singapore, the case is poised to become a landmark moment in the evolution of international arbitration law and intra-corporate disputes. Involving allegations of forced transfer to competitors and an expensive series of litigations, this dispute necessitates that potential investors and investee companies (and their founders) glean an understanding of the key takeaways.
Background of the Relationship between the Parties
Timeline
Event
1997
People Interactive (India) Private Limited (“Company”) founded and Mumbai-based “sagaai.com” launched by Anupam Mittal and family (“Founders”), offering an online matchmaking platform for Indians around the world.
2001
The platform is renamed to “Shaadi.com” and becomes the Company’s flagship brand. [1]
October 2004
Anupam Mittal appointed as Managing Director of the Company.
February 10, 2006
WestBridge Ventures II Holdings, a Mauritius-based private equity fund (“WestBridge”) invests INR 165,89,00,000 (Rupees One Hundred Sixty Five Crores Eighty Nine Lakhs) in the Company (“Investment”). Company, Founders and WestBridge sign a shareholders’ agreement. [2]
Parties agree on exit rights for WestBridge, which includes the following options:(i) an Initial Public Offering (IPO) to be completed within 5 years of closing;(ii) sale of WestBridge shares to third parties (excluding significant competitors);(iii) redemption or buyback provisions if the IPO was not completed within 5 years; and(iv) drag-along rights if the Company fails to buyback shares within 180 days of exercising the buyback option (“Drag Along”). If an IPO was not completed within 5 years, WestBridge could redeem all its shares and if necessary, “drag along” all other shareholders (including Founders) to sell their shares to a third party.
Parties agree in the SHA that:(i) the SHA is governed by the laws of India; (ii) any disputes arising from the agreement would be resolved through arbitration as per the International Chamber of Commerce Rules (“ICC”) with seat of arbitration in Singapore; and (iii) the enforcement of arbitration award would be subject to Indian laws.
2006
Consequent to the investment, WestBridge holds 44.38% and Anupam Mittal holds 30.26% of the shareholding of the Company.
2011
Contractually agreed period to complete IPO expires.
2017 – 2019
WestBridge seeks to exit the Company by allegedly entering into discussions to sell its shares to a direct competitor, Info Edge India Limited (“Info Edge”), owner of matchmaking platform ‘Jeevansathi’. [3]
Tensions between the parties continue, with alleged acts of oppression and mismanagement by WestBridge “facilitated” by other Founder directors [4], including a joint requisition to the Company to convene an extraordinary general meeting of the Company. The agenda for such meeting involves replacing Anupam Mittal as the managing director.
December 2020
WestBridge exercises its buyback option, requiring that the Company: (i) convert the 1,000 Series A1 preference shares into 580,779 equity shares; and then, (ii) effect a buyback of said equity shares. Company converts the preference shares, but is unable to offer the buyback price for the converted equity shares.
October 2021
WestBridge issues a drag-along notice compelling the sale of shares to a “significant competitor”, relying on the SHA which states that if the buyback could not be completed, the Drag Along rights would be triggered, which included the right to have the holding of the minority shareholders (including founders) liquidated and sold to any party without restriction.
Jurisdiction is Key – India v/s Singapore:
This dispute has highlighted significant challenges in cross-border legal disputes and the complexities of enforcing shareholder agreements in international fora. Despite litigation stretching on since 2021, the issue of oppression and mismanagement has yet to be ruled on, and the current issue before the courts is actually of: (i) jurisdiction, i.e., determining the competent authority to adjudicate on the SHA and allegations of oppression and mismanagement; and (ii) enforceability of foreign arbitration awards:
Singapore Jurisdiction: WestBridge argued that since the SHA stipulated that arbitration would be governed by International Chamber of Commerce (ICC) rules with Singapore as the arbitration seat, the dispute was to be heard and adjudicated in Singapore. The Singapore courts upheld this on the basis of: (i) the composite test, ruling that whether a dispute is arbitrable or not will be determined by the law of the seat as well as the law governing the arbitration agreement; and (ii) oppression/mismanagement disputes being arbitrable under Singapore law.
Indian Jurisdiction: Mittal argued that jurisdiction to hear issues of corporate oppression and mismanagement is exclusively vested with the NCLT under Sections 241-244 of the Companies Act, 2013 and are not arbitrable under Indian law, in accordance with Section 48(2) of the Indian Arbitration & Conciliation Act, 1996 (“A&C Act”), which is briefly excerpted below:
“Enforcement of an arbitral award may also be refused if the Court finds that—
(a) the subject-matter of the difference is not capable of settlement by arbitration under the law of India; or
(b) the enforcement of the award would be contrary to the public policy of India.
Explanation 1: For the avoidance of any doubt, it is clarified that an award is in conflict with the public policy of India, only if – (i) the making of the award was induced or affected by fraud or corruption or was in violation of section 75 or section 81; or (ii) it is in contravention with the fundamental policy of Indian law; or (iii) it is in conflict with the most basic notions of morality or justice.” (emphasis added)
It is crucial to note that the provisions of the A&C Act have been interpreted to limit the arbitrability of intra-company disputes and consequently, provide Mittal with the legal grounds to resist enforcement of the foreign arbitration award.
Implications of the Case
This case holds significant implications for corporate law, cross-border investments, and the arbitration landscape, particularly in the context of Indian startups and venture capital:
Jurisdiction Determination: The case emphasizes the importance of clearly defining jurisdiction in cross-border agreements, especially where legal disputes span multiple countries. The differing interpretations of arbitration clauses by Singapore and Indian courts underscore the complexities of jurisdictional overlaps.
Extent of Arbitration in Legal Disputes: The case explores the limits of arbitration, particularly concerning corporate governance issues like oppression and mismanagement. The contrasting legal positions in Singapore and India highlight the potential conflicts that arise when arbitration is attempted in disputes traditionally reserved for domestic courts.
Enforcement of Cross-Border Orders: The enforceability of foreign arbitration awards in domestic courts is a critical concern, especially when the awards conflict with local laws. The Bombay High Court’s observation that corporate oppression disputes are non-arbitrable under Indian law, thus rendering foreign awards unenforceable, could set a precedent for future cases.
Corporate Oppression and Minority Rights in India: The case brings to light the challenges of protecting minority shareholder rights in complex financial arrangements involving multiple jurisdictions. It illustrates the potential for exit mechanisms, such as drag-along rights, to be used in ways that might disadvantage minority stakeholders.
Adverse Impact on Shaadi.com
The crux of Anupam Mittal’s case is simple – if the Drag Along with sale of shares to a significant competitor is enforced, the impacts to the Company and the ‘Shaadi.com’ brand are adverse:
Control of the Company: If Info Edge or any other competitor were to purchase the shares sold as part of the Drag Along structure, this would open the path for them to acquire the majority shareholding in the Company, and could drastically alter the Company’s control dynamics. Currently, Anupam Mittal holds a 30% stake, while WestBridge controls 44.3%. With the consummation of the Drag Along sale, this could facilitate a takeover by such competitor and potentially diminish the Founder’s influence over the Company.
Business, Strategy and Culture: A shift in control/ownership could lead to a major restructuring of Shaadi.com’s strategic direction and operations. This might affect key business decisions, brand positioning, and market strategies. Additionally, a change in control could impact the Company’s culture and its relationships with stakeholders, including employees, customers, and partners.
Competition: As one of three prominent names in the online matchmaking platform industry (including ‘BharatMatrimony’ and ‘JeevanSathi’), any potential acquisition of the Company by a competitor would result in a potential acquisition of the ‘Shaadi.com’ brand absorbing the customer base and effectively, the market share held. This could not only result in a dramatic change in the existing market competition but potentially require strategic realignment within the industry.
Future Implications for Startups and Venture Capital Firms
For startups and venture capital (VC) firms, this case underscores several crucial lessons.
Lessons in Drafting: It is crucial that: (i) exit clauses and dispute resolution mechanisms be drafted with precision; and (ii) transaction documents include clearly outlined terms for various scenarios, including exits, buybacks, and drag-along rights, to prevent ambiguous interpretations and conflicts. Properly crafted agreements and well-defined dispute resolution processes can mitigate risks and facilitate smoother exits and transitions
Jurisdictional Issues: It is critical that arbitration provisions be aligned with the legal frameworks of all involved jurisdictions. This alignment helps avoid prolonged and expensive legal disputes that can arise when different legal systems have conflicting interpretations of agreements. Startups and VCs should also consider the implications of international arbitration clauses and ensure they are practical and enforceable across jurisdictions.
Preference for Singapore-seated arbitration: One of the key takeaways from this dispute is that differing principles of law governing arbitrability of a subject matter, would impact the enforceability of foreign awards in India. Given its reputation as an arbitration-friendly jurisdiction, Singapore is often designated as the seat of arbitration in investment and shareholder agreements. However, in light of this case it is crucial for parties to keep two elements in mind when negotiating an arbitration clause designating a foreign seat: (i) the law applicable to the arbitration agreement must be expressly stipulated to avoid any uncertainty; and (ii) the subject matter of the anticipated dispute should be arbitrable under both the law applicable to the arbitration agreement as well as the law of the seat.
Conclusion
The WestBridge vs. Shaadi.com dispute transcends a typical investor-company conflict and stands as a landmark case in corporate governance and cross-border legal disputes, with particular impact on arbitration law. It has the potential to reshape how shareholder agreements are interpreted and enforced, particularly in complex, multi-jurisdictional contexts. The outcome of this case is likely to set important precedents for the management of shareholder rights, dispute resolution, and arbitration processes in international investments, especially given the popularity of choice of Singapore as a seat of arbitration for foreign investors. It also sheds light on the intricate balance between protecting minority shareholder interests and upholding contractual agreements. The implications of this case extend beyond Shaadi.com, influencing future legal frameworks and practices for corporate governance and investor relations in the global business landscape.
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References:
[1] Article published in the business journal from the Wharton School of the University of Pennsylvania on May 11, 2012, accessible here. [2] NCLT Order on September 15, 2023, in Anupam Mittal v People Interactive (India) Private Limited and others, available here.
[3] Article published by Inc42 on September 05, 2024, accessible here. [4] Bombay High Court Judgement on September 11, 2023, in Anupam Mittal v People Interactive (India) Private Limited and others, available here.
The Companies Act, 2013 (the “Act”), has introduced significant changes to the rules governing application monies received by companies through private placement and preferential allotment of shares, aiming at enhanced transparency, protection of investor interests, and ensuring timely utilization of funds.
This article outlines the key provisions and implications of non-compliance regarding the refund of application monies under the Act.
Following the recent budget announcement, which aimed to simplify regulations for Foreign Direct Investment (FDI) and Overseas Investment (ODI), the Department of Economic Affairs has amended the FEMA (Non-debt Instruments) Rules 2019. A significant aspect of this amendment is the introduction of a new provision that enables FDI-ODI swaps. We have curated a slide below to help you understand this better.
Broad Mechanics
Foreign Company A holding shares in Foreign Company B.
Foreign Company A transferring shares of Foreign Company B to Indian Company.
Indian Company issuing its shares to Foreign Company A as consideration for acquiring shares of Foreign Company B.
Indian Company now permitted to acquire shares of a Foreign Company under ODI Rules via the swap route. i.e., Consideration for purchase of shares of Foreign Company B from Foreign Company A can be discharged by way of issuing its own equity shares to Foreign Company A.
𝘖𝘵𝘩𝘦𝘳 𝘢𝘮𝘦𝘯𝘥𝘮𝘦𝘯𝘵𝘴:
1. Investment by OCIs on non-repat basis 𝐞𝐱𝐜𝐥𝐮𝐝𝐞𝐝 from calculation of indirect foreign investment. Earlier only NRI investment was excluded.
2. Aggregate FPI cap of 49% of paid-up capital on a fully diluted basis has now been removed. FPIs now required to 𝐨𝐧𝐥𝐲 𝐜𝐨𝐦𝐩𝐥𝐲 𝐰𝐢𝐭𝐡 𝐬𝐞𝐜𝐭𝐨𝐫𝐚𝐥 𝐨𝐫 𝐬𝐭𝐚𝐭𝐮𝐭𝐨𝐫𝐲 𝐜𝐚𝐩.
3. ‘White Label ATM Operations’ has been recognized as a new sector, with 100% 𝐅𝐃𝐈 𝐧𝐨𝐰 𝐚𝐥𝐥𝐨𝐰𝐞𝐝 𝐮𝐧𝐝𝐞𝐫 𝐭𝐡𝐞 𝐚𝐮𝐭𝐨𝐦𝐚𝐭𝐢𝐜 𝐫𝐨𝐮𝐭𝐞.
Key Indian players in this sector: India1 Payments, Indicash ATM (Tata Communications), Vakrangee, and Hitachi Payments.
4. NR to NR transfer will require prior Govt approval 𝐰𝐡𝐞𝐫𝐞𝐯𝐞𝐫 𝐚𝐩𝐩𝐥𝐢𝐜𝐚𝐛𝐥𝐞. In the erstwhile provisions, it was required only if investment in the specific sector required prior Govt approval.
5. Definitions – Control now defined in Rule 2, and definition of “startup company” has been aligned with “startups” recognised by DPIIT vide notification dated February 19, 2019. Definitions of “control” and “startup company” elsewhere have been deleted.
The IFSCA issued a consultation paper yesterday proposing an “informal guidance” framework, summarized below:
Who can request:
Existing players in IFSCA
Persons intending to undertake business in IFSC
Others as may be specified
Types of guidance:
No-Action Letters: Request IFSCA to indicate whether or not it would take any action if the proposed activity/ business/ transaction is carried out
Interpretive Letters: Request for IFSCA’s interpretation of specific legal provisions
Process:
Application fee: USD 1,000
IFSCA aims to respond to requests within 30 days
The consultation paper invites stakeholders / public to submit feedback by September 10, 2024 via email This is a proactive approach by the IFSCA to foster transparency and provide support to entities operating or looking to operate within the IFSC, ensuring that they have the necessary guidance to comply with the evolving regulatory landscape.
The Reserve Bank of India has updated its Master Directions on Foreign Investment in India (FED Master Direction No.11/2017-18) as of August 08, 2024, introducing key definitions and clarifying various provisions.
Among these updates, the validity of the Valuation Certificate is particularly noteworthy.
Loan from Directors or Relatives and Compliances involved
In urgent situations, companies often seek to quickly augment their working capital by sourcing funds from their Directors in the form of loans. This approach provides a rapid solution for meeting immediate financial needs. However, it is crucial to ensure that such transactions comply with the provisions outlined in the Companies Act, 2013 (the “Act”).
Key Compliance Points
01. Board Approval Required According to Section 179(3)(d) of the Act, any loan from Directors or their relatives must be approved by a formal Board resolution. This means that the company must convene a Board Meeting and pass a resolution authorizing approval of these loans.
02. Declaration of Source of Funds Under Rule 2(c)(viii) of the Companies (Acceptance of Deposits) Rules, 2014 (“Deposit Rules”), the Director or their relatives must provide a declaration stating that the funds are not sourced from loans or deposits accepted from other parties.
03. Permissible Loans The Deposit Rules outline specific conditions for permissible loans that are not classified as deposits. Compliance with these conditions is crucial to ensure proper categorization and regulatory adherence.
04. Disclosure in Financial Statements and Director’s Report Any loans received must be appropriately disclosed in the notes to the Financial Statements and the Director’s Report, ensuring transparency and compliance with regulatory requirements.
A Wholly Owned Subsidiary (WOS) is a company whose entire share capital is held by another company, known as the holding or parent company. The process of incorporating a wholly-owned subsidiary in India is governed by the Companies Act, 2013. The application is processed by the Central Registration Centre (CRC), Ministry of Corporate Affairs.
Prerequisites for setting up a WOS (Private Company) in India
Holding Company to pass a resolution authorising the setup of a WOS in India and identifying the proposed name(s); paid up capital and authorised signatories / nominees of the WOS
Check if RBI/Government approval is required for receiving Foreign Direct Investment (FDI) Identify minimum 2 directors, 1 of whom shall be a Resident Director
Identify an Authorised Representative on behalf of Holding Company to sign documents to be submitted for incorporation
Identify a Nominee Shareholder of the Holding Company who will hold minimum shares in the WOS on behalf of the Holding Company
While ODI offers opportunities for persons resident in India to expand their market reach in bona fide businesses, access new resources, and achieve economies of scale, it also comes with significant challenges that can affect the success of such investments.
Key challenges and recommendations
● Identification of First Subscriber of Foreign Entity: First subscribers to be identified at the time of incorporation of the foreign entity, to avoid additional undertakings by CA/CPAs.
● Documentation to entail recent Forex Rate: Check with your AD bank at what rate the transaction will go through. Exchange rate volatility can affect the value of investments and returns when converted back to INR and AD banks usually insist on putting recent dates in all their documents.
● Certification Complexity: Obtaining various certifications from Chartered Accountants to verify investment limits, source of funds, and compliance with both Indian and foreign regulations adds to administrative burden. Bankers typically require Audited Financials not older than six (6) months or CA Certified provisional statements and interim reports in addition to Section E certification & host country compliances certification.
● Financial commitment Cap: Financial commitments of an Indian Entity must not exceed 400% of the net worth from the latest audited balance sheet (within 18 months) or USD 1 billion per year, whichever is lower. Resident individuals can invest in equity capital up to the Liberalized Remittance Scheme limit of USD 250,000 annually.
● Deferred Payment Agreement (DPA): Mandatory requirement if securities are not subscribed to immediately upon incorporation of Foreign Entity.
● Submission of Evidence of Investment: Share certificate to be submitted as a proof of investment within six months of the generation of UIN.
● Permissibility of ODI in specific cases: If there are outstanding reports or submissions such as APR, Share Certificate, Foreign Liabilities & Assets (FLA), LSF payment for that Foreign Entity, ODI will not be permitted.
● All ODIs under the same UIN: All future ODIs must be processed through the same AD Bank that issued the UIN. Transactions through a different AD Bank are only possible after transferring the UIN, which is a complex and cumbersome process.
Conclusion
Foreign Exchange Management (Overseas Investment) Directions, 2022 (dated August 22, 2022) offers Indian companies significant opportunities for growth and expansion. However, the process is complex and requires careful navigation of legal, regulatory, and financial challenges.
Success in overseas investment requires careful planning and a good grasp of both Indian and international regulations. Overall, the ODI process requires meticulous planning, adherence to regulatory requirements, and coordination between various stakeholders.
Therefore, Indian businesses looking to venture abroad must engage with legal and financial experts who can guide them through these challenges, ensuring compliance with all relevant regulations and maximizing the potential return on their investments. With the right strategy, businesses can seize global opportunities, minimize risks, and expand their international footprint.
The Union Budget 2024, announced on July 23, 2024, proposed a significant change in the long-term capital gains tax regime. The long-term capital gains tax rate is set to be reduced from 20% to 12.5%. However, this proposal included removal of the indexation benefit for long-term capital gains on the sale of assets, including real estate.
Initially, this removal of indexation benefit was to apply to properties acquired after 2001. In a relief to real estate owners, it has now been proposed to extend the option of availing indexation benefit to properties purchased until July 23, 2024.
Taxpayers selling property purchased before July 23, 2024 will have two options to compute their long term capital gains tax:
– Continue under the old tax regime : Pay a 20% long-term capital gains tax with the indexation benefit
– Opt for the new tax regime: Pay a lower tax rate of 12.5% without any indexation benefit
But what happens in case of a long term capital loss? Will the loss on account of indexation benefit be allowed to be carried forward? Let us know your thoughts in the comments below or reach out to us at [email protected] for a detailed discussion.
The International Financial Services Centres Authority (IFSCA) has proposed amendments to the FME Regulations to introduce a Platform Play framework, discussed below:
What?
Fund Management Entities (FMEs) operating in GIFT IFSC may extend their fund management platforms to other clients.
Who?
All FMEs registered with IFSCA can manage schemes (funds) for other clients, up to an AUM of USD 10 million per fund.
How?
– Adequate disclosures in offer documents
– Appointment of distinct Principal and Compliance Officers for each strategy.
– Implementation of a comprehensive risk management framework.
– Regular internal audits and reviews.
– A robust mechanism to address investor complaints and disputes.
– Operational independence for each strategy.
Why?
This framework draws inspiration from the Luxembourg ManCos model, managing more than EUR 100 bn in AUM, where investment funds are managed on behalf of others, handling key tasks such as portfolio management, risk control, compliance, and investor relations.
The proposed Platform Play framework will allow fund managers to explore opportunities in GIFT IFSC by using the platform of an existing FME. Additionally, this framework offers existing FMEs the opportunity to expand their service offerings to other funds.
General public and stakeholders are requested to forward their comments/suggestions on this framework on or before August 26, 2024.
What do you think of this? Reach out to us at @[email protected] for a deeper discussion or leave a comment below.
1. Who is a Company Secretary? 2. Appointment criteria as per the Companies Act, 2013. 3. Penalties for non-compliance. 4. Key insights and compliance tips.
Circular resolutions, as per Section 175 of the Companies Act, 2013, allow the Board of Directors to make urgent decisions without formal meetings. This method is quick, efficient, and essential for time-sensitive matters.
Key Points:
1. Process: Circulate the draft to all directors via hand delivery, post, or electronic means. 2. Approval: Resolution passes with majority approval. 3. Exclusions: Certain significant decisions like issuing securities or approving financial statements must be made in formal meetings.
Our latest document provides comprehensive insights into the various types of meetings mandated by the Act, including the crucial first board meeting for private companies.
Key topics covered include: 1. Board Meetings 2. Annual General Meetings (AGM) 3. Extraordinary General Meetings (EGM) 4. First Board Meeting for Private Companies
We’re thrilled to share the remarkable growth in fund management activities at GIFT-IFSC! Our latest infographic highlights the significant increase in the number of FMEs and funds, investment commitments, and quarterly growth. This impressive surge underscores the expanding scale and acceptance of GIFT-IFSC as a premier fund management hub.
At Treelife, we believe that financial literacy is the cornerstone of business success. Understanding key financial concepts can empower you to make informed decisions and drive your business forward. We’ve created this post to help you get familiar with 10 essential financial terms that every professional should know.
Swipe through to enhance your financial knowledge!
We at Treelife have compiled a guide to help you manage the process of the intricate landscape of share transfers efficiently and comply with the legal requirements under The Companies Act, 2013, and The Foreign Exchange Management Act, 1999.
Key Highlights:
1. Form SH-4 Submission 2. Board and RBI Approvals 3. Documentation
Navigating the startup ecosystem can be a daunting task, especially for new entrepreneurs trying to turn innovative ideas into viable businesses. Understanding key terms and concepts in the startup world is essential for anyone aiming to succeed in this dynamic environment. Here, we break down some of the most important terms that every startup founder, investor, and enthusiast should be familiar with.
1. Product-Market Fit: This term refers to the degree to which a product satisfies a strong market demand. Achieving product-market fit is crucial for the success of any startup, as it signifies that the product meets the needs of the target audience. An example of this is Zomato, which successfully identified the need for a reliable platform for restaurant discovery and food delivery, thereby catering to the urban consumer’s demand for convenience and variety.
2. Minimum Viable Product (MVP): MVP is the simplest version of a product that can be launched to test a new business idea and gauge consumer interest. The goal is to validate the product concept early in the development cycle with minimal investment. Paytm is a prime example, initially launching as a simple mobile recharge platform before expanding into a full-fledged digital wallet and financial services provider.
3. Go-To-Market Strategy: This strategy outlines how a company plans to sell its product to customers, including its sales strategy, marketing, and distribution channels. It is essential for effectively reaching and engaging the target market. For instance, a well-known ride-hailing company used aggressive marketing and deep partnerships with banks and manufacturers to penetrate the Indian market by offering significant discounts and loans to drivers.
4. Customer Acquisition Cost (CAC): CAC is the total cost incurred by a company to acquire a new customer, including expenses related to marketing, advertising, promotions, and sales efforts. It is a critical metric for assessing the efficiency of a startup’s customer acquisition strategies. According to a 2022 report by IMAP India, the average CAC for Indian startups across various sectors is approximately ₹1,200-1,500.
5. Lifetime Value (LTV): LTV represents the total revenue a business can expect from a single customer account over the entirety of their relationship with the company. For instance, Swiggy evaluates LTV through its Swiggy One membership, analyzing factors such as average order value, order frequency, and subscription renewals to determine the enhanced value brought by members compared to typical customers.
6. Freemium Model: This business model offers basic services for free, with advanced features or functionalities available for a fee. LinkedIn is a prominent example, providing free networking services while offering premium subscriptions for enhanced job search features and LinkedIn Learning.
7. Runway: The runway is the length of time a company can continue operating before needing additional funding, based on its current cash reserves and burn rate. For instance, Unacademy recently made financial adjustments that reduced its cash burn by 60%, securing a financial runway of over four years.
8. Burn Rate: Burn rate refers to the rate at which a company spends its cash reserves or venture capital to cover operating expenses before achieving positive cash flow. Monitoring burn rate is crucial for ensuring a startup’s long-term sustainability. A notable example is WeWork, which in 2018 lost $1.6 billion despite generating $1.8 billion in revenue, indicating a burn rate that far exceeded its ability to generate profit.
9. Fundraising: This is the process of securing financial investments from investors to support and expand business operations. A significant example is Flipkart’s $2.5 billion investment in August 2017, which played a critical role in scaling its operations and strengthening its position in the competitive e-commerce market against global players like Amazon.
By understanding these essential terms, startup founders can better navigate the complexities of the entrepreneurial landscape, make informed decisions, and increase their chances of building a successful business.
The ‘transaction flow’ refers to the various stages involved in a Company obtaining funding from an Investor. Given that this imposes numerous obligations on the Company and the Founders, it becomes critical for Founders to have a clear understanding of the steps involved in receiving funding from an Investor. However, fledgling startups often find the complex terms involved overwhelming and are thus unable to gain a clear picture of the process flow involved in raising funding.
Important Steps
Term Sheet – a non-binding agreement that outlines the basic terms and conditions of the transaction.
Transaction Documents – refers to the agreements required to be entered into between the parties to lay down the governing framework of the investment. This would typically take the form of a securities subscription agreement (“SSA”) and a shareholders’ agreement (“SHA”), or a variation of the same known as a securities subscription and shareholders’ agreement (“SSHA”). These agreements will contain detailed language on the nature of each party’s rights and obligations under the contract and will be binding on the parties.
Execution – refers to the stage where the parties actually sign and ‘execute’ the Transaction Documents, validating the same and binding the parties to the terms agreed.
Conditions Precedent – refers to the conditions required to be completed by the Company and/or Founders to the Investor’s satisfaction before the investors wire the funds to the Company’s bank account (also referred to as Closing). The conditions precedent shall be completed in parallel with execution of transaction documents so that there is no delay in Closing.
Closing – refers to the stage at which the funds are received by the company and securities are allotted to the Investors.
Conditions Subsequent – refers to the conditions required to be completed by the Company and/or Founders after Closing, typically include conditions arising out of due diligence of the company and other compliance related steps.
The ‘Transaction Flow’ – A Founders’ perspective
Important Terms
Points to bear in mind for Founders
Term Sheet
A Term Sheet helps layout the structure for the Transaction Documents and can help establish the negotiated position on critical terms early in the process, which in turn, enables a quick flow from drafting and vetting of agreements to Execution. Term Sheets are non-binding and the terms, although not advisable, but, can vary in the transaction documents.
Due Diligence
A due diligence exercise reviews the records maintained by the Company to ascertain whether the Company’s operations are in accordance with the applicable law. The findings are then highlighted to the Investors basis the magnitude of risk involved in a due diligence report.
Typically, startups have trouble ensuring the secretarial compliances prescribed under Companies Act, 2013 (and relevant rules thereunder) or compliances prescribed under labour legislations, and rectifying the same is made a Condition Precedent or a Condition Subsequent. This would vary from Investor to Investor, based on how risk averse they are.
Transaction Documents
In the event that the Company has already completed previous round(s) of funding, Founders must pay heed to the rights of existing Investors and ensure that the appropriate waiver of rights (as applicable) is captured in the agreements. Further, in case of an existing SHA with Investors from earlier rounds of funding, the parties would execute an amendment to SHA or a complete restated SHA, which would be signed by all shareholders of the Company, in addition to the incoming Investors. Consequently, the transaction documents would require consensus of terms from both existing and incoming Investors.
It is also important to note that employment agreements between the Founder(s) and the Company (sometimes prescribing specific conditions of employment by Investors) are often made part of this stage.
Execution
Every agreement would require payment of stamp duty to the competent state government. The duty payable varies from state to state and agreement to agreement, and is either a fixed value or a percentage (%) value of the investment amount (i.e., the ‘consideration’). The Stamp papers are required to be procured prior to the execution of the transaction documents.
Execution can be done through either wet ink or digital signatures.
Conditions Precedent
This usually encompasses a variety of obligations on the Company/Founders. Typically, completion of this stage is marked by a “Completion Certificate” issued by the Company.
We can broadly categorise Conditions Precedent into two headings: (a) statutorily mandated conditions; and (b) Investor mandated conditions.
Statutorily mandated conditions – this would include actions such as passing board and shareholders’ resolutions for increasing authorised capital of the Company and issuance of shares, circulation of offer letters and filing the legally mandated forms for private placement of securities (such as SH-7, MGT-14), procuring requisite valuation reports, et al.
Investor mandated conditions – this would typically arise from a due diligence exercise undertaken by the Investors of the Company. Legal and/or financial issues in the operations of the Company would be actioned for resolution here. However, based on the regulatory requirements applicable to a foreign Investor, sometimes satisfaction of certain compliances that would ordinarily be undertaken later, are included in this stage.
Closing
This stage is marked by movement of funds from the Investors and related compliances to be undertaken under law/the Transaction Documents to complete the allotment of securities, such as: filing of PAS-3, issue of share certificates, amending the articles of association, compliance with Foreign Exchange Management Act, 1999 (including filing form FC-GPR reporting the remittance received), appointment of directors, etc.
It is critical to understand that this is the stage at which the Investors actually become shareholders of the Company.
Conditions Subsequent
Conditions subsequent are usually required to be completed within a specific period after the Closing Date (i.e., the date on which Closing takes place).
These can include items such as amendment of articles of association and memorandum of association of the Company or even statutory filings (such as under Companies Act, 2013 or Foreign Exchange Management Act, 1999). However, this can also include special items mandated by the Investors such as appointment of a labour law consultant or privacy law consultant to ensure that the Company is in compliance with applicable laws that might be too complex for the Founders to navigate without professional expertise.
Conclusion
It is important to realise that every Investor is different and therefore the ‘transaction flow’ can look different for two different rounds of funding for the same Company. The above terms are simplified for Founders to gain an understanding of what to expect when preparing to raise funding. Founders who are aware of the intricacies involved in raising funding can:
be better prepared in structuring the round;
gain an understanding of the ancillary costs roughly involved; and
negotiate a position that allows for the completion of certain action items in a manner that does not cause significant financial strain or undue delay in reaching the Closing stage.
Reach out to us at [email protected] to discuss any questions you may have!
The Limited Liability Partnership Act, 2008 (LLP Act) has truly transformed how businesses operate in India, offering the best of both worlds by combining the benefits of companies and partnership firms. One fantastic feature of the LLP Act is its broad definition of “business”.
According to section 2(e) of the LLP Act, “Business” covers every trade, profession, service, and occupation, except for those activities the Central Government specifically excludes through notifications. This expansive definition shows off just how flexible and adaptable the Limited Liability Partnership (LLP) structure is, making it a great fit for all sorts of business activities.
But hey, setting up an LLP comes with its own set of rules, especially for certain sectors. If you’re in banking, insurance, venture capital, mutual funds, stock exchanges, asset management, architecture, merchant banking, securitization and reconstruction, chit funds, or non-banking financial activities, you gotta get that in-principle approval from the relevant regulatory authority.
Investment activities fall under non-banking financial activities, so if an LLP wants to jump into the investment game, it needs the thumbs up from the Reserve Bank of India (RBI).
RBI’s Stance on LLPs Engaging in Investment Business Activities
The RBI, the big boss of financial and banking operations in India, keeps a close eye on non-banking financial activities to make sure they play by the rules and keep the financial system rock solid.
When it comes to setting up entities with a main gig in investment, India has some pretty tight regulations, all under the watchful eye of the RBI.
This is super important for Limited Liability Partnerships (LLPs) looking to jump into the investment game. The RBI’s guidelines, along with the Reserve Bank Act, 1934, lay down the law on who can get in and what they need to do to stay legit in the world of non-banking financial activities, including investment business.
Key Provisions of the Reserve Bank Act, 1934
Defining: Business of Non-Banking Financial Institution:
Section 45-I (a) of the RBI Act, 1934
“Business of a Non-Banking Financial Institution” means carrying on of the business of a financial institution referred to in clause (c) and includes business of a non-banking financial company referred to in clause (f);
Defining: Non-Banking Institution and Financial Institution
Section 45-I (e) of the RBI Act, 1934
Non-Banking Institution has been defined as a “Company, Corporation, or Co-Operative Society”
Section 45-I (c) of the RBI Act, 1934
Financial Institution” means any non-banking institution which carries on as its business or part of its business any of the following activities, namely: —
The financing, whether by way of making loans or advances or otherwise, of any activity other than its own;
The acquisition of shares, stock, bonds, debentures or securities issued by a government or local authority or other marketable securities of a like nature;
*The definition is very exhaustive so we have kept it limited to our topic
Defining: “Non-Banking Financial Company’’
Section 45-I (f) of the RBI Act, 1934
‘‘Non-Banking Financial Company’’ Means–
(i)A financial institution which is a company;
(ii)A non-banking institution which is a company, and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner;
(iii)Such other non-banking institution or class of such institutions, as the bank may, with the previous approval of the central government and by notification in the official gazette, specify;
Mandates by the RBI
Section 45-IA of the RBI Act, 1934
This section mandates that no non-banking financial company shall commence or carry on business without:
Obtaining a certificate of registration from the RBI.
Maintaining a net owned fund of at least twenty-five lakh rupees or as specified by the RBI, up to two hundred lakh rupees.
Implications for LLPs
Given the definitions and requirements stipulated by the Reserve Bank Act, it becomes clear that the RBI’s regulatory framework is tailored to companies as defined under the Companies Act, 2013. This specific requirement means that only entities registered as companies under the Companies Act, 2013, are eligible for registration with the RBI to conduct non-banking financial activities, including investment businesses. Here are some of the reasons as to why the LLPs are in-eligible for carrying on the business of Investment Activities:
Legal Structure: LLPs, while flexible and beneficial for many business activities, are distinct from companies in their legal structure and registration under the LLP Act, 2008.
Regulatory Compliance: The RBI’s regulatory provisions explicitly require the registration of non-banking financial companies (NBFCs) to be entities formed under the Companies Act. This ensures that such entities adhere to the rigorous compliance, reporting, and governance standards applicable to companies.
Notification and Specificity: The RBI, through its notifications and the provisions of the Reserve Bank Act, explicitly delineates the types of entities that can engage in non-banking financial activities. LLPs do not meet these criteria due to their differing legal status and operational framework.
Conclusion
In summary, while the LLP Act, 2008, provides a robust framework for various business activities, it falls short when it comes to non-banking financial activities, specifically investment businesses. The RBI’s regulations necessitate that only companies registered under the Companies Act, 2013, are eligible for registration and approval to operate as NBFCs. Therefore, LLPs cannot be registered as NBFCs for the purpose of carrying out investment activities. This clear demarcation ensures that the financial sector remains regulated and compliant with the highest standards set forth by the RBI, maintaining the stability and integrity of the financial system.
Rights issue is a process of offering additional shares to the existing equity shareholders (“Shareholders”) of the Company at a pre-determined price which is generally lower than the market value of shares. The concept of a rights issue stands out as a significant mechanism for raising capital. One unique feature of a rights issue is providing the right to shareholders to renounce the shares offered to them in favour of any other person who may or may not be an existing shareholder of the Company. This article explores the process and implications of rights issue by way of renunciation under the Companies Act, 2013.
Overview
Rights issue helps companies raise additional capital while giving preference to current shareholders. The key points regarding a rights issue under the Companies Act, 2013, includes:
Proportionate Allotment: Shares are offered to existing shareholders in proportion to their current holdings.
Price: Typically, shares are offered at a price lower than the prevailing market price or at any price decided by the Board of Directors of the Company.
Fixed Time Frame: Shareholders are given a specific period to exercise their rights (minimum 7 days to maximum 30 days).
Provisions for Renunciation:
The Companies Act, 2013 outlines the procedures for rights issue and renunciation.
Section 62 of the Companies Act, 2013 governs the rights issue and Section 62(a)(ii) permits the renunciation of these rights in favour of any other person.
Procedure for Renunciation
The process of renunciation involves several steps:
Offer Letter: Anoffer letter is circulated to existing shareholders with details on the rights issue, including shares offered, price, terms, offer period, and options to accept or waive or renounce.
Acceptance or Renunciation: Shareholders are given the option to either partially or wholly renounce their rights. To renounce their rights, shareholders must submit the renunciation form within the stipulated time.
In case the shares are renounced to foreign investors, the Company will need a valuation report.
Subscription by Renouncee: The new holder (renouncee) can subscribe to the offered shares by paying the requisite amount.
Allotment: The Board allot the shares to the renouncee after receiving acceptance letter and payment.
Conclusion
The rights issue mechanism under the Companies Act, 2013, with its provision for renunciation, provides a balanced approach for companies to raise capital while offering flexibility to shareholders. By understanding and effectively utilizing these provisions, companies can enhance their financial strategies, and shareholders can make informed decisions to optimize their investment portfolios. The renunciation process, governed by clear legal guidelines, ensures transparency and efficiency, contributing to the overall stability and growth of the capital markets in India.
Looking at the title above, the meaning of same may not be clear because it includes two technical terms:
General Meeting
Shorter Notice
So, what is a General Meeting?
Going by the technical terms, a General Meeting is defined as a “a duly convened, held and conducted Meeting of Members”. In common words, a General Meeting is a gathering where the Shareholders of a Company meet to discuss and take decisions on important matters concerning the Company.
and what is a shorter notice?
Further, as per the provisions of Section 101(1) of Companies Act, 2013, a General Meeting may be called by giving a notice of 21 clear days (meaning the day of sending the notice and the day of the meeting are excluded from calculation of 21 days). Any notice not confirming with above requirement is a shorter notice.
However, MCA has granted a special exemption for Private Limited Companies in this case through its notification dated June 5, 2015. These companies can have a notice period shorter than 21 clear days, provided their Articles allow for it.
A General Meeting may be called at shorter notice if consents for the same have been received from the required number of shareholders in writing or in electronic mode, as further explained below:
Type of Meeting
Annual General Meeting (In general terms, the meeting where annual financial statements are approved by Shareholders)
Other General Meetings
Consent Required
Atleast 95% of the members entitled to vote at the meeting
Majority of Voting Members
Holding not less than 95% of the Paid-up Share Capital that gives Right to Vote
Are we required to file the above consents for shorter notice anywhere?
There is no legal provision that necessitates the requirement to file the consents of members with the registrar for holding a meeting at shorter notice. However, a recent adjudication order no. ROCP/ADJ/Sec-101(1)/(JTA(B)/24-25/17/422 to 425 issued by the Registrar of Companies, Pune on May 28, 2024, highlighted a case where a company filed a resolution in Form MGT-14 without furnishing consents of members for shorter notice. The officer concluded this omission as a default under Section 101(1) of the Companies Act, 2013, treating it similarly to holding a General Meeting at shorter notice without proper consent from members.
Consequently, a penalty of Rs. 3,00,000 (Three Lakh Rupees) was imposed on the company and its directors
Therefore, it is advisable to attach these consents with Form MGT-14 when filing a resolution passed at such a meeting.
A health-tech company operating a digital clinic under the brand name ‘Proactive For Her’, providing a digital platform to offer accessible, personalized, and confidential healthcare solutions for women.
Project Undertaken
Review of accounting records and tax filings on a monthly basis
Compliance assistance for fundraising
How We Helped?
Review of Accounts and Tax Filing:
Treelife conducted a thorough review of the monthly accounting books to ensure accuracy and completeness, helping the company maintain precise financial records.
We ensured GST payments and returns were filed timely and accurately, reducing the risk of non-compliance and potential penalties for the company.
Our team streamlined and regularized tax returns, annual filings, and other statutory compliances according to applicable due dates, ensuring the company met all regulatory requirements promptly.
Fundraising (Compliance Advisor):
Treelife provided compliance advisory services for the company’s fundraising efforts, ensuring that all financial records and compliance requirements were up-to-date.
We assisted with the timely updating of accounting entries and filings, completing requisite regulatory compliances efficiently.
Our involvement ensured a reduction in the turnaround time (TAT) for payments and MIS processing, facilitating smoother financial operations and improved investor confidence.
By leveraging our expertise in financial and compliance advisory, Treelife enabled ‘Proactive For Her’ to maintain accurate financial records, meet all compliance requirements, and support its fundraising activities. Our comprehensive support helped the company focus on its core mission of providing accessible and personalized healthcare solutions while ensuring robust financial and compliance management.
Treelife played a pivotal role in helping an Indian private limited company transition to a US-headquartered structure. By setting up an LLP in India and guiding the investment process under the ODI route, we ensured compliance with FEMA and income-tax regulations. Our strategic approach enabled the company to raise funds from foreign investors and expand globally with minimal tax implications.
Business Overview
Indian individual promoters had established a private limited company in India and sought to expand their business globally. They aimed to raise funds from foreign investors and transition to a US-headquartered structure.
Project Undertaken
Setting up an LLP in India
Investment in a newly incorporated US entity under the ODI route
Acquisition of Indian entity shares by the US entity from the promoters
Structure Mechanics:
Indian individual promoters set up an LLP in India.
The LLP makes investments in a newly incorporated US entity under the ODI route.
The US entity acquires the shares of the Indian entity from the promoters, adhering to FEMA and income-tax regulations.
A benchmarking study is undertaken for all ongoing transactions between the US entity and the Indian entity.
Parameters:
The gift structure used under the erstwhile ODI rules was no longer possible, as Indian resident founders can now receive gifts of shares from their relatives.
Recently revamped ODI rules by RBI do not permit a foreign company to set up an Indian subsidiary where the Indian promoters control such a foreign company.
Any transaction between the offshore company and its Indian subsidiary needs to be benchmarked from a transfer pricing perspective.
Minimal income-tax implications and adherence to FEMA pricing norms.
Facts:
Indian promoters aimed to expand their business globally and raise funds from foreign investors.
They sought to move to a US-headquartered structure to facilitate this expansion.
By strategically structuring the investment and ensuring compliance with the latest ODI rules and FEMA pricing norms, Treelife enabled the company to achieve its global expansion goals. Our financial advisory services provided the necessary support to navigate complex regulatory landscapes and optimize tax implications, ensuring a smooth transition for the company’s international growth.
In just a few weeks, Treelife transformed the financial infrastructure of an innovative SaaS company. We set up efficient accounting systems, ensured seamless bookkeeping, and provided critical fundraising support. Discover how our strategic approach reduced their operational burden and enhanced their financial management.
Business Overview
An innovative insurance-tech company using technology and innovation to transform the traditional insurance model. The company offers a cloud-based platform that connects distributors to the insurance ecosystem.
Project Undertaken
Setting up systems for HR, accounting, and payroll
Ongoing bookkeeping, tax compliance, and payments
Fundraising and due diligence support
How We Helped?
Setting Up:
Treelife took ownership and set up the entire accounting system for the company from inception using Zoho Books and Zoho Payroll.
Assisted in migrating from Zoho Payroll to Keka, ensuring a smooth transition.
Effective implementation of software and processes reduced the time and effort required by the founders.
Bookkeeping and Accounting:
Timely updating of accounting entries and filing, ensuring compliance with regulatory requirements.
Completion of requisite regulatory compliances, reducing TAT for payments and MIS processing.
Fundraising & Vendor Due Diligence:
Represented the company during the due diligence process conducted by investors, assisting them in understanding the business model and transaction workflow.
Submitted data in the requisite formats and seamlessly resolved queries from the diligence team regarding finance and tax-related areas promptly.
By leveraging our expertise in financial management, Treelife significantly improved the company’s operational efficiency and supported its growth journey. Our comprehensive services ensured that the company was well-prepared for investor scrutiny and ongoing financial challenges.
The Union Budget 2024 marks a significant milestone in India’s economic journey. This Budget underscores the Government’s commitment to maintaining fiscal prudence while driving substantial investments in critical sectors. Despite global economic challenges, the Indian economy has fared well, maintaining stability and growth. For 2024-25, the fiscal deficit is expected to be 4.9% of GDP, with a target to reduce it below 4.5% next year. Inflation remains low and stable, moving towards the 4 percent target, with core inflation (non-food, non-fuel) at 3.1 percent.
The theme of the Budget focuses particularly on employment, skilling, MSMEs, and the middle class. This budget outlines the roadmap to Viksit Bharat 2047 focusing on nine priority areas to generate ample opportunities for all: productivity and resilience in agriculture, employment and skilling, inclusive human resource development and social justice, manufacturing and services, urban development, energy security, infrastructure, innovation and R&D, and next-generation reforms.
The Budget introduces several pivotal reforms aimed at simplifying tax structures, incentivizing investments, and promoting sustainable growth. The abolition of angel tax, reduction in corporate tax rates for foreign companies, and comprehensive review of the Income-tax Act, 1961 in the coming days are expected to bolster the startup ecosystem and attract international investments.
The subsequent sections of this Budget document provide an in-depth analysis and key highlights related to personal taxation, business reforms, investment opportunities, and developments in GIFT-IFSC. Personal taxation changes include revised income tax slabs, increased deductions, and adjustments in Taxes Collected at Source (TCS) and Taxes Deducted at Source (TDS) regulations. Business reforms cover the abolition of the angel tax, reduction in corporate tax rates for foreign companies, and measures to enhance ease of doing business. Investment opportunities are improved through rationalization of the capital gains tax regime, changes in holding periods and tax rates, and amendments related to buyback taxation and Securities Transaction Tax (STT) rates. GIFT-IFSC developments include tax exemptions for Retail Schemes and Exchange Traded Funds (ETFs), removal of surcharges on specified income, and other measures. These sections provide a comprehensive overview of the Union Budget 2024’s measures to support individuals, businesses, and investors, and to enhance India’s position as an attractive destination for global investment and financial activities.
The Union Budget 2024 is a balanced and forward-looking document, reflecting the Government’s resolve to steer the economy towards sustainable growth, innovation, and inclusiveness. This detailed presentation analysis aims to provide a comprehensive analysis of the Budget’’s key highlights, policy changes, and their implications for various sectors of the economy.
Overview
Key Macroeconomic Indicators from Budget 2024
Key indicators
Budget 2024-25
Budget 2023-24
Total Receipts (other than borrowings)
⬆️INR 32.07 lakh crore
INR 27.2 lakh crore
Net Tax Receipts
⬆️INR 25.83 lakh crore
INR 23.3 lakh crore
Total Expenditure
⬇️INR 48.21 lakh crore
INR 45 lakh crore
Fiscal Deficit (as % of GDP)
⬇️4.9%
5.90%
Gross Market Borrowings
⬇️INR 14.01 lakh crore
INR 15.4 lakh crore
Net Market Borrowings
⬇️INR 11.63 lakh crore
INR 11.8 lakh crore
Notes: 1. Inflation: Low, stable and moving towards the 4 per cent target, 2. Core inflation (non-food, non-fuel): 3.1 per cent
Key Policy Highlights – Budget 2024
1. Employment and Skilling
Provides wage support and incentives for first-time employees and job creation in manufacturing, along with employer reimbursements for EPFO contributions. Expected to benefit 2.1 crore youth, 30 lakh manufacturing jobs, and incentivize 50 lakh employees.
Internships for 1 crore youth in 500 top companies over 5 years, with INR 5,000 monthly allowance along with one-time assistance of INR 6,000. Companies eligible to cover training costs and 10% of internship costs from their CSR funds.
2. MSMEs and Manufacturing
Credit Guarantee and Support: The Credit Guarantee Scheme facilitates term loans for machinery and equipment purchases without collateral, covering up to INR 100 crore per applicant. Additionally, a new mechanism will ensure continued bank credit to MSMEs during stress periods, supported by a Government-promoted fund.
New Assessment Model for MSME Credit: Public sector banks to develop new credit assessment models based on digital footprints rather than traditional asset or turnover criteria.
3. Ease of Doing Business (Tax and Compliance)
Angel Tax Abolished: Abolishment of angel tax for all classes of investors to boost the startup ecosystem and entrepreneurial spirit.
Income Tax Reforms: Comprehensive review of the Income-tax Act, 1961 in the coming days to reduce disputes and litigation.
Variable Capital Company (VCC) Structure: Legislative approval sought for providing an efficient and flexible mode for financing leasing of aircrafts and ships and pooled funds of private equity through a ‘variable company structure’.
Stamp Duty Reduction: Encouraging states to moderate high stamp duty rates and consider further reductions for properties purchased by women.
Foreign Direct Investment (FDI) and Overseas Investment: The rules and regulations for FDI and Overseas Investments will be simplified to facilitate foreign direct investments, nudge prioritization, and promote opportunities for using Indian Rupee as a currency for overseas investments.
4. Space Economy and Technology
A venture capital fund of INR 1,000 crore to expand the space economy by five times in the next decade.
Full exemption of customs duties on 25 critical minerals and reduction on two others to support sectors like space, defense, and high-tech electronics.
5. Services
Development of Digital Public Infrastructure (DPI) applications at population scale for productivity gains, business opportunities, and innovation by the private sector. Planned areas include credit, e-commerce, education, health, law and justice, logistics, MSME services delivery, and urban governance.
An Integrated Technology Platform will be set up to improve the outcomes under the Insolvency and Bankruptcy Code (IBC) for achieving consistency, transparency, timely processing, and better oversight for all stakeholders.
6. Others
Urban Land Related Actions: Land records in urban areas will be digitized with Geographic information system (GIS) mapping. An IT-based system for property record administration, updating, and tax administration will be established. These will also facilitate improving the financial position of urban local bodies.
9 Pillars to Viksit Bharat 2047 and Policy Initiatives
To drive India’s growth and development, the Union Budget 2024 outlines nine strategic pillars that form the foundation for the nation’s economic agenda, aiming towards Viksit Bharat 2047. These pillars encompass key sectors and initiatives aimed at enhancing productivity, fostering innovation, and ensuring inclusive development. Each pillar is supported by targeted policy measures designed to create opportunities, boost investments, and address critical challenges. The following sections detail these pillars and the corresponding policy initiatives.
Decoding Tax in Budget 2024
The subsequent part of this Budget document is broken down into 4 primary sections providing in-depth tax analysis including:
Personal – Individuals including founders, team members, etc.
Investment – Primarily taxation norms around capital gains.
Business – Startups and other businesses.
GIFT-IFSC – Proposed amendments for IFSC units.
These sections provide a comprehensive overview of the Union Budget 2024’s measures to support global investment and financial activities.
I. Personal
Revision of slab rates for individuals under new tax regime
Proposed changes in personal income tax slabs for individuals (highlighted below) resulting in a tax saving of up to INR 17,500 excluding surcharge and cess under new tax regime.
Existing Slabs (INR)
Proposed Slabs (INR)
Tax Rate
0-3,00,000
0-3,00,000
NIL
3,00,001-6,00,000
3,00,001-7,00,000
5%
6,00,001-9,00,000
7,00,001-10,00,000
10%
9,00,001-12,00,000
10,00,001-12,00,000
15%
12,00,001-15,00,000
12,00,001-15,00,000
20%
>15,00,000
>15,00,000
30%
Note : Full tax rebate available for taxable income upto of INR 7,00,000
Treelife Insight:
We have prepared a tax calculator to explore potential tax savings here.
Increase in tax deductions under new tax regime
Standard deduction for salaried employees is proposed to be increased to INR 75,000 from INR 50,000.
Cap of deduction against income from family pension for pensioners increased to INR 25,000 from INR 15,000.
Deduction for employer’s contribution to NPS increased from 10% to 14% even for employees other than Central or State Government employees.
TCS collected from minors
TCS collected from minors can only be claimed as credit by the parent in whose income the minor’s income is clubbed. This amendment is effective from January 1, 2025.
Credit for TCS and all TDS for salaried employees
It is proposed to allow employees to club their TCS and TDS (other than salaries) for the purpose of computing TDS to be deducted from salary.
Treelife Insight:
TCS is usually collected on foreign travel, LRS remittances, purchase of cars beyond a limit. This will help salaried employees effectively manage tax cash flows.
Income classification of rent on residential house
It has been clarified that income from letting out of a residential house to be classified under the heading “Income from house property” and not “business income”.
Increase in limits for applicability of Black Money Act, 2015 for disclosure of foreign income and asset in the Income Tax Return (ITR)
Penal provisions under section 42 and 43 of the Black Money Act, 2015 proposed to not apply in case of non-reporting of foreign assets (other than immoveable property) with value less than INR 20,00,000 (increased from earlier threshold of INR 5,00,000).
Quoting of Aadhaar Enrolment ID in ITRs discontinued
Quoting of Aadhaar Enrolment ID proposed to be no longer allowed in place of Aadhaar number for ITRs filed after October 1, 2024.
II. Investment
1. Rationalization of Capital Gains Tax Regime
Capital gains tax regime is proposed to be rationalized with effect from July 23, 2024 as summarized below:
Rationalization of Holding Period:
Type of Asset
Period to qualify as Long term
All listed securities
12 months
All other assets (including immovable property)
24 months
Change in Tax Rates:
Long term capital assets
Type of Asset
Residents
Non-residents
Current
Proposed
Current
Proposed
Listed equity shares and units of equity oriented mutual fund
10%
12.5%
10%
12.5%
Unlisted equity shares
20%
12.5%
10%
12.5%
Unlisted debentures and bonds
20%
Applicable rates
10%
Applicable rates
Units of REITs & InvITs
10%
12.5%
10%
12.5%
Immovable property
20%
12.5%
20%
12.5%
Notes:
Exemption available under LTCG has been increased to INR 125,000.
No indexation benefit available for LTCG however forex fluctuation benefit available to NR on sale of unlisted shares.
Indexation available for unlisted shares on March 31, 2018 and sold in Offer for Sale (OFS)
Short term capital assets
Type of Asset
Residents
Non-residents
Current
Propose
Current
Proposed
Listed equity shares and units of equity oriented mutual fund
15%
20%
15%
20%
Others
No change – taxable at applicable rates
Treelife Insight:
Mandatory classification of income on sale debentures (including CCDs / NCDs) and bonds as short term capital gains is a big move and could impact the Real Estate investors where such instruments are widely used. It will be interesting to see how such investors will react to this increase in tax rates.
Reduction in tax rates for long term capital gains on unlisted equity shares should give an impetus to PE / VC funds investing in startups as the lower tax rate will ultimately lead to an increase in the IRR for investors.
Reducing the period of holding for immovable properties to 24 months and reducing the long term capital gains tax rate to 12.5% will be looked at positively.
2. Change in taxation of buyback
Currently, buyback distribution tax is levied on the company at ~23% on the distributed income. It is proposed to tax the buyback proceeds in the hands of the shareholders as “dividend income” at applicable tax rates. The cost of acquisition of shares being bought back to be claimed as a capital loss (depending on holding period).
This amendment is proposed to be effective from October 1, 2024
Treelife Insight:
This will deter companies from offering buybacks as there is a significant tax outflow for the shareholders under the proposed regime. Further there could be timing mismatch between the claiming of loss and payment of tax on buyback proceeds resulting in cash outflow for the shareholders.
3. Increase in STT rates
STT rates for futures and options proposed to be increased with effect from to be effective from October 1, 2024:
Current
Proposed
Options
0.0625%
0.1%
Futures
0.0125%
0.02%
III. Business
1. Abolition of Angel Tax
Angel tax i.e. section 56(2)(viib) of the Income-tax Act, 1961 proposed to be abolished with effect from April 01, 2024
Treelife Insight:
This is a big and welcome move for the startup ecosystem which should significantly boost investor confidence, especially foreign investors which were bought under the ambit of angel tax recently
This amendment is prospective in nature and thus, past tax disputes to still continue
Gift tax i.e. section 56(2)(x) for recipient of shares continues to apply
Differential equity pricing structures will now evolve with this relief
It may be interesting to see if investors insist on ‘merchant banker’ valuation reports under section 56 (2) (x) in small equity fundings which materially affect startups.
2. Reduction in corporate tax rate for foreign companies
Tax rates for foreign companies proposed to be reduced from 40% to 35%.
3. Clarification for taxes withheld outside India
It is clarified that taxes withheld outside India are to be included for the purposes of calculating total income.
4. Increase in limit of remuneration to working partners of a firm allowed as deduction
Existing Structure
Allowable Remuneration
Proposed
Allowable Remuneration
on the first INR 3,00,000 of the book profit
or in case of a loss
INR 1,50,000 or at the rate of 90 % of the book profit, whichever is more
on the first INR 6,00,000 of the book profit or in case of a loss
INR 3,00,000 or at the rate of 90 % of the book profit, whichever is more
on the balance of the book-profit
60%
on the balance of the book-profit
60%
5. Miscellaneous
Equalisation levy of 2% proposed to be abolished with effect from August 1, 2024
Vivaad Se Vishwas Scheme proposed to be introduced
Time limit for issue of notice for initiation of re-assessment reduced from maximum 10 years from end of assessment year to 5 years and 3 months from end of assessment year.
Insertion of section 74A , an approach that consolidates the dealing with discrepancies irrespective of fraud and simplifying the procedural aspects under the CGST Act (on recommendations of GST Council) from FY 2024-25 as under
Limitation period stands at 42 months (from the due date of furnishing the annual return for the financial year) for the purpose of issuance of notice (earlier it was 36 months in case of no allegation of fraud or suppression and 60 months in case of allegation of fraud or suppression)
Time period of 12 months for purposes of passing order (beyond 42 months as aforesaid) extendable by 6 months with approval.
6. Clarificatory amendments related to TDS
Section 194-IA (TDS on sale of immovable property) – Proposed to add a proviso to clarify that the threshold limit of INR 50 lakhs is to be checked on the total value of the property and not on amount paid to each individual seller (with effect from October 1, 2024).
Excluding sums paid under section 194J from section 194C (Payments to Contractors) –Earlier, taxpayers used to deduct TDS under section 194C even if the payment was liable to TDS under section 194J because there was no specific mutually exclusive clause while defining the word “work”. It is proposed to amend the definition of “work” under section 194C to specifically exclude any sum referred to in section 194J (with effect from October 1, 2024)
7. Rationalization of TDS/TCS rates
Section
Old rates
Proposed new rates
Section 194D – Payment of insurance commission (in case of resident person other than company)
5%
2%
(with effect from April 1, 2025)
Section 194DA – Payment in respect of life insurance policy
5%
2%
(with effect from October 1, 2024)
Section 194G – Commission etc on sale of lottery tickets
5%
2%
(with effect from October 1, 2024)
Section 194H – Payment of commission or brokerage
5%
2%
(with effect from October 1, 2024)
Section 194-IB – Payment of rent by certain individuals or HUF
5%
2%
(with effect from October 1, 2024)
Section 194M – Payment of certain sums by certain individuals or Hindu undivided family
5%
2%
(with effect from October 1, 2024)
Section 194-O – Payment of certain sums by e-commerce operator to e-commerce participant
1%
0.1%
(with effect from October 1, 2024)
Section 194F – Payments on account of repurchase of units by Mutual Fund or Unit Trust of India
20%
Proposed to be omitted
(with effect from October 1, 2024)
New Section 194T – Payment of salary, remuneration, interest, bonus or commission by partnership firm to partners
NA
10% on various payments made to partners – salary, remuneration, interest, bonus or commission
(with effect from April 1, 2025)
New Section 193 – Interest paid exceeding on Floating Rate Savings (Taxable) Bonds (FRSB) 2020 with effect from October 1, 2024
NA
10% (threshold – exceeding INR 10,000)
(with effect from October 1, 2024)
Section 206(7) – Interest on late payment of TCS
1% per month or part of the month
1.5% per month or part of the month
(with effect from April 1, 2025)
8. Procedural changes related to TDS proposed:
Time limit to file belated TDS/TCS return in order to not-attract penal provisions to be reduced from 1 year to 1 month from the due date of filling of such TDS/TCS returns (Section 271H) – with effect from April 1, 2025.
Provision to include levy of TCS at 1% on Luxury goods of value exceeding INR 10 lakhs. (Section 206C(1F)) List of such luxury goods are yet to be notified. – with effect from January 1, 2025
Exemption from prosecution if the payment of TDS is made before the due date of filing of TDS return as applicable for such TDS payments (Section 276B) – with effect from October 1, 2024
Applications for Lower tax deductions / collection at source can be made in respect of TDS/TCS u/s 194Q and 206C respectively – with effect from October 1, 2024.
Non revision of the TDS / TCS filings post 6 years of the end of the financial year in which the returns are to be filed. – with effect from April 1, 2025.
Fixation of time limit for deeming an assessee in default as under –
6 years from the end of FY in which credit given / payment was made.
2 years from the end of FY in which the correction statement is filed – with effect from April 01, 2025.
Nil / Lower Tax rates for certain class of notified persons (Class of persons yet to be notified) – with effect from October 1, 2024.
IV. GIFT-IFSC
1. Tax exemptions extended to Retail Schemes and ETFs
Proposed to amend the definition of ‘Specified Fund’ under Section 10(4D) to include Retail Schemes and ETFs launched in GIFT-IFSC thereby extending the beneficial tax regime applicable for CAT III AIFs to GIFT-IFSC to Retail Schemes and ETFs
Treelife Insight:
Relevant only for Inbound Funds setup by pooling money from non-resident investors as the condition that units (other than Sponsor / Manager units) to be held by non-resident investors continues to apply.
2. No surcharge on income for Specified Fund
Surcharge rate on interest and dividend income proposed to be removed for Specified Fund set-up in GIFT-IFSC even if setup as other than Trust
3. Section 68 provisions no longer applicable to Venture Capital Funds (VCFs)
Section 68 dealing with unexplained cash credits allows the tax officer to seek an explanation to provide the source of its funds used for making investment / offer loans to companies subject to these provisions. It is proposed to amend the definition of ‘venture capital funds’ to include VCFs in GIFT-IFSC thereby exempting them from questioning by the tax officer under section 68.
4. Finance Companies exempted from complying with ‘Thin capitalisation’ norms
Exemption from ‘Thin Capitalisation’ norms prescribed under section 94B for Bank and NBFCs extended to Finance Companies in GIFT-IFSC
Treelife Insight:
Finance companies in GIFT-IFSC, especially those engaged in treasury functions, lending or borrowing from non-residents should benefit from the removal of the cap on the deduction for interest expenditure, which was previously limited to 30% of EBITDA for that financial year.
5. Exemption on specified income from Core Settlement Fund setup by recognised clearing corporations
Proposed to amend the definition of ‘recognised clearing corporations’ under Section 10(23EE) to include ‘recognised clearing corporations’ setup in GIFT-IFSC, thereby, exempting any specified income of Core Settlement Guarantee Fund, set up by such corporations.
IFSCA has released a Circular prescribing the fees for the newly introduced Book-keeping, Accounting, Taxation, and Financial Crime Compliance Services (BATF) Regulations.
𝐀𝐧𝐧𝐮𝐚𝐥 𝐅𝐞𝐞𝐬 𝐟𝐨𝐫 𝐒𝐞𝐫𝐯𝐢𝐜𝐞 𝐏𝐫𝐨𝐯𝐢𝐝𝐞𝐫𝐬: – Less than 500 employees: $5,000 per activity – 500 to 1,000 employees: $7,500 per activity – More than 1,000 employees: $10,000 per activity
𝐊𝐞𝐲 𝐏𝐨𝐢𝐧𝐭𝐬 𝐟𝐨𝐫 𝐄𝐱𝐢𝐬𝐭𝐢𝐧𝐠 𝐀𝐧𝐜𝐢𝐥𝐥𝐚𝐫𝐲 𝐒𝐞𝐫𝐯𝐢𝐜𝐞 𝐏𝐫𝐨𝐯𝐢𝐝𝐞𝐫𝐬 (𝐀𝐒𝐏𝐬): – Existing ASPs rendering BATF services under the IFSCA ASP Framework are not required to pay the application fee for the same activity under BATF regulations. – Annual/recurring fees will be adjusted for the fees already paid under the ASP framework.
𝐈𝐦𝐩𝐨𝐫𝐭𝐚𝐧𝐭 𝐃𝐚𝐭𝐞: – Existing ASPs must communicate their willingness to operate under the new BATF regulations for bookkeeping, accountancy, and taxation services by August 2, 2024.
The “Navigating Labour Laws: A Comprehensive Regulatory Guide for Startups” by Treelife offers a comprehensive overview of India’s intricate labour law landscape, emphasising the significance of these compliances for startups. Rooted in the fundamental rights (specifically, the Rights to Equality; to Freedom; and against Exploitation) and the directive principles of state policy (contained in Articles 38, 39, 41, 42, and 43) enshrined in the Indian Constitution, labour laws in India are fundamentally welfare legislations, imposing significant compliance responsibility on employers as a result of a socialist outlook seeking to protect the dignity of human labour.
Given the dual role played by central and state governments in labour law, startups are oftentimes unaware of applicable compliances or are under-equipped to navigate the complex framework, lacking the deep technical understanding required. It is this gap in understanding that this Regulatory Guide attempts to bridge, with the major highlight being a quick reference guide for startups to identify critical compliances at both levels of governance.
Other key highlights include:
Complex Regulatory Framework: A breakdown of the multifaceted compliance environment, highlighting for instance, added layer of compliance as seen in the Industrial Employment (Standing Orders) Act, 1946, which dictates terms of employment, and the relevant state-specific Shops and Establishments Acts, which also prescribe similar conditions but with variations, necessitating detailed assessments to determine applicable compliances.
Critical Central Legislations: In order to ensure complete clarity of compliances at the central level, the Regulatory Guide highlights the critical legislations that are typically applicable across industries/sectors to startups, applicability factors, compliance requirements and penalties for violation. Notwithstanding the inconsistent enforcement in these laws, it is pertinent to note that many of these legislations prescribe imprisonment for the officer in default, as potential penalty for failure to comply.
State-Specific Regulations: Beyond central laws, startups must navigate state-specific legislations, which can provide detailed provisions governing the terms of employment and service and even tax obligations, and impose additional compliance requirements.
Statutory Leave Entitlements: A critical point for any startup formulating a leave policy, the Regulatory Guide provides a quick reference to the types of and minimum number of leaves that are mandated by laws. Typically, this can flow from a central legislation (like in the case of maternity benefits) or from state-specific legislations (such as each state’s Shops and Establishments Act, the mandates under which can vary from state to state).
Upcoming Labour Codes: While highlighting the structural issues in the Indian labour law framework, the Regulatory Guide also provides an overview of the proposed Labour Codes, which aim to simplify and reduce ambiguities in law enforcement across states, making it easier for startups to understand and comply with labour regulations, thereby fostering a more straightforward regulatory environment conducive to business operations and growth. The Indian government is consolidating existing the labour laws into four new codes: i) Code on Wages ii) Occupational Safety, Health and Working Conditions Code iii) Social Security Code iv) Industrial Relations Code
Challenges and Recommendations: In addition to navigating the two-level governance required, the Regulatory Guide also identifies some critical challenges faced by startups in complying with the applicable labour laws which include: i) Lack of technical expertise to understand the critical distinctions in certain legally defined terms, such as “workman” and “employee” which have similar meaning outside of the legal parlance, but which can have varying definitions across laws, affecting the applicability of protections and remedies. ii) Requirement for proactive compliance, which can help startups avoid legal pitfalls but which may result in increased compliance costs.
The Labour Law Handbook by Treelife is an essential guide for businesses navigating India’s complex labour law framework. Tailored for startups and growth-focused enterprises, this report simplifies intricate compliance requirements, offering actionable insights into central and state-specific regulations, statutory obligations, and upcoming labour code reforms. With detailed explanations of critical laws, practical compliance checklists, and expert recommendations, this handbook empowers businesses to mitigate legal risks, ensure workforce welfare, and operate confidently in a dynamic regulatory environment.
Artificial Intelligence (AI), especially Large Language Models (LLMs) are transforming the legal and financial sectors. These models enhance efficiency, accuracy, and decision-making through advanced natural language processing (NLP) and text generation. LLMs are built on deep learning architectures and trained on vast datasets to understand, interpret, and generate human-like text and thereby support professionals by automating routine tasks. This article explores how LLMs are transforming both the legal and financial industries, their applications, benefits, challenges, and future implications. [1]
Understanding Large Language Models
LLMs are AI systems designed to understand, generate, and respond to human language in a manner that mimics human-like understanding and reasoning. These models are trained on vast amounts of textual data, allowing them to learn patterns, relationships, and nuances in language. Recent advancements have expanded the capabilities of LLMs beyond simple language understanding to complex tasks such as language generation, translation, summarization, and even dialogue. [2]
Applications of LLM in the Legal Sector
With these developments, LLMs have been given the challenge of revolutionizing the legal sector by offering advanced capabilities in natural language processing (NLP) and understanding legal texts. Here’s how LLMs are being applied in the legal sector, at relatively small scales (at present):
Automating Routine Tasks
LLMs are transforming legal practices by automating routine tasks such as document review, legal research, and case analysis. They can sift through extensive legal databases, extract relevant information from case law, statutes, and regulations, and provide summaries or insights that aid legal professionals in decision-making. [3]
Streamlining Contract Analysis and Due Diligence
In contract law and due diligence processes, LLMs streamline the analysis of contracts by extracting key terms, identifying risks, inconsistencies, or anomalies, and suggesting revisions based on predefined legal criteria, and also provide significant support contract management by analyzing contracts, extracting key points, and categorizing them based on legal issues, thereby saving time on administrative tasks. This reduces the time and effort required for contract review and enhances accuracy in identifying potential legal issues.
Moreover, LLMs assist in legal compliance by monitoring legislative updates, identifying pertinent legal developments, and providing insights to mitigate risks and ensure regulatory adherence. [4]
Compliance Monitoring and Regulatory Analysis
LLMs assist legal departments in compliance monitoring by analyzing regulatory texts, monitoring changes in laws and regulations, and ensuring adherence to compliance requirements. They facilitate the preparation of compliance reports, regulatory filings, and disclosures, thereby improving efficiency and reducing compliance-related risks. [5]
Case Studies and Examples for Legal Sector
Examples of successful integration of LLMs into legal practices include the use of AI-powered platforms for legal research and contract management by law firms and corporate legal departments. These platforms leverage LLMs to enhance productivity, accuracy, and decision-making capabilities in handling legal documents and regulatory requirements.
Some examples wherein LLMs have been opined on or even used by Indian Judiciary include:
In 2023, the Delhi High Court issued a temporary injunction, commonly known as a “John Doe” order, prohibiting social media platforms, e-commerce websites, and individuals from using actor Anil Kapoor’s name, voice, image, or dialogue for commercial purposes without authorization. The Court specifically banned the use of Artificial Intelligence (AI) tools to manipulate his image and the creation of GIFs for monetary gain. Additionally, the Court directed the Union Ministry of Electronics and Information Technology to block pornographic content that features altered images of the actor. [6]
Since 2021, the Supreme Court has employed an AI-powered tool designed to process and organize information for judges’ consideration, though it does not influence their decision-making process. Another tool utilized by the Supreme Court of India is SUVAS (Supreme Court Vidhik Anuvaad Software), which facilitates the translation of legal documents between English and various vernacular languages.
In the case of Jaswinder Singh v. State of Punjab, the Punjab & Haryana High Court put the question of the worldwide view on bail for assaults with cruelty to ChatGPT, and included the excerpt of the response from ChatGPT as a part of the order. While no reliance was placed on the response from ChatGPT itself, the excerpt was in support of the honorable court’s findings and explained that “if the assailants have been charged with a violent crime that involves cruelty, such as murder, aggravated assault, or torture, they may be considered a danger to the community and a flight risk”. [7]
AI-powered platforms have enabled law firms and corporate legal departments to enhance productivity and accuracy in legal research and contract management, including players such as Harvey AI, Leya AI, Paxton AI, DraftWise, Robin, etc., all of which use LLMs and other technologies to provide support to legal professionals to assist lawyers with drafting, negotiating, reviewing, and summarizing legal documents, and to provide more useful legal research and contract management tools.
Moreover, within the Indian Judiciary, LLMs have been employed for tasks ranging from issuing injunctions to aiding in translation and providing broader insights into legal considerations.
These advancements underscore the growing role of AI technologies in augmenting judicial processes while maintaining clarity on their role in supporting, rather than determining, legal outcomes. As AI continues to evolve, its integration promises to further streamline legal operations and foster more informed and equitable judicial decisions.
Impact of LLM on Financial Services
The finance sector faces a deluge of data, including filings, reports, and contracts, requiring meticulous scrutiny due to the high stakes involved. Errors are not an option when handling finances. The recent integration of Large Language Models (LLMs) represents a transformative shift. LLMs have the capability to rapidly process and generate extensive text, automate repetitive tasks, and condense information into accessible formats. Functions such as fraud detection, anomaly analysis, and predictive modeling can now leverage AI and machine learning techniques effectively.
Risk Assessment and Fraud Detection
Machine-learning AI models analyze large datasets in real-time to quickly spot potential fraud by learning from past data. Trained on both fraudulent and legitimate examples, these models categorize transaction patterns, improving fraud detection.
Processing insurance claims for property and casualty involves complex assessments to determine validity and cost, tasks prone to errors and time consumption. While usually requiring human judgment, LLMs can assist by summarizing damage reports.
When combined with AI systems that analyze incident images, LLMs further automate insurance claim processing, speeding up cost assessments. This saves time and money, potentially enhancing customer satisfaction, and strengthens fraud detection to ensure claims are valid and payments are secure. [8]
Improving Compliance and Regulatory Reporting
The financial services sector works under strict rules and regulations. Companies must follow these rules carefully to stay compliant. It’s challenging because regulations change often, so businesses must regularly update their policies and procedures to meet the latest requirements.
Automation plays a crucial role in enhancing compliance processes within banking and financial organizations by streamlining workflows, monitoring regulatory updates, and managing risk effectively. Automated systems, such as Robotic Process Automation (RPA), help banks maintain regulatory compliance by automating tasks like document verification, data entry, and compliance reporting. They also ensure that compliance procedures stay current with evolving regulations, continuously monitoring changes and triggering necessary updates.
Automation further supports Know Your Customer (KYC) and Anti-Money Laundering (AML) compliance by automating customer due diligence and identity verification processes, enhancing fraud detection capabilities. Additionally, automated data management and reporting systems improve the accuracy and efficiency of compliance reporting, while automated audit trails enhance transparency and control over compliance activities. Lastly, automation aids in managing vendor and third-party risks by automating due diligence, risk assessments, and monitoring processes, ensuring compliance with contractual obligations and regulatory requirements. [9]
Implementation of AI in Financial Services
Companies like PayPal and Mastercard are leveraging AI to combat payment fraud effectively. PayPal, handling billions of transactions annually, employs deep learning and machine learning to analyze vast amounts of data, including customer purchase history and fraud patterns. This allows PayPal to accurately detect potential fraud instances, such as unusual account access from multiple countries in a short period. By continuously analyzing data in real-time and generating thousands of rules, PayPal maintains a low transaction-to-revenue ratio, significantly below the industry average.
Similarly, Mastercard has developed its own AI model, Decision Intelligence, which uses a recurrent neural network trained on billions of transactions to predict and prevent fraudulent activities within milliseconds. This technology has substantially improved fraud detection rates across Mastercard’s network, demonstrating AI’s pivotal role in enhancing security and efficiency in the payments industry. [10]
Challenges and Considerations
Data Privacy and Security Concerns
The deployment of LLMs in India’s legal and financial sectors raises significant concerns regarding data privacy and security, due to the lack of any formal legislation or rule-making in relation to use of LLMs in these sectors. Furthermore, these sectors manage sensitive information such as financial records, legal documents, and personal data, necessitating stringent measures to ensure LLMs handle this information securely. While we still lack a dedicated regulation for LLMs in India, compliance with Indian data protection laws, including the Digital Personal Data Protection Act, 2023 and existing regulations like the Information Technology (Intermediary Guidelines and Digital Media Ethics Code) Rules, 2021, is crucial to maintaining trust and legality.
Ethical Implications and Bias
LLMs trained on extensive datasets may unintentionally perpetuate biases present in Indian societal contexts. In legal applications, biased language models could influence outcomes unfairly, or create a cultural bias of overrepresentation impacting judgments based on factors such as caste, religion, or socioeconomic status. Similarly, biased algorithms in financial services could lead to discriminatory practices in lending or investment decisions. Addressing biases requires meticulous scrutiny during model development, robust testing for fairness, and ongoing monitoring to mitigate unintended consequences, aligning with Indian principles of equality and non-discrimination.
Need for Balanced Human Oversight
While LLMs offer automation and efficiency gains, they cannot replace human judgment in India’s legal and financial decision-making processes. These domains require nuanced understanding, ethical reasoning, and cultural sensitivity—attributes that current AI technologies may lack. Human oversight is essential to ensure LLMs are deployed ethically, interpret outcomes correctly, and intervene when necessary to prevent errors or ethical breaches. Effective oversight by a dedicated regulatory body and audits conducted by independent third parties help ensure compliance and transparency. This oversight aligns with Indian legal principles of fairness, justice, and accountability.
Regulatory Challenges
Integrating AI, including LLMs, into India’s legal and financial sectors must navigate complex regulatory landscapes. Indian laws, such as the Indian Contract Act, 1872, the Banking Regulation Act, 1949, and the Reserve Bank of India’s guidelines on data protection and cybersecurity, impose stringent requirements on data handling, fairness, and transparency. Compliance with these regulations is essential to mitigate legal risks and ensure responsible AI deployment. Collaborative efforts among AI developers, legal experts, and regulatory authorities are crucial to align LLM applications with Indian regulatory frameworks effectively. Stringent guidelines that clearly define acceptable uses of LLMs, along with strict penalties for any violations, are crucial parts of the framework.
Public Awareness
Public awareness campaigns and programs to improve digital literacy aim to empower citizens to navigate AI-generated content confidently. Investment in research and development, international collaboration, flexible regulations, strengthened data protection, and a comprehensive approach are all necessary steps forward.
Conclusion & Future Prospect
In conclusion, LLMs present transformative opportunities for India’s legal and financial sectors, enhancing productivity, decision-making, and customer service. Addressing challenges such as data privacy, bias mitigation, human oversight, and regulatory compliance is paramount to realizing these benefits responsibly. In the legal domain, LLMs can automate document review, streamline contract analysis, and enhance legal research capabilities, thereby boosting efficiency and reducing costs for law firms and legal departments. This technology also holds potential in providing legal assistance to a broader segment of the population, bringing efficiency and improving access to justice. In the financial sector, LLMs can analyze vast amounts of data to aid in risk assessment, customer service automation, and predictive analytics for investment decisions.
While LLMs bring automation and efficiency benefits,human oversight remains indispensable to mitigate these risks, ensuring that LLMs are deployed ethically, interpreting results accurately, and intervening as needed to uphold ethical standards and regulatory compliance in alignment with Indian principles of justice and accountability. Overall, while LLMs offer substantial benefits in terms of efficiency and innovation, their integration into the legal and financial sectors will require careful planning, regulatory adherence, and continuous monitoring to mitigate risks and maximize their positive impact.
The doctrine of “work for hire” is a legal concept that determines the ownership of a copyrighted work when it is created in the context of an employment relationship or under a specific contractual arrangement. The purpose of this doctrine is to establish clarity regarding the rights and ownership of creative works, particularly when multiple parties are involved in the creation process.
Criteria for Work to Qualify as a “Work for Hire”
To qualify as a “work for hire,” certain criteria must be met, although the specifics may vary depending on the jurisdiction. Generally, the following elements are considered:
Employee-Employer Relationship: In an employment scenario, the work created by an employee within the scope of their employment duties is automatically considered a “work for hire.” The employer is deemed the legal author and owner of the copyright.
Commissioned Works: In some cases, a work may be commissioned from an independent contractor, such as a freelancer or consultant. For such works to be categorized as “works for hire,” there must be a written agreement explicitly stating that the work is a “work for hire” and that the commissioning party will be considered the legal owner of the copyright.
It is important to note that different jurisdictions may have variations in the specific requirements and definitions of a “work for hire.” Therefore, it is essential to consult the copyright laws of the relevant jurisdiction for a comprehensive understanding.
“Work for Hire” In The United Kingdom
In collaborative scenarios, where multiple parties contribute to the creation of a work, it becomes necessary to ascertain the ownership of the copyright. The terms of the collaboration agreement and the intentions of the parties involved play a crucial role in such cases.
The case of Creation Records Ltd v. News Group Newspapers Ltd [1997] EMLR 444 shed light on this issue. The court considered a situation where a photograph was taken by a photographer for a newspaper article. The court emphasized the importance of the contractual arrangements and the intention of the parties involved in determining the ownership of the copyright. The photographer, in this case, retained the copyright as the collaboration agreement did not clearly transfer it to the newspaper.
“Work for Hire” In The United States
In the United States, the concept of “work for hire” is extensively addressed under the Copyright Act of 1976. According to Section 101 of the Act, a work qualifies as a “work for hire” if it is:
Prepared by an Employee: The work must be created by an employee within the scope of their employment duties. In such cases, the employer is considered the legal author and owner of the copyright.
The landmark case of Community for Creative Non-Violence v. Reid (490 U.S. 730, 1989) explored the scope of an employment relationship and ownership of a work. The Supreme Court considered factors such as the control exerted by the employer, the provision of employee benefits, and the nature of the work to determine whether the work was a “work for hire.” The court ultimately ruled that the work in question did not meet the criteria for a “work for hire,” and the copyright ownership remained with the creator.
“Work for Hire” In India
In India, the concept of “work for hire” is not explicitly defined in copyright legislation. However, the Copyright Act, 1957, does provide provisions related to the ownership of copyright in works created in the course of employment. The case of Eastern Book Company v. D.B. Modak (2008) addressed the ownership of copyright in works created by employees. The court held that if an employee creates a work during the course of their employment and it falls within the scope of their duties, the employer will be considered the first owner of the copyright unless there is an agreement to the contrary.
When it comes to works created by freelancers or under contractual arrangements, the ownership of copyright is typically determined by the terms of the agreement between the parties involved. In the case of Indian Performing Right Society v. Eastern Indian Motion Pictures Association (2012), the court emphasized the importance of contractual arrangements and the intent of the parties involved in determining copyright ownership. The court ruled that the ownership of copyright rests with the party who commissions the work unless otherwise specified in the agreement.
Similarities and Differences between U.K., U.S., and Indian Approaches
The U.K., U.S., and India have different approaches to the “work for hire” doctrine. While all jurisdictions consider the employment relationship and written agreements as important factors, the specific criteria and legal provisions differ. The U.S. has a more detailed statutory framework for “works for hire,” while the U.K. and India rely on case law and contractual agreements to determine copyright ownership.
Emerging Trends and Future Outlook
Evolving Nature of Employment Relationships: The nature of employment relationships is undergoing significant changes, driven by factors such as the gig economy, remote work, and freelance culture. These developments pose new challenges in applying the doctrine of “work for hire.” The line between employee and independent contractor can become blurred, making it more complex to determine copyright ownership. As the workforce becomes more flexible and diverse, legal frameworks may need to adapt to address these evolving employment relationships.
Influence of Technology and Remote Work: Advancements in technology have transformed the creative industries, enabling collaboration and work across geographical boundaries. Remote work has become more prevalent, and creative projects often involve contributors from different locations. This raises questions about jurisdictional issues and the application of copyright laws in cross-border collaborations. Clear contractual agreements and international harmonization of copyright laws may be necessary to provide guidance and ensure fair treatment of creators.
Practical Considerations for Creators and Employers
Clear Contractual Agreements: Creators and employers should prioritize clear and comprehensive contractual agreements that address the issue of copyright ownership explicitly. These agreements should clearly define the scope of work, the intended ownership of copyright, and any limitations or conditions related to its use, licensing, or transfer.
Negotiating Fair Terms: Creators, especially freelancers and independent contractors, should be proactive in negotiating fair terms that protect their rights and interests. This may involve discussing ownership, compensation, attribution, moral rights, and the ability to use their work for self-promotion or future projects.
Consultation with Legal Professionals: Seeking legal advice from professionals well-versed in copyright law is crucial, particularly when dealing with complex projects or cross-jurisdictional collaborations. Legal experts can provide guidance, ensure compliance with relevant laws, and help draft contracts that protect the rights of creators while meeting the needs of employers.
Awareness of Jurisdictional Differences: When engaging in international collaborations, it is important to have a thorough understanding of the copyright laws and regulations in the relevant jurisdictions. Being aware of jurisdictional differences can help parties anticipate potential conflicts and take proactive measures to address them through appropriate contractual provisions.
Regular Review and Updates: Contracts and agreements should be periodically reviewed and updated to reflect changes in circumstances, business relationships, or legal frameworks. Regularly revisiting contractual arrangements can help ensure that they remain relevant and provide adequate protection to all parties involved.
Collaboration and Communication: Open and transparent communication between creators and employers is essential for a successful working relationship. Engaging in discussions about copyright ownership, expectations, and any potential issues can help prevent misunderstandings and disputes down the line.
Conclusion
In conclusion, the doctrine of “work for hire” under copyright law is a complex and significant concept that determines copyright ownership in various employment and contractual relationships. Through our critical survey of cases in the United Kingdom, United States, and India, several key insights emerge. In India, while there is no explicit provision for “work for hire,” the Copyright Act recognizes the ownership of copyright in works created during the course of employment. Ownership in freelance and contractual arrangements is determined by the terms of the agreement. Throughout our survey, it becomes apparent that clear and explicit contractual agreements are vital in all jurisdictions to address copyright ownership and prevent disputes.
In the bustling markets and stores of India, where buying and selling happens every day, there’s a set of rules quietly at work to make sure you get what you pay for. These acts and rules are colloquially known as ‘Legal Metrology’. The rules are intended to make sure that measurements and weights used in trade are accurate and fair, and are represented to the consumer clearly. The rules are enforced by the Legal Metrology Division, which is managed by the Department of Consumer Affairs under the Ministry of Consumer Affairs, Food & Public Distribution.
What is Legal Metrology?
Legal Metrology sets out to ensure that whatever you buy (whether it’s rice, oil, fruits, cosmetics, backpacks, electronics, or any other packaged goods or commodities) is in compliance with requirements and guidelines about the quantity, weight, measurements, expiry date, origin, manufacturer, etc., and is also packaged in a manner that these details are captured and made available to you. It’s like having referees in the game of trade, making sure everyone plays fair.
How Does It Work?
Ensuring Accuracy:You might notice a stamp or mark on the weighing/measuring devices/equipments, this is to show that they’ve been verified and are accurate. In fact, the Legal Metrology department also issues Licenses to manufacturers, dealers and repairer of weighing/measuring devices for dealing with such instruments.
Packaged Goods: Ever look at a pack of biscuits or a bottle of shampoo and see all those details like MRP, manufacturing date, expiry date, consumer care information as well as the quantity of the package? Legal Metrology rules make it mandatory for companies to give you this information in the manner prescribed under the Legal Metrology Act, 2009 as well as the Legal Metrology (Packaged Commodities) Rules, 2011 so you are aware of the contents of the package and of your mode of communication with the company in case of any complaints.
What a Consumer Should Know?
Rights as a Consumer: You have the right to get what you pay for. If you feel something is not right, like the weight of a product or the information on the pack, you can file a complaint through the online platform – https://consumerhelpline.gov.in/ , which will be forwarded to the appropriate officer for grievance redressal. One can register complaints by call on 1800-11-4000 or 1915 or through SMS on 8800001915.
Checking for Stamps: Next time you buy something by weight, look for the stamp or mark on the scale or the measuring device. It means it’s been checked and is okay to use
What a Business Owner (For Consumer Goods) Should Know?
Product Packaging and Labelling: You must ensure that all products intended for retail sale are accurately weighed or measured and are packaged as per the prescribed standards. This includes providing essential information such as net quantity, MRP (Maximum Retail Price), date of manufacture, expiry date, and consumer care details on the packaging.
Weighing and Measuring Instruments: Businesses using weighing and measuring instruments (like scales, meters, etc.) must ensure these instruments are verified and stamped by authorized Legal Metrology officers. Regular calibration and maintenance of these instruments are essential to maintain accuracy and compliance.
Compliance and Audits: Regular audits and inspections are conducted by Legal Metrology authorities to verify compliance with Legal Metrology rules. Non-compliance can lead to penalties, fines, seizure of goods or even legal repercussions, which can impact a company’s reputation and operations.
Challenges and Moving Forward
Offences relating to weights and measures are punished with fine or imprisonment or with both depending on the offence committed. The government is working on making these rules easier to understand and ensuring everyone follows them correctly.
Conclusion
Legal Metrology rules are not just about weights and measures; they are about fairness and trust in every transaction you make. By making sure everything is measured and packaged correctly, these rules protect you as a consumer and ensure that businesses play by the rules. So, next time you shop, remember these rules are on your side to make sure you get what you deserve!
The International Financial Services Centres Authority (IFSCA) has recently rolled out the 𝐁𝐨𝐨𝐤-𝐤𝐞𝐞𝐩𝐢𝐧𝐠, 𝐀𝐜𝐜𝐨𝐮𝐧𝐭𝐢𝐧𝐠, 𝐓𝐚𝐱𝐚𝐭𝐢𝐨𝐧, 𝐚𝐧𝐝 𝐅𝐢𝐧𝐚𝐧𝐜𝐢𝐚𝐥 𝐂𝐫𝐢𝐦𝐞 𝐂𝐨𝐦𝐩𝐥𝐢𝐚𝐧𝐜𝐞 𝐒𝐞𝐫𝐯𝐢𝐜𝐞𝐬 (𝐁𝐀𝐓𝐅) 𝐑𝐞𝐠𝐮𝐥𝐚𝐭𝐢𝐨𝐧𝐬 𝐢𝐧 𝐉𝐮𝐧𝐞 2024. We are thrilled to share a snapshot of the permissible activities and essential considerations to keep in mind before setting up a BATF unit.
Permissible Activities
Book-keeping Services
Inclusion: Classify and record transactions, including payroll ledgers in books of account
Exclusion: Does not include payroll management and taxation services
Accounting Services (excluding audit)
Inclusion: Review, compilation, preparation, and analysis of financial statements
Exclusion: Audit; Review and compilation without any assurance and attestation
Taxation Services
Offer tax consultation, preparation, and planning
Advise on all forms of direct and indirect taxes
Prepare and file various tax returns
Financial Crime Compliance Services
Render compliance services of AML/CFT measures, FATF recommendations, and related activities
Additional Requirements
Legal Form: Company or LLP
Service Recipient: Non-resident and does not reside in a high-risk jurisdiction identified by FATF.*
Minimum Office Space Criteria: 60 sq. ft. per employee
*Please refer to the list of High-Risk Jurisdictions – February 2024.
In today’s interconnected global economy, businesses engage in cross-border transactions and collaborations, necessitating robust legal frameworks to govern contractual relationships and resolve disputes. Governing law and jurisdiction clauses play pivotal roles in international commercial contracts, providing clarity, predictability, and mechanisms for effective dispute resolution. This comprehensive guide delves into the intricacies of governing law and jurisdiction clauses, offering insights from legal principles, industry best practices, and relevant regulatory frameworks.
Understanding Governing Law Clauses
Definition and Purpose: Governing law clauses, commonly included in commercial agreements, specify the legal system and laws that will govern the interpretation, validity, and enforcement of contractual rights and obligations. These clauses serve to provide certainty and predictability to parties involved in international transactions, ensuring uniformity in legal interpretation and dispute resolution. The selection of a governing law in international contracts assumes paramount significance, as it delineates the legal framework governing the formation, performance, and termination of contractual relationships. Failure to specify the governing law can culminate in costly jurisdictional disputes, highlighting the indispensability of clear and unequivocal clause articulation. Through diligent consideration of factors such as suitability, parties’ jurisdictions, and intellectual property protection, stakeholders can strategically align the governing law with their commercial imperatives, thereby bolstering contract enforceability and mitigating legal risks.
Importance of Governing Law
The selection of an appropriate governing law is crucial for several reasons:
Consistency and Predictability: By designating a governing law, parties ensure consistency and predictability in the interpretation and application of contractual terms, thereby reducing uncertainty and potential conflicts.
Enforcement of Rights: Understanding the governing law facilitates the effective enforcement of contractual rights and obligations, enabling parties to seek legal remedies in a familiar legal environment.
Mitigation of Legal Risks: Parties can mitigate legal risks associated with unfamiliar legal systems by selecting a governing law that aligns with their business objectives and risk tolerance.
English law is widely preferred in international commercial contracts due to its:
Predictability: English law offers a well-established and predictable legal framework, providing parties with clarity and certainty in contractual matters.
Commercial Expertise: The city of London, renowned as a global financial center, boasts a sophisticated legal infrastructure and expertise in commercial law, making it an attractive jurisdiction for international business transactions.
Arbitration Facilities: London is home to prestigious arbitration institutions like the London Court of International Arbitration (LCIA), offering efficient and impartial dispute resolution mechanisms for international disputes.
Exploring Jurisdiction Clauses
Definition and Scope: Jurisdiction clauses, often coupled with governing law provisions, determine the forum where disputes arising from the contract will be adjudicated and the procedural rules that will govern the resolution process. These clauses play a crucial role in establishing the legal framework for dispute resolution and clarifying the parties’ rights and obligations. Absence of a jurisdiction clause can precipitate jurisdictional ambiguities, exacerbating legal costs and impeding timely resolution of disputes. Through meticulous consideration of factors such as geographical locations, dispute resolution mechanisms, and governing law recognition, stakeholders can strategically align the jurisdiction clause with their commercial objectives, thereby facilitating efficient and cost-effective dispute resolution.
Key Considerations in Jurisdiction Clause Drafting
Type of Jurisdiction: Parties must decide whether to opt for exclusive, non-exclusive, or one-sided jurisdiction clauses, each with distinct implications for dispute resolution.
Geographical Factors: Considerations such as the location of parties, performance of contractual obligations, and the subject matter of the contract influence the selection of an appropriate jurisdiction.
Enforcement Considerations: Parties should assess the enforceability of judgments and awards in potential jurisdictions, considering factors such as reciprocal enforcement treaties and local legal practices.
Best Practices for Clause Selection
Clarity and Precision: Drafting governing law and jurisdiction clauses requires clarity and precision to avoid ambiguity and potential disputes over interpretation.
Conclusion
Navigating governing law and jurisdiction issues in international commercial contracts requires careful consideration of legal principles, industry best practices, and regulatory frameworks. By selecting appropriate governing law and jurisdiction clauses that align with their commercial objectives and risk tolerance, parties can mitigate legal risks, enhance contractual certainty, and foster successful business relationships on a global scale. With a comprehensive understanding of the complexities surrounding these clauses and adherence to best practices, businesses can navigate the challenges of international commerce with confidence and resilience.
The Doctrine of Unconscionable Contract stands as a vital safeguard in the realm of Indian contract law, aiming to prevent exploitation and injustice arising from unfair or oppressive contractual agreements. Unconscionability is a legal concept rooted in fairness, particularly within contractual relationships. It allows a party to challenge a contract if it contains excessively harsh or oppressive terms or if one party gains an unjust advantage over the other during negotiation or formation. This principle has been acknowledged by the Law Commission of India in its 199th report on Unfair (Procedural & Substantive) Terms in Contract. The Doctrine of Unconscionable Contract serves as a mechanism to rectify these imbalances by empowering courts to scrutinize contractual agreements and invalidate provisions that contravene principles of fairness and equity.
In addition to unconscionability, the principles of non est factum offer further protection to individuals against unfair contracts. Non est factum, meaning “it is not the deed,” applies when a party signs a document under circumstances where they are mistaken as to its nature or contents. This principle recognizes that individuals should not be bound by contracts they did not understand or intend to enter into. Indian courts have invoked non est factum to set aside contracts in cases of fraud, misrepresentation, or extreme misunderstanding, thereby safeguarding individuals from unjust contractual obligations.
Furthermore, the doctrines of coercion and undue influence provide additional safeguards against unfair contractual practices. Coercion refers to situations where one party compels another to enter into a contract through threats, undermining the voluntariness of the agreement. Undue influence, on the other hand, occurs when one party having apparent authority of a fiduciary relationship exploits a position of power or trust to exert undue pressure on the other party, thereby influencing their decision-making. Indian courts scrutinize contracts for signs of coercion or undue influence, and contracts tainted by these factors may be declared void or unenforceable.
UK and Indian Law
In the United Kingdom, scholars have associated “exploitation” with the concept of unconscionability. They distinguish between unconscionable enrichment and unjust enrichment, with the former focusing on preventing exploitation and providing restitution for damages caused by exploitative bargains. Courts assess whether one party has taken advantage of the other, often due to factors like immaturity, poverty, or lack of adequate advice.
Indian law, while not explicitly codifying the doctrine of unjust enrichment, embodies principles that align with its core tenets. Within Indian jurisprudence, concepts of undue influence and unequal bargaining power, as delineated in Sections 16 (Undue Influence) and 19 (Voidability of Agreements without Free Consent) of the Indian Contract Act 1872, establish a foundation for equitable treatment in agreements. Unjust enrichment, though not codified, encapsulates the essence of retaining benefits unjustly at another’s expense, contravening principles of justice and fairness. Despite the absence of specific legislative mandates, Indian courts possess inherent authority to order restitution, aiming to dismantle unjust gains and restore fairness. This empowerment enables courts to fashion remedies tailored to the unique circumstances of each case, ensuring that aggrieved parties are made whole again.
Landmark Judgments in India:
The evolution of unconscionability in Indian contract law is punctuated by landmark judgments that have shaped its contours and applications. In Central Inland Water Transport Corporation v. Brojo Nath Ganguly (1986 SCR (2) 278), the Supreme Court of India set a precedent by declaring a clause in an employment contract, which waived an employee’s right to sue for breach of contract, as unconscionable and therefore void. Similarly, in Mithilesh Kumari v. Prem Behari Khare (AIR 1989 SC 1247), the court deemed a lease agreement clause requiring exorbitant security deposits as unconscionable and unenforceable. These judgments underscore the judiciary’s commitment to upholding fairness and equity in contractual relationships, irrespective of the parties’ relative bargaining positions.
Recent judicial pronouncements further illuminate the significance of the Doctrine of Unconscionable Contract in protecting vulnerable parties from exploitation. In Surinder Singh Deswal v. Virender Gandhi (2020 (2) SCC 514), the Supreme Court struck down a clause in a promissory note that deprived the borrower of due process rights, reaffirming the judiciary’s commitment to rectifying injustices arising from unconscionable contracts.
Broader Implications and Legal Perspectives:
The Doctrine of Unconscionable Contract transcends its immediate legal implications, embodying broader principles of distributive justice and societal welfare. By addressing power imbalances and ensuring equitable outcomes in contractual relationships, unconscionability contributes to a legal framework that prioritizes fairness and integrity. Moreover, the doctrine underscores the judiciary’s role as a guardian of individual rights and a bulwark against exploitative practices in commercial transactions.
Conclusion:
In conclusion, the Doctrine of Unconscionable Contract serves as a cornerstone of Indian contract law, safeguarding individuals against exploitation and injustice in contractual agreements. Through landmark judgments and insightful analyses, Indian courts have reaffirmed the legality and relevance of unconscionability, underscoring its pivotal role in upholding fairness and equity in contractual relationships. By promoting principles of distributive justice and societal welfare, unconscionability contributes to a legal landscape that fosters integrity, equality, and justice for all parties involved.
Software as a Service (SaaS) agreements have become increasingly prevalent in the digital era, especially in India, where the technology sector is rapidly expanding. These agreements typically involve the provision of software applications hosted on cloud-based platforms to users on a subscription basis. One critical aspect of SaaS agreements is the disclaimer of warranty clause, which plays a pivotal role in defining the rights and responsibilities of both the service provider and the user. In this article, we delve into the significance of the disclaimer of warranty clause in SaaS agreements under Indian contract law, exploring its implications, legal framework, and practical considerations.
Contextualizing the Disclaimer of Warranty Clause
At its essence, the disclaimer of warranty clause embodies the principle of caveat emptor – let the buyer beware. In the realm of SaaS agreements, this clause assumes paramount significance as it pertains to the assurances and guarantees, or lack thereof, regarding the performance, functionality, and suitability of the software platform provided by the service provider. By disclaiming certain warranties, the provider seeks to mitigate legal exposure and shield itself from potential claims arising from performance discrepancies, operational disruptions, or functional inadequacies inherent to software solutions.
Providing Platform on an “As Is” Basis
Central to the disclaimer of warranty clause is the provision of the SaaS platform on an “as is” basis. This legal construct signifies that the service provider makes no representations or warranties regarding the platform’s fitness for a particular purpose, merchantability, or non-infringement of third-party rights. Essentially, the platform is delivered in its current state, devoid of any implicit or explicit assurances regarding its performance, reliability, or compatibility with the user’s specific requirements.
Waiving Off All Warranties
By waiving off warranties of merchantability, fitness for purpose, and infringement, the service provider seeks to insulate itself from potential liabilities stemming from software deficiencies, operational disruptions, or intellectual property conflicts. This blanket waiver underscores the contractual understanding that the user assumes all risks associated with platform utilization, including but not limited to data loss, system incompatibility, or third-party claims arising from intellectual property violations.
Legal Framework in India
Under Indian contract law, SaaS agreements are governed primarily by the Indian Contract Act, 1872, which provides the legal framework for the formation, interpretation, and enforcement of contracts. Section 16 of the Act specifies that contracts which are entered into by parties under a mistake of fact or under certain misrepresentations may be voidable at the option of the aggrieved party. However, the Act also recognizes the principle of freedom of contract, allowing parties to negotiate and agree upon the terms of their agreement, including limitations of liability and disclaimer of warranties.
Implications and Importance
Limitation of Liability: The disclaimer of warranty clause serves to limit the liability of the service provider in case of software defects, performance issues, or service interruptions. By explicitly stating that the platform is provided “as is” and disclaiming certain warranties, the service provider seeks to shield itself from potential claims or lawsuits arising from user dissatisfaction or system failures.
Risk Allocation: In SaaS agreements, the disclaimer of warranty clause helps to allocate risks between the parties more equitably. It puts the onus on the user to assess the suitability of the platform for their intended purposes and acknowledges that the service provider cannot guarantee flawless performance or absolute compatibility with the user’s specific requirements.
Clarity and Transparency: Clear and explicit disclaimer of warranty clauses promote transparency and facilitate informed decision-making by apprising users of the inherent risks associated with platform utilization. Users are empowered to assess the platform’s suitability for their specific requirements and risk tolerance, thereby fostering a relationship grounded in mutual understanding and transparency. Further, a well-drafted disclaimer of warranty clause ensures compliance with Indian contract law principles, particularly regarding the requirement of clear and unambiguous contractual terms. Indian courts generally uphold the principle of freedom of contract and give effect to the intentions of the parties as expressed in their agreement, provided that such terms are not contrary to public policy or statutory provisions.
Flexibility and Innovation: By disclaiming warranties of merchantability and fitness for purpose, service providers are afforded greater flexibility and autonomy to innovate and iterate upon their software solutions without the burden of implicit contractual obligations. This fosters an environment conducive to continuous improvement and technological advancement, thereby enhancing the platform’s competitiveness and value proposition in the marketplace.
Conclusion
In the ever-evolving landscape of SaaS agreements, the disclaimer of warranty clause emerges as a cornerstone of legal protection, risk mitigation, and transparency. By delineating the scope of warranties provided and waiving off certain assurances, service providers and users alike navigate the SaaS ecosystem with prudence, clarity, and mutual understanding. As digital solutions continue to redefine business paradigms and empower enterprises with unprecedented capabilities, embracing the nuances of the disclaimer of warranty clause becomes indispensable for fostering resilient, mutually beneficial contractual relationships in the digital age.
In the intricate realm of Indian Contract law, the doctrine of severability and the Blue Pencil Rule serve as vital tools in ensuring fairness and enforceability in agreements. When confronted with contracts containing both legal and illegal provisions, courts employ these doctrines to salvage the valid portions while nullifying the illegal ones. This article delves into the principles behind severability and the Blue Pencil Rule, their application in various jurisdictions, and their significance in modern contract law.
The Doctrine of Severability
At the heart of the contract law lies the Doctrine of Severability, which dictates that if any provision of a contract is deemed illegal or void, the remaining provisions should be severed and enforced independently, provided such severance does not thwart the original intentions of the parties. This principle, embodied in the Severability Clause, safeguards the validity of contracts by allowing courts to salvage the enforceable portions while disregarding the unlawful ones.
The Severability Clause is based on the ‘Doctrine of Severability’ or ‘Doctrine of Separability’, according to which, if any provision of a contract is rendered illegal or void, the remaining provisions shall be severed and enforced independent of the unenforceable provision, ensuring the effectuation of the parties’ intention.
The Blue Pencil Rule
The Blue Pencil Doctrine, rooted in the principle of severability, offers a solution to this dilemma by allowing courts to strike out the illegal, unenforceable, or unnecessary portions of a contract while preserving the remainder as enforceable and legal. The term “blue pencil” originates from the practice of using a blue pencil for editing or censoring manuscripts and films. In contract law, the doctrine gained prominence through the case of Mallan v. May (1844) 13 M and W 511, initially applied in disputes over non-compete agreements.
Subsequently, the doctrine received broader application through cases like Nordenfelt v. Maxim Nordenfelt Guns and Ammunitions Co. Ltd. [1894] A.C. 535, extending its reach beyond non-compete agreements. The concept was officially named in the case of Atwood v. Lamont [1920] 3 K.B. 571. Grounded in the principle of severability, the Blue Pencil Doctrine operates in common law jurisdictions, allowing courts to salvage valid contractual terms by excising the problematic ones.
In India, the Blue Pencil Doctrine finds expression in Section 24 and Section 27 of the Indian Contract Act, 1872. Section 24 states that if any part of the consideration in a contract is unlawful, the entire contract becomes void. Similarly, Section 27 provides that any restraint on lawful profession or trade is void to that extent. Initially applied in cases involving non-compete agreements, the doctrine has since been expanded to cover various aspects of contracts, including arbitration agreements, memorandum of understanding, sale of real estate, and contracts against public policy.
Judicial Pronouncements and Principles
Judicial pronouncements, particularly in landmark cases like Shin Satellite Public Co. Ltd. v. Jain Studios Limited, have elucidated the principles underlying severability. The Supreme Court of India has emphasized the doctrine of substantial severability, focusing on retaining the core aspects of contracts while disregarding trivial or technical elements. Furthermore, principles governing statutory provisions, as outlined in cases like R.M.D. Chamarbaugwalla & Anr. v. Union of India & Anr., provide a roadmap for the application of severability in contractual contexts.
The landmark case of Shin Satellite Public Co. Ltd. v. Jain Studios Limited, AIR 2006 SC 963, underscores the significance of the Blue Pencil Doctrine in Indian jurisprudence. The court emphasized the principle of “substantial severability” over “textual divisibility,” highlighting the importance of preserving the main or substantial portion of the contract while excising trivial or unnecessary elements. For the Blue Pencil Doctrine to be applied, substantial severability is essential, and it is incumbent upon the court to carefully assess the contract to determine its validity.
Importance of Express Severability Clauses
The insertion of express Severability Clauses in contracts serves to clarify the intentions of the parties regarding the enforceability of contractual provisions. While such clauses are invaluable in eliminating ambiguity, their absence does not preclude the application of severability principles. Courts rely on established tests and principles to determine the validity and enforceability of contracts, even in the absence of explicit Severability Clauses.
Conclusion
In conclusion, the doctrines of severability and the Blue Pencil Rule stand as bulwarks of fairness and equity in contract law. These principles enable courts to navigate complex contractual disputes, ensuring that valid agreements remain enforceable while invalid clauses are appropriately disregarded. As contract law continues to evolve, the application of these doctrines remains essential in preserving the integrity of contractual relationships and upholding the principles of justice and fairness.
In employment agreements in India, certain clauses often give rise to more debate or controversy compared to others. These contentious clauses, their significance, and aspects of their enforceability and negotiability are as follows:
Non-Compete and Non-Solicitation:
Importance: Restricts employees from working with competitors or soliciting clients or other employees after leaving the company. This helps employers safeguard their trade secrets and customer relationships.
Enforceability: Non-solicit clauses are generally valid. However non-compete clauses are generally not enforceable post-termination of employment, except in special circumstances with limited scope and duration.
Negotiability: Scope and duration can sometimes be negotiated.
Confidentiality:
Importance: Ensures protection of sensitive business information.
Enforceability: Strongly upheld, often extending beyond the employment tenure.
Negotiability: Generally non-negotiable due to its critical nature for safeguarding business interests.
Intellectual Property Rights (IPR):
Importance: If done correctly, automatically transfers rights of employee inventions created during employment to the employer.
Enforceability: Widely enforced, especially in roles involving research and development.
Negotiability: Typically not negotiable.
Termination Clauses:
Importance: Defines conditions for ending employment, either ‘at-will’, for cause, or by resignation.
Enforceability: Enforceable when compliant with labor laws (such as the reason for termination).
Negotiability: Limited, as it usually aligns with statutory requirements.
Probationary Period:
Importance: Establishes a trial period to evaluate the employee’s suitability.
Enforceability: Standard practice, conditions usually enforced as stated.
Negotiability: Duration or terms may be negotiable.
Salary and Compensation:
Importance: Details salary, bonuses, and other benefits.
Enforceability: Highly enforceable as per agreed terms.
Negotiability: Often negotiable, dependent on the role and candidate’s experience.
Working Hours and Leave:
Importance: Specifies expected working hours, workdays, and leave entitlements.
Enforceability: Generally enforceable within labor law guidelines.
Negotiability: Limited, generally adheres to company policy.
Appointment and Position:
Importance: Specifies role, designation, and key responsibilities.
Enforceability: Generally binding but subject to changes in organizational structure.
Negotiability: Limited, often aligned with organizational needs.
Dispute Resolution:
Importance: Outlines how employment disputes will be resolved.
Enforceability: Generally upheld, often includes arbitration clauses.
Negotiability: May be negotiable but usually follows standard legal practices.
Governing Law and Jurisdiction:
Importance: Indicates the legal jurisdiction and laws governing the agreement.
Enforceability: Standard and enforceable.
Negotiability: Typically non-negotiable, aligns with the company’s operational jurisdiction.
In these agreements, the most contentious clauses tend to be those that limit future employment opportunities (non-compete and non-solicitation) and protect business secrets (confidentiality and IPR). While clauses like salary and probation can be more open to negotiation, those related to legal compliance and the company’s proprietary rights are usually firmly set.
Restricting Future Employment: Non-Compete clauses prevent employees from joining competitors or starting a competing business for a specified period post-employment.
Preventing Talent Poaching: Non-Solicitation clauses help companies prevent ex-employees from poaching their clients and current employees.
Employment Agreements Enforceability
Reasonableness of Terms: The Indian Contract Act, 1872, governs these clauses. A Non-Compete clause is generally not enforceable post-termination of employment if it is overly restrictive or unreasonable in terms of duration, geographic scope, and the nature of restrictions.
During Employment: However, during the term of employment, such restrictions are usually considered reasonable and enforceable.
Judicial Interpretation: Courts in India have often held that any clause which ‘restrains trade’ is void to the extent of the restraint, post-termination of employment, as per Section 27 of the Indian Contract Act. However, a balance is sought between the employee’s right to earn a livelihood and the employer’s right to protect its interests.
Employment Agreements Negotiability
Depends on Bargaining Power: The scope for negotiation often depends on the employee’s bargaining power, which varies based on seniority, uniqueness of skills, and market demand.
Customization for High-Value Employees: For senior-level employees or those with access to sensitive information, these clauses are often tailored more specifically and may involve negotiations.
Clarity and Fairness: Prospective employees can negotiate for clarity, a reasonable duration, and a specific scope to ensure the clauses are fair and not overly burdensome.
Compensation in Lieu of Restrictions: Sometimes, negotiations can include compensation for the period during which the employee is restricted from certain activities post-termination.
Under India’s new Digital Personal Data Protection Act, 2023 (the “DPDP Act”), entities which process any personal data in digital form will be required to implement appropriate technical and organizational measures to ensure compliance. In addition, entities will remain responsible for protecting such data as long as it remains in their possession or under their control, including in respect of separate processing tasks undertaken by data processors on their behalf. These overarching responsibilities will extend to taking reasonable security safeguards and procedures to prevent data breaches, as well as complying with prescribed steps if and when a breach does occur.
Importantly, compared to its predecessor draft and unlike the General Data Protection Regulation (“GDPR”) of the European Union which places direct regulatory obligations on data processors, the DPDP Act appears to attribute sole responsibility upon the main custodians of data vis-à-vis the individuals related to such data – as opposed to a mechanism of ‘joint and several’ or shared liability with contracted data processors – even when the actual processing may be undertaken by the latter pursuant to a contract or other processing arrangement.
This position appears to be based on the principle that an entity which decides the purpose and means of processing should be held primarily accountable in the event of a personal data breach. Such liability may also be invoked when an event of non-compliance arises on account of the negligence of a data processor. While processing tasks can be delegated to a third party, such delegation and/or outsourcing needs to be made under a valid contract in specified cases.
Further, organizations need to ensure that their own compliance requirements and other statutory obligations remain mirrored in their supply chain in terms of (i) implementing appropriate technical and organizational measures, as well as (ii) taking reasonable security safeguards to prevent a personal data breach. This parallel compliance regime will extend to the actions and practices of data processors, including in terms of rectifying or erasing data. For example, when an individual withdraws a previously issued consent with respect to the processing of personal data for a specified purpose, all entities processing their data – including contracted data processors – must stop, and/or must be made to stop, the processing of such information – failing which the primary entity may be held liable.
CONTRACTUAL ARRANGEMENTS
Although the term ‘processing,’ as defined in the DPDP Act, involves automated operations, such operations can be either fully or partially automated. Besides, the definition includes any activity among a wide range of operations that businesses routinely perform on data, including the collection, storage, use and sharing of information. Thus, even those business operations which involve some amount of human intervention and/or stem from human prompts will be covered under the definition of ‘processing,’ and thus, the DPDP Act will remain applicable in all such cases.
A “data fiduciary” (i.e., those entities which determine the purpose and means of processing personal data, including in conjunction with other entities) can engage, appoint, use or otherwise involve a data processor to process personal information on its behalf for any activity related to the offering of goods or services to “data principals” (i.e., specifically identifiable individuals to whom the personal data relates) as long as it is done through a valid contract. However, irrespective of any agreement to the contrary, a data fiduciary will remain responsible for complying with the provisions of the law, including in respect of any processing undertaken on its behalf by a data processor.
DUE DILIGENCE AND RISK ASSESSMENT
Given that data fiduciaries may be ultimately responsible for the omissions of data processors, contracts between such entities need to be negotiated carefully. In this regard, the risks associated with such outsourced data processing activities need to be taken into account by data fiduciaries, including in respect of risks related to the following categories:
Compliance: where obligations under the DPDP Act with respect to implementing appropriate technical and organizational measures, preventing personal data breach and protecting data are not adequately complied with by a data processor;
Contractual: where a data fiduciary may not have the ability to enforce the contract;
Cybersecurity: where a breach in a data processor’s information technology (“IT”) systems may lead to potential loss, leak or breach of personal data;
Legal: where the data fiduciary is subjected to financial penalties due to the negligence or omission of the data processor; and
Operational: arising due to technology failure, fraud, error, inadequate capacity to fulfill obligations and/or to provide remedies.
Thus, data fiduciaries need to (1) exercise due diligence, (2) put in place sound and responsive risk management practices for effective supervision, and (3) manage the risks arising from outsourced data processing activities. Accordingly, data fiduciaries need to select data processors based on a comprehensive risk assessment strategy.
A data fiduciary may need to retain ultimate control over the delegated data processing activity. Since such processing arrangements will not affect the rights of an individual data principal against the data fiduciary – including in respect of the former’s statutory right to avail of an effective grievance redressal mechanism under the DPDP Act – the responsibility of addressing such grievances will rest with the data fiduciary itself, including in respect of the services provided by the data processor.
If, on the other hand, a data fiduciary outsources its grievance redressal function to a third party, it needs to provide data principals with the option of accessing its own nodal officials directly (i.e., a data protection officer, where applicable, or any other person authorized by such data fiduciary to respond to communications from a data principal for the purpose of exercising their rights).
In light of the above, before entering into data processing arrangements, a data fiduciary may want to have a board-approved processing policy which incorporates specific selection criteria for: (i) all data processing activities and data processors; (ii) parameters for grading the criticality of outsourced data processing; (iii) delegation of authority depending on risks and criticality; and (iv) systems to monitor and review the operation of data processing activities.
DATA PROCESSING AGREEMENT
The terms and conditions governing the contract between the data fiduciary and the data processor should be carefully defined in written data processing agreements (“DPAs”) and vetted by the data fiduciary’s legal counsel for legal effect and enforceability. Each DPA should address the risks and the strategies for mitigation. The agreement should also be sufficiently flexible to allow the data fiduciary to retain adequate control over the delegated activity and the right to intervene with appropriate measures to meet legal and regulatory obligations. In situations where the primary or initial interface with data principals lies with data processors (e.g., where data processors are made responsible for collecting personal data on behalf of data fiduciaries), the nature of the legal relationship between the parties, including in respect of agency or otherwise, should also be made explicit in the contract. Some of the key provisions could incorporate the following:
Defining the data processing activity, including appropriate service and performance standards;
The data fiduciary’s access to all records and information relevant to the processing activity, as available with the data processor;
Providing for continuous monitoring and assessment by the data fiduciary of the data processing activity, so that any corrective measures can be taken immediately;
Ensuring that controls are in place for maintaining the confidentiality of customer data, and incorporating the data processor’s liability in case of a security breach and/or a data leak;
Incorporating contingency plans to ensure business continuity;
Requiring the data fiduciary’s prior approval for the use of sub-contractors for all or part of a delegated processing activity;
Retaining the data fiduciary’s right to conduct an audit of the data processor’s operations, as well as the right to obtain copies of audit reports and findings made about the data processor in conjunction with the contracted processing services;
Adding clauses which make clear that government, regulatory or other authorized person(s) may want to access the data fiduciary’s records, including those that relate to delegated processing tasks;
In light of the above, adding further clauses related to a clear obligation on the data processor to comply with directions given by the government or other authorities with respect to processing activities related to the data fiduciary;
Incorporating clauses to recognize the right of the data fiduciary to inspect the data processor’s IT and cybersecurity systems;
Maintaining the confidentiality of personal information even after the agreement expires or gets terminated; and
The data processor’s obligations related to preserving records and data in accordance with the legal and/or regulatory obligations of the data fiduciary, such that the data fiduciary’s interests in this regard are protected even after the termination of the contract.
LEARNINGS FROM THE GDPR
Many companies that primarily act as data processors have standard DPAs which they ask data fiduciaries to agree to, or negotiate from. The GDPR provides a set of requirements for such DPAs, including certain compulsory information. In India, such standards could evolve through practice, such as by including clauses in DPAs related to the following:
Information about the processing, including its: (i) subject matter; (ii) duration; (iii) nature; and purpose
The types of personal data involved
The categories of data principals (e.g., customers of the data fiduciary)
The obligations of the data fiduciary
A DPA in India could also set out the obligations of a data processor, including those that require it to:
Act only on the written instructions of the data fiduciary
Ensure confidentiality
Maintain security
Only hire sub-processors under a written contract, and with the data fiduciary’s permission
Ensure all personal data is deleted or returned at the end of the contract
Allow the data fiduciary to conduct audits and provide all necessary information on request
Inform the data fiduciary immediately if something goes wrong
Assist the data fiduciary, where required, with respect to: (i) facilitating requests from data principals in exercise of their statutory rights; (ii) maintaining security; (iii) data breach notifications; and (iv) data protection impact assessments and audits, if required.
CAN A DPA BE USED TO TRANSFER LIABILITY?
Even if a personal data breach or an incident of non-compliance arises on account of a data processor’s act or omission, a DPA alone may not be sufficient to relieve the corresponding data fiduciary of its obligations (including in terms of a financial penalty, as may be imposed by the Data Protection Board of India (the “DPBI”)). However, a DPA may be negotiated such as to allow the data fiduciary to recover money from the data processor in some circumstances.
To be sure, if a data processor fails to comply with its contractual obligations under a DPA and thereby causes a data breach or leads to some other ground of complaint under the DPDP Act, the data fiduciary may still be required to pay the penalty, if and when imposed by the DPBI. However, if such breach and/or non-compliance occurs because the data processor did (or did not do) something, thus amounting to a breach of its DPA with the data fiduciary, then the data fiduciary may be able to seek compensation from the data processor for a breach of the DPA and/or invoke the indemnity provisions under such contract.
For example, a DPA can include a “hold harmless” clause. Such clauses may serve to govern how liability falls between the parties. On the other hand, a limitation (or exclusion) of liability clause may aim to limit the amount that one party will pay to the other in the event that it breaches the contract.
WHAT IF A DATA PROCESSOR PROCESSES PERSONAL DATA OUTSIDE THE CONFINES OF A DPA?
If a data processor processes personal data beyond what is permitted under a DPA, or does so contrary to the data fiduciary’s directions, such processor may become a data fiduciary by itself (other than possibly being in breach of the DPA). As long as a data processor operates pursuant to the instructions of a data fiduciary, it is only the latter that will remain directly responsible to data principals under the DPDP Act (for the specified purpose with respect to the processing of such personal data). However, as soon as a data processor determines the means and purpose of processing in its own right, it may become directly responsible to corresponding data principals.
In this regard, a data fiduciary may wish to include a clause in the DPA that obliges the data processor to process personal data only in accordance with the DPA, and to the extent necessary, for the purpose of providing the services contemplated under such DPA. Alternatively, a data processor could be permitted to process personal data further to the written instructions of corresponding data principals. Further, processing outside the scope of the DPA could require a prior contract between the data principal(s) concerned and the data processor, respectively, with respect to a separate arrangement.
Nevertheless, the personal information that a data processor receives from a data fiduciary for the purpose of processing, or that it collects on the latter’s behalf, can only be processed pursuant to the restrictions of a DPA. If the data processor starts processing such personal data outside the confines pf a DPA, e.g., by gathering additional personal data that it has not been instructed to collect, or starts processing data in a way that is inconsistent with, or contrary to, the data fiduciary’s directions, such data processor is likely to be considered a data fiduciary for the purposes of the DPDP Act.
INDEMNIFICATION
As mentioned above, data fiduciaries may need to include indemnity clauses in their DPAs with data processors, where data processors agree to indemnify the data fiduciary against all third-party complaints, charges, claims, damages, losses, costs, liabilities, and expenses due to, arising out of, or relating in any way to a data processor’s breach of contractual obligations. A mutual “hold harmless” clause is one in which the protections offered and/or excluded are reciprocal between the parties.
CONFIDENTIALITY AND SECURITY
Data fiduciaries need to ensure the security and confidentiality of customer information which remains in the custody or possession of a data processor. Accordingly, the access to customer information by the staff of the data processor should be strictly on a ‘need-to-know’ basis, i.e., limited to such areas and issues where the personal information concerned is necessary to perform a specifically delegated processing function.
Further, the data processor should be able to isolate and clearly identify the data fiduciary’s customer information to protect the confidentiality of such individuals. Where the data processor acts as a processing agent for multiple data fiduciaries, there should be strong safeguards (including via encryptions of customer data) to avoid the co-mingling of such information related to different entities.
Nevertheless, a data fiduciary should regularly monitor the security practices of its data processors, and require the latter to disclose security breaches and/or cybersecurity-related incidents, including, in particular, a personal data breach. After all, a data fiduciary is required to notify the DPBI as well as each affected individual if a personal data breach occurs. In addition, cybersecurity incidents also need to be reported to the Indian Computer Emergency Response Team (“CERT-In”) within six hours from the identification or notification of such incident. At any rate, the data processor must be obliged through a DPA to notify the data fiduciary about any breach of security or leak of confidential information related to customers or other individuals as soon as possible.
BUSINESS CONTINUITY AND DISASTER RECOVERY
Data processors could be required to establish a framework for documenting, maintaining and testing business continuity and recovery procedures arising out of any data processing activity. The data fiduciary could then ensure that the data processor periodically tests such continuity and recovery plans. Further, a data fiduciary could consider conducting occasional joint exercises with its data processors for the purpose of testing such procedures periodically.
To mitigate the risk of an unexpected DPA termination or the liquidation of a data processor, the data fiduciary should retain adequate control over the data processing activities and retain its contractual right to intervene with appropriate measures to continue business operations and customer services. As part of its contingency plans, the data fiduciary may also want to consider the availability of alternative data processors, as well as the possibility of bringing back the outsourced processing activity in-house, especially in the event of an emergency. In this regard, the data fiduciary may need to assess upfront the cost, time and resources that would be involved in such an exercise.
In the event of a DPA termination, where the data processor deals with the data fiduciary’s customers directly, the fact of such termination should be adequately publicized among data fiduciary customers to ensure that they stop dealing with the concerned data processor.
CONCLUSION
As discussed in our previous note, organizations need to check whether and to what extent the DPDP Act applies to them and their operations. Although the provisions of the DPDP Act are not effective as yet, organizations may need to improve their IT and cybersecurity systems to meet new compliance requirements. Relatedly, organizations should monitor entities in their supply chains, such as suppliers and vendors, about data processing obligations. Further, existing contractual arrangements may need to be reviewed, and future contracts with data processors must be negotiated in light of the DPDP Act’s compliance requirements.
SLA stands for service level agreement. It refers to a document that outlines a commitment between a service provider and a client, including details of the service, the standards the provider must adhere to, and the metrics to measure the performance.
Typically, it is IT companies that use service-level agreements. These contracts ensure customers can expect a certain level or standard of service and specific remedies or deductions if that service is not met. SLAs are usually between companies and external suppliers, though they can also be between departments within a company.
Why are SLAs important?
Service Level Agreements (SLAs) are essential in the B2B (Business-to-Business) SaaS (Software as a Service) industry for several reasons:
Customer Expectations: SLAs help set clear and specific expectations for customers regarding the level of service they can expect. This transparency is crucial in B2B SaaS, where businesses rely on the software for critical operations. Clear expectations reduce misunderstandings and improve customer satisfaction.
Quality Assurance: SLAs provide a framework for measuring and maintaining the quality of service. By defining metrics, response times, and availability requirements, B2B SaaS companies can ensure that their software consistently meets or exceeds customer needs and industry standards.
Risk Mitigation: SLAs also serve as risk mitigation tools. They outline what happens in the event of service disruptions, downtime, or other issues. This helps both parties understand their rights and responsibilities, reducing legal disputes and financial liabilities.
Service Improvement: SLAs encourage continuous improvement. When B2B SaaS companies commit to specific performance metrics, they have a strong incentive to invest in infrastructure, monitoring, and support to meet these commitments. Regular performance evaluations can lead to service enhancements and increased customer satisfaction.
Competitive Advantage: Having well-crafted SLAs can be a competitive advantage. B2B customers often compare SLAs when evaluating SaaS providers. Companies that offer more robust and reliable service levels are more likely to win and retain customers.
Trust and Credibility: B2B SaaS companies build trust and credibility by adhering to their SLAs. Meeting or exceeding the agreed-upon service levels demonstrates a commitment to customer success and reliability.
Compliance Requirements: In some industries, regulatory requirements demand that service providers maintain certain service levels and provide documentation of compliance. SLAs serve as the basis for demonstrating adherence to these regulations.
Scalability: As a B2B SaaS company grows and serves a larger customer base, SLAs can help ensure that the quality of service remains consistent and can be scaled to meet increasing demand.
Communication and Accountability: SLAs provide a structured means of communication between the service provider and the customer. They help define roles and responsibilities, making it clear who to contact in case of issues and who is accountable for specific aspects of service delivery.
Customer Satisfaction and Retention: Meeting SLAs leads to higher customer satisfaction and loyalty. Satisfied customers are more likely to renew their subscriptions and recommend the service to others, contributing to long-term business success.
In April 2023, the five-judge constitution bench of the Supreme Court of India (“Supreme Court”), in M/s NN Global Mercantile Private Limited (“NN Global”) v. M/s Indo Unique Flame Limited (“Indo Unique”) & Ors.,1 has held that an unstamped instrument (including an arbitration agreement contained in it) which is otherwise exigible to stamp duty is non-existent in law and must be impounded by the Court before appointing an arbitrator. In respect of such unstamped agreements, the rights of the parties will remain frozen, or they would not exist until the defect is cured.
In July 2023, the Delhi High Court in Arg Outlier Media Private Limited v. HT Media Limited,2 while considering a challenge to an arbitral award passed on an unstamped agreement held that although in terms of NN Global, the agreement not being properly stamped could not have been admitted in evidence; however, once having been admitted in evidence by the arbitrator, the award passed by relying on such agreement cannot be faulted on this ground. Similar view has been expressed by the Delhi High Court in SNG Developers Limited v. Vardhman Buildtech Private Limited (initially by the Single Judge,3 and later confirmed by the Division Bench4).
In another recent judgment in August 2023, the Delhi High Court in Splendor Landbase Ltd. (“Splendor”) v. Aparna Ashram Society & Anr. (“Aparna Ashram”),5 has laid down the guidelines for expeditiously carrying out the process of impounding the agreement, and determining the stamp duty (and penalties, if applicable) payable. The judgment is in the context of appointment of the arbitrator under Section 11 of the Arbitration Act, and as such, not a binding precedent, as clarified by the Supreme Court in State of West Bengal & Ors.v. Associated Contractors.6
BACKGROUND TO THE DISPUTE
Indo Unique was awarded a work order and entered into a sub-contract with NN Global. The work order (which included the sub-contract) contained an arbitration agreement. A dispute arose in relation to encashment of a bank guarantee between NN Global and Indo Unique. NN Global filed a suit against Indo Unique. Indo Flame applied under Section 8 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”) for referring the dispute to arbitration. The application was rejected on the ground that the work order was unstamped, and therefore, unenforceable under Section 357 of the Indian Stamp Act, 1899 (“Stamp Act”).
Indo Flame filed a writ petition challenging the order of rejection. The Bombay High Court allowed the writ. Subsequently, NN Global approached the Supreme Court, where the primary issue was whether an arbitration clause, contained in an unstamped work order, can be acted upon. A three-judge bench of the Supreme Court, vide its judgment dated 11 January 2021 in NN Global vs. Indo Unique,8 held that an arbitration agreement is a distinct and separate agreement, and can be acted upon even if contained in an unstamped instrument.
ISSUE BEFORE THE SUPREME COURT
As there existed contrary judgments of the Supreme Court on this issue,the three-judge bench referred the question of law (reproduced below) to be conclusively decided by the five-judge constitutional bench of the Supreme Court:
“Whether the statutory bar contained in Section 35 of the Stamp Act, 1899 applicable to instruments chargeable to stamp duty under Section 3 read with the Schedule to the Act, would also render the arbitration agreement contained in such an instrument, which is not chargeable to payment of stamp duty, as being non-existent, unenforceable, or invalid, pending payment of stamp duty on the substantive contract/instrument?”
DISCUSSION BY THE SUPREME COURT
Existence vs. validity of the arbitration agreement
The Supreme Court discussed the purpose of insertion of Section 11(6A) in the Arbitration Act.10 Noting that under Section 11(6A), Courts must confine their examination to the existence of an arbitration agreement in proceedings under Section 11 of the Arbitration Act, it held that the examination of the existence of an arbitration agreement under Section 11(6A) does not mean mere “existence in fact”. In enquiry under Section 11, the Courts must see if the arbitration agreement exists in law, i.e., the arbitration agreement must be enforceable in the eyes of the law.
Reliance was placed on Vidya Drolia & Ors. vs. Durga Trading Corporation (“Vidya Drolia”),11 where it was held that for an arbitration agreement to “exist”, it should meet and satisfy the requirements under both Arbitration Act and the Indian Contract Act, 1872 (“Contract Act”).12 Therefore, an arbitration agreement must be a valid and enforceable contract under the law. The phrase “arbitration agreement” under Section 11(6A) of the Arbitration Act must mean a contract, by meeting the requirements under Section 2(h) & (j) of the Contract Act.13 Any agreement that cannot be enforced under law cannot be said to be a valid contract and therefore cannot be said to “exist”.
Effect of non-stamping of a document under the Stamp Act
It was held that under Section 35 of the Stamp Act, an unstamped agreement cannot be “acted upon” by the Courts. Relying on the judgment in Hindustan Steel Limited vs. Dilip Construction Company,14 it was held that to “act upon” an instrument or document would mean to give effect to it or enforce it. Therefore, an unstamped agreement, which is otherwise exigible to stamp duty, cannot be enforced by the Courts and cannot be said to have any existence in the eyes of the law.
Further reliance was placed on Mahanth Singh vs. U Ba Yi15 to observe that Section 2(j) of the Contract Act would only be attracted when a contract is rendered unenforceable by application of a substantive law. While the Stamp Act is a fiscal statute, it was held to be substantive law. Therefore, any unstamped contract exigible to stamp duty shall be rendered void under Section 2(j) of the Contract Act. It was further observed that the rights of the parties under an unstamped agreement would remain frozen or rather would not exist until such an agreement is duly stamped.16
Lastly, it was held that Courts are bound under Section 3317 of the Stamp Act to impound an instrument that has not been stamped or is unduly stamped.
On the doctrine of severability
It was observed that doctrine of severability would not play any role in the Courts duty to impound and not give effect to an unstamped instrument under the Stamp Act. While upholding that the arbitration agreement is a separate and distinct agreement from the principal agreement containing the arbitration clause, it was held that the evolution of the doctrine of severability indicates that the same cannot be invoked when dealing with the provisions of the Stamp Act.
It was observed that the doctrine of severability was primarily developed to preserve the arbitration clause in situations where the principal contract is terminated or rescinded for any reason. This was to protect the rights of the parties to resolve their disputes through arbitration, and to ensure that the powers of the arbitrator are not extinguished with the termination of the main contract. The Supreme Court opined that since arbitration agreement by itself is also exigible to stamp duty,18 the doctrine of severability would not be of help where the main contract, containing the arbitration clause, is unstamped.
DECISION OF THE SUPREME COURT
In light of the above analysis, the majority held as under:
An instrument containing the arbitration clause, if exigible to stamp duty, will have to be necessarily stamped before it can be acted upon. Such instrument, if remains unstamped, will not be a contract and not be enforceable in law, and therefore, cannot exist in law.
Section 33 and 35 of the Stamp Act would render an arbitration agreement contained in an unstamped instrument as being non-existent in law, unless the instrument is validated under the Stamp Act.
However, the Supreme Court specifically observed that it is not pronouncing any judgment in relation to the proceedings under Section 9 of the Arbitration Act, i.e., interim protection in aid of arbitration.
EMERGING CHALLENGES IN THE AFTERMATH OF THE JUDGMENT
The judgment of the Supreme Court will have far reaching implications on the pro-arbitration trend that started in 2012 with the BALCO judgment by the Supreme Court. The process for impounding an unstamped or unduly stamped instrument is generally marred by extreme delays, which would in turn cause delays in initiating arbitral proceedings. From a policy perspective, the judgment will also impede the implementation of the institutional arbitration in India, as recommended by the high-level committee chaired by Justice Srikrishna (retd.), as the arbitral institution may not be able to appoint an arbitrator in proceedings arising from unstamped arbitration agreements governed by Indian law. However, the Delhi High Court has provided guidance on the expeditious disposal of the impounding proceedings in cases where the agreement has to be impounded in relation to appointment of arbitrator under Section 11 of the Arbitration Act.
The finding that an unstamped agreement does not exist in law, and the rights of the parties under such an agreement would rather not exist may adversely impact foreign-seated arbitrations. For example, an unstamped agreement, executed outside India, and subject to Indian laws, may not be given effect to by the foreign-seated tribunal, as such an agreement would not exist under the Indian laws. Moreover, while the Supreme Court has stated that it has not pronounced on the matter in relation to Section 9 of the Arbitration Act, it remains to be seen if the Courts would grant any interim reliefs in an agreement that does not “exist” in law.
Lastly, as recognized in the dissenting opinion of Justice Hrishikesh Roy, there have been technological advances in the manner of execution of agreements (such as electronic signatures through DocuSign, etc.) and the advent of smart contract arbitration. The majority judgment has not considered such developments. This may threaten the developing ecosystem of dispute resolution through deployment of technological and artificial intelligence tools.
Proof of Concept (‘PoC’) can also be called as ‘Proof of Principle’, it can be explained as a realization of a particular method/ idea in direction to demonstrate or determine its feasibility or determination or demonstration in principle with the aim of verifying that the concept or theory of the particular agenda has some practical potential. A Proof of Concept is an exercise in which focus is on determining whether an idea/ agenda can be turned into a practicality/ reality. For example, in Software Development, PoC would examine whether an idea is practically feasible from a technology viewpoint. A PoC is usually small, crisp study and incomplete. In simple terms, a Proof of Concept (PoC) is like a plan to test if an idea, product, or design can actually be made into a reality. It’s a way to check if something is doable before committing to full production. It doesn’t deal with things like finding a market for the product or figuring out the best way to make it. One important thing to remember is that a PoC doesn’t focus on what you’ll get in the end but rather on whether the project can work. It’s not meant to figure out if people want the idea or to find the most efficient way to make it. Instead, it’s all about testing if the idea is feasible – giving the people involved a chance to see if it can be developed or built.
Important Considerations for POC Agreement
When creating a Proof of Concept agreement, there are a few things to consider:
Duration of the contract;
Defining the criteria for considering the product or service a success;
Deciding how to evaluate the PoC;
Planning what to do next if the PoC either succeeds or fails.
Benefits of Proof of Concept (PoC)
Proof of Concept (PoC) plays a crucial role in product development due to its significant benefits. It aids in problem identification, leading to resource savings. Products subjected to PoC tend to have a higher likelihood of success, as extensive testing during this phase minimizes business risks. This holds particular significance in today’s fiercely competitive business environment. Some of the advantages of PoC include:
Time and resource conservation for businesses;
Assessing market feasibility;
Detecting technical challenges and offering remedies;
Enhancing product quality;
Offering alternatives through market research.
Key Clauses in a PoC Agreement
Definitions This section defines and clarifies the terms used in the agreement to ensure a clear understanding of their exclusivity and scope. It typically serves as the opening clause of the agreement and helps prevent potential ambiguities in the future.
Duration This clause outlines the period of validity for the Proof of Concept agreement, specifying when it begins and ends. It provides exact dates for the agreement’s effectiveness and termination.
Termination The Termination clause is a critical part of any legal agreement, allowing for the agreement’s termination under specified circumstances or in case of breaches of obligations. It is usually included alongside the terms and conditions.
Performance Obligation This section details the product or service for which the agreement is executed. The specifics of the performance clause may vary depending on the industry and the products or services involved. It typically addresses questions such as the target audience, the nature and purpose of the product or service, desired outcomes, accident prevention measures, and any product/service-specific information.
Ownership The ownership clause is one of the most important clauses in the Proof of Concept Agreement and that is imperative to the agreement. This clause declares that notwithstanding anything mentioned in any other clause the rights to the product or service mentioned in the agreement belong to its manufacturer.The rights mentioned above include all rights such as copyright, patent, trademark, trade secrets and any other intellectual property rights. It includes all copies, modifications, changes made in the product or service by either of the parties to the agreement. Any new product/service that is resultant from the existing product or service mentioned in the agreement that shall also be the property of the manufacturer and no receiving party shall have any obligations or rights on it. The receiving party shall use the product or service only in the manner as specified in the general performance clause of this agreement; however, if the manufacturer creates or invents any other product or service to aid such usage or add value to the mentioned product or service then the additional product or service also belongs to the manufacturer along with all its rights.
Payment Terms The payment terms outline the compensation or payment to be made by the recipient to the manufacturer in return for the services they have utilized. The payment provision should encompass the following elements:
The specified remuneration, service fee, or consideration to be paid;
Any additional charges or reimbursements, if applicable;
Provisions for compensating damages in the event of product or service damage or deviations;
Penalties for delayed delivery; and
Interest penalties for late payments.
Conclusion
A Proof of Concept (PoC) is a valuable tool utilized across various sectors such as science, engineering, drug discovery, hardware, software, and manufacturing. Its primary purpose is to evaluate the feasibility of an idea before committing to full-scale production. In a PoC, it is essential to clarify how the product or service will be employed, define the objectives to be accomplished, and address any other business requirements.
It’s important to note that the effectiveness of a Proof of Concept greatly hinges on the specific business environment in which it is tested. When a PoC is not evaluated in a realistic business setting, the results it yields may lack accuracy. This doesn’t necessarily mean replicating the entire market environment, but rather creating a close approximation to enhance result accuracy.
The PoC Agreement template is designed for situations where more protection is needed than in a final decision, yet it doesn’t constitute a full commitment or engagement. To determine the appropriateness of using the PoC template, a three-step evaluation process is required to ascertain whether it represents a final decision and if the PoC aligns with the situation at hand.
Consequential damages, as the name suggests, refer to the compensation granted to one party for the harm or loss they experience as a result of a breach of the terms in an agreement. These damages are primarily linked to financial losses suffered by the party, including but not limited to potential profits delayed due to the breach or expenses incurred to address the harm caused by the agreement breach.
One of the essential conditions for claiming consequential damages is that they should be clearly and undoubtedly linked to the breach of the contract, rather than being remotely related. It is necessary for the plaintiff to demonstrate that the pecuniary loss or expenses incurred are a direct consequence of the other party’s breach of the agreement.
Important considerations in determination of consequential damages
When determining the extent of consequential damages, several important aspects must be considered:
Proximity/Natural ConsequenceThe first step in assessing consequential damages is to establish that the loss being claimed by the plaintiff is a direct result of the contract breach. Section 73 of the Indian Contract Act, 1872 emphasizes that damages cannot be sought for losses that are remote or indirect. To determine proximity, the concept of the remoteness of damages is applied. According to the Indian Contract Act, for damages to be awarded, it is essential that the loss or damage “arose in the usual course of things from such breach, or the parties knew that such loss or damage could reasonably occur at the time of entering into the contract.” Consequently, the defendant would not be held responsible for damages that are not closely connected to the breach of the contract. The landmark case of Hadley v. Baxendale provided guidelines for assessing the remoteness of damages. According to this case, a party suffering from a contract breach can only recover damages that can reasonably be considered as naturally arising from the breach, following the usual course of events, or that both parties could have reasonably anticipated as the likely result of the breach when making the contract. In summary, consequential damages must be a direct and foreseeable consequence of a contract breach, and damages for remote or indirect losses are generally not recoverable, as established by the Indian Contract Act and the principles outlined in the Hadley v. Baxendale case.
Reasonable ContemplationIn order to understand the remoteness of damage, the first thing which is needed to be determined is whether such loss on the event of a breach was contemplated or anticipated by the party while entering into a contract. When the terms of the agreement are formulated the parties envisage the possible/potential outcomes arising out of the breach of contract. If such loss for which the consequential damages are claimed, was genuinely contemplated by both the parties, then the defendant party cannot evade liability to pay consequential damages by saying that such loss was remote or indirect. This is the unique thing about consequential damages, that even after the apprehension of the possibility of such loss, it is not explicitly mentioned in the contract but the claim can be raised for such loss because it seems plausible to seek damages for such loss.
TestTo establish the connection between default committed and loss is suffered is the necessary concomitant for claiming damages, the breach has to have the real and effective cause for the loss. So basically, the impact of the breach which transcends actual loss and causes other ancillary damages closely related to the subject matter of contract can be recovered in the name of consequential damages. To ascertain the link between breach and injury, the English Courts introduced the “But For” test. In this test, the court discerns on a simple question, whether the loss would have taken place if it weren’t for the wrongful acts/omission by the defendant. The test was first applied in Reg Glass Pty Ltd v. Rivers Locking Systems Ltd, the defendant did not insert the locks on the doors in accordance with the terms of the agreement, later a robbery took place in the house of the plaintiff. The court held that if it weren’t for the defendant’s failure in putting locks in accordance with the agreement the robbery could have been precluded.
The same test of “but for” test was applied by the Hon’ble Supreme Court of India in a landmark case “but for” test, the Hon’ble Supreme Court had stated that neglect of duty of the defendant to keep the goods insured resulted in a direct loss of claim from the government (there was an ordinance that the government would compensate for damage to property insured wholly or partially at the time of the explosion against fire under a policy covering fire risk). The Supreme Court concluded that “But for the appellants’ neglect of duty to keep the goods insured according to the agreement, they (the respondents) could have recovered the full value of the goods from the government”.
Advancements in technology and the expansion of global markets have introduced more intricate challenges, necessitating the businesses take steps to safeguard their rightful interests. To maintain and secure assets like confidential data, unique concepts, and trade secrets, parties entering into contracts frequently find it necessary to incorporate restrictive clauses, which limit the freedom of the other party to utilize confidential information or engage in a particular profession, trade, or business with other parties.
However, it is pertinent to note that these are often a subject of debate since these covenants contradict Section 27 of the Indian Contract Act, 1872 (ICA), which sets out that any agreement restraining someone from engaging in a legal profession, trade, or business is void to that extent. Since the legal framework addressing these conflicts is still in its early stages in India, judicial rulings and established legal principles have been crucial in shaping a jurisprudence that balances the competing interests and rights inherent in restrictive covenants and the provisions of Section 27 of the Indian Contract Act, 1872.
Nevertheless, conflicting interpretations continue to arise, making it necessary to thoroughly review the developments and validity of restrictive covenants in light of Section 27 of the Act.
What are restrictive covenants?
Restrictive covenants typically form a part of most agreements and aims to prevent employees from sharing confidential or valuable information which they gain access to during the term of their employment, a restrictive covenant is a provision that restricts an employee from seeking new employment for a specified period after leaving a company or organization. Notable examples of such restrictive clauses include contracts related to maintaining confidentiality, refraining from disclosing sensitive information, and avoiding solicitation of former colleagues or clients.
Restrictive covenants in employment agreements are contractual obligations placed on employees prohibiting them from engaging in certain actions/activities. The most common kinds of restrictive covenants in the employment context are:
Exclusivity Clauses: These obligations are coterminous with employment and prohibit employees from taking up any other employment or engagements without the express permission of the employer.
Non-Compete Clauses: Employers use these clauses to bar employees during and post-termination from taking up employment or engagements with competitors or from conducting business that would compete with the employer.
Non-Solicit Clauses: These clauses typically restrict an employee from soliciting the employer’s and clients post cessation of the employee’s employment with the organization.
Confidentiality Clauses: These clauses protect trade secrets or other proprietary information from unauthorized disclosure by an employee during and after employment. A confidentiality clause usually defines what information should be considered confidential, the temporal and geographical scope of the obligation, and related rights and consequences for breach of the obligation.
Types of Restrictive Covenants
Points to Remember
Is it lawful for the employers to use restrictive covenants beyond the termination of the employment of the employee? No. Any agreement which restrains a person from exercising a lawful profession, trade or business of any kind is, to that extent, void under the Indian Contract Act, 1872. The only statutory exception to this rule applies to agreements involving the sale of goodwill, wherein the seller and the buyer may agree to certain reasonable restrictions on carrying out a similar trade or business within a certain geographic area. In interpreting this provision, Indian courts have consistently held that while restrictive covenants operating during the term of the employment contract are valid, any clauses restricting an employee’s activities post-employment would be in restraint of trade
How to ensure that the Restrictive Covenants are not in contradiction to Section 27 of the Act? It is advisable that restrictive covenants are drafted narrowly to ensure their enforceability. However, even if restrictions are drafted broadly, the courts ordinarily use the principle of severability to invalidate the restrictions only to the extent that they are excessively broad. The courts can do this whether or not the contract contains a severability clause, although it is advisable to include such a clause in the interests of clarity. An excessively broad restriction may not render the covenant unenforceable in its entirety. For example, it is common for contracts to include restrictive covenants protecting the business of group companies, but the courts will enforce such a clause only to the extent that the employer can demonstrate a reasonable nexus between its business and that of the company concerned.
If an employee is dismissed or the employee resigns in response to a repudiatory breach, will the employee be still bound by any restrictive covenants? The restrictive covenants of non-solicitation, confidentiality and misrepresentation would survive a repudiatory breach or wrongful dismissal and would continue to be enforceable.
While liquidated damages refer to the amount of damages which the party estimates for the breach of the contract. On the other hand, Penalty is damages which are additional to the liquidated damages. The expression ‘penalty’ is an elastic term with many different shades, but it always involves an idea of punishment. The Purpose of a Penalty clause is not to ensure compensation in case of a breach but the performance of a contract. In English Law, the penalty clause is against Public Policy. However, the Indian Courts have been silent on this particular aspect. Section 23 of the Indian Contract Act states that Agreements whose object is opposed to Public Policy is void.
The Indian statue has made a classification on Liquidated Damages and Penalty with reasonability. It means that liquidated damages are reasonable whereas anything which is unreasonable and excessive of the amount of breach is penalty. Liquidated damages or Penalty act as a penalty beyond which the Court cannot give reasonable compensation.
Current legislation governing penalty clauses regulation
The legislature in India has not stated the validity of penalty clauses. These clauses are governed under Chapter VI of the Indian Contract Act, 1872.
Section 73 of the Act states that compensation for loss is caused by breach of contract. It is defined as “When a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it.
Such compensation is not to be given for any remote and indirect loss or damage sustained by reason of the breach.” It is clear from this Section that the loss should be natural and should arise directly out of the breach of this contract. Further, this Section also discusses the remoteness of damage. Remoteness refers to whether the said damage was directly related to the breach. In cases where the damage is indirect and remote, the Court shall not give compensation to the defaulting party. Penalty clauses on the other hand are penal damages which are more than the loss which is incurred.
Section 74 of the Act defines Compensation for breach of Contract where penalty is stipulated for. Contracts in which there is a penalty clause, the aggrieved party can only ask for a reasonable compensation from the parties. The word reasonable is not stated but shall be taken up on a case-to-case basis looking at the circumstances of the case, the amount of default, paying capabilities of the parties etc.
Both liquidated damages and penalty follow the doctrine of reasonable compensation. Doctrine of Reasonable Compensation refers to when the compensation is “reasonable”. Reasonability is determined by the facts and circumstances of each case. In case of a breaching party, reasonability may mean the damage suffered.
The Supreme Court of India in various judgements has mentioned the importance of reasonable compensation. In the case of Construction & Design Services v. Delhi Development Authority [8], the Court stated that the Court must determine the reasonable compensation and then grant it to the injured party.
Enforceability of a penalty clause
In India, the Validity of Penalty Clauses was questioned in various Supreme Court judgements. Generally, penalty clauses are taken in consideration with liquidated damages. In ONGC v Saw Pipes, the Court laid down certain observations referring to Section 73 and 74 of the Act one of which was that “If the terms are clear and unambiguous stipulating the liquidated damages in case of the breach of the Contract unless it is held that such estimate of damages/compensation is unreasonable or is by way of penalty, the party who has committed the breach is required to pay such compensation and that is what is provided in Section 73 of the Contract Act.” The Law not only decides the amount of liquidated damages but also the compensation which is ‘likely’ to arise from the breach of the Contract.
Therefore, the Apex Court had explicitly stated that liquidated damages unless unreasonable or penalty shall be allowed. It further stated that even in case of unliquidated damages, if it is not unreasonable or penal then the Court shall allow compensation which is a genuine pre-estimate of the loss.
In Fateh Chand v Balkishan Das, the Supreme Court similarly stated that the “Duty not to enforce the penalty clause but only to award reasonable compensation is statutorily imposed upon Courts by Section 74.” Contracts with penalty clauses often are unreasonable and put a burden on the defaulting party. Parties in case of wilful default might suffer consequences which are much more than their default. It can be said that putting unreasonable penalties on the defaulting party is against Public Policy. In Central Inland Water Transport Corpn. Ltd. V Brojo Nath Ganguly [12], the Supreme Court said that “Public Policy” and “Opposed to Public Policy” is not defined under the Indian Contract Act and is incapable of a precise definition. Therefore, what is injurious to public good can be the basic definition of ‘Opposed to Public Policy’. Contracts with Penalty Clauses can be said to be against Public Policy because it is harmful to the parties who have defaulted even in cases when the default is not wilful.
Conclusion
Damages are of two types – liquidated and unliquidated. Liquidated damages are defined at the start of the Contract whereas the unliquidated damages refer to when damages have not been pre-estimated but are equal to the amount of breach.
Penalty on the other hand is often added to the Agreement in order to deter the parties to not perform their part of the obligation. In the common law jurisdictions, penalty clauses are not valid. However, the amount of penalty should be excessive and unreasonable.
In India, a variety of cases have been filed with reference to Liquidated Damages and Penalty. Only the amount which is reasonable to the breach shall be provided by the Courts. Therefore, the Indian judiciary makes penalty clauses valid only till the point where it is reasonable and not in excess of the breach.
Under ordinary circumstance, when a person is making any payment to a non-resident, the AD Banker mandates such person to furnish Form 15CA and / or Form 15CB for the transaction before releasing any payment to non-residents in their foreign currency account / offshore bank account. This is because the AD Banker is mandated by the RBI to obtain a certain set of documents (which includes Form 15 CA and / or Form 15 CB) 𝐛𝐞𝐟𝐨𝐫𝐞 𝐩𝐫𝐨𝐜𝐞𝐬𝐬𝐢𝐧𝐠 𝐚𝐧𝐲 𝐫𝐞𝐦𝐢𝐭𝐭𝐚𝐧𝐜𝐞𝐬 𝐨𝐮𝐭𝐬𝐢𝐝𝐞 𝐈𝐧𝐝𝐢𝐚.
Now, here’s the tricky part, what happens if you are making a payment to a non-resident who has an NRO account (for example, NRIs or Person of Indian origin)?
Let’s first understand what is an NRO account? NRO accounts are a popular way for NRIs to manage their deposits or income earned in India such as dividends, pension, rent, sale proceeds, etc. in INR.
If you end up making a payment to an NRO account holder, technically, there is no money going outside India. Hence, the AD Banker is not involved and the remittance can happen directly from the payer’s Indian bank account to the NRO account holder like any other day-to-day transaction.
But, does that mean there is no obligation on the payer to file Form 15CA and / or Form 15CB since there is no money going outside India? 𝐓𝐡𝐞 𝐚𝐧𝐬𝐰𝐞𝐫 𝐭𝐨 𝐭𝐡𝐚𝐭 𝐢𝐬 𝐍𝐨.
The obligation on the payer to file Form 15CA and / or Form 15CB stems from Section 195 of the Income-tax Act, 1961 read with Rule 37BB of the Income-tax Rules, 1962. The section requires any person responsible for making a payment to a non-resident / foreign company to file Form 15CA and / or Form 15CB 𝐩𝐫𝐢𝐨𝐫 𝐭𝐨 𝐫𝐞𝐦𝐢𝐭𝐭𝐢𝐧𝐠 𝐭𝐡𝐞 𝐩𝐚𝐲𝐦𝐞𝐧𝐭.
In layman terms, the obligation to file Form 15CA and / or Form 15CB is not associated with remittance of funds outside India but actually associated with making 𝐩𝐚𝐲𝐦𝐞𝐧𝐭𝐬 𝐭𝐨 𝐧𝐨𝐧-𝐫𝐞𝐬𝐢𝐝𝐞𝐧𝐭𝐬, a fact that is often overlooked by most players.
So keep this in mind 𝐛𝐞𝐟𝐨𝐫𝐞 making your next remittance to a NRO account holder, be it for rent or sale proceeds on transfer of property / shares even if your banker does not mandate as the penalty for non-filing / filing inaccurately is ₹ 1 𝐥𝐚𝐤𝐡!!
Stay ahead of the curve with our insights on FLA reporting, mandated by the Reserve Bank of India (RBI) under the Foreign Exchange Management Act (FEMA),1999.
What is covered? 1. Understanding the purpose of FLA Reporting 2. Annual filing requirements for Indian companies and LLPs 3. Step-by-step guide to key FLA filing requirements 4. Penalties for non-compliance
Do you hold equity shares in a private limited company that has invested in immovable property or shares of another company? It’s essential to understand how Fair Market Value (FMV) is calculated for equity share transfers of such private limited company.
Under the Income Tax Act, equity share transfers must be executed at FMV, as determined by Rule 11UA. According to Rule 11UA of the Income Tax Rules, the FMV is calculated based on the Net Asset Value (NAV).
The NAV is calculated by subtracting total liabilities from total assets. However, special consideration is required for: 1. Investments in Shares and Securities: These must be valued at their fair market value, not book value. 2. Investments in Immovable Property: The value should be the stamp duty value adopted or assessed by any governmental authority. This necessitates obtaining a valuation report from a registered valuer (L&B).
For companies and stakeholders, understanding these nuances is crucial.
Starting June 18, 2024, all advertisers and advertising agencies must upload a ” – ” before publishing ads on TV, radio, print, or online platforms, as per the . Ensure your ads comply with all guidelines!
Did you know that transfers of shares in a foreign company can be taxable in India if they derive substantial value from Indian assets? Here’s how:
Tax Event: Shares of a foreign company are deemed to derive its value substantially from India, if on the specified date, the value of shares of Indian company: – exceeds INR 10 crore (approx. USD 1.2mn); and – represent at least 50% of the foreign company’s asset value
Key Exemptions – Small Shareholders: Shareholders holding 5% or less, directly or indirectly – Category I FPIs
Background The landmark Vodafone case brought this issue to the forefront. This case involved Vodafone’s acquisition of Hutchison’s stake in a Cayman Islands company, indirectly owning substantial assets in India. The Indian tax authorities claimed tax on the transaction, arguing that the transfer derived significant value from Indian assets. Vodafone contended that the transaction was not taxable under existing laws. The Supreme Court of India ruled in Vodafone’s favor in 2012. However, in response, the Indian government introduced a retrospective amendment to the Income Tax Act, 1961 allowing taxation of such indirect transfers, thereby overturning the Supreme Court’s decision and leading to prolonged legal disputes.
In the realm of financial analysis, a metric known as EBITDA holds significant weight. EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is an additional measure of profitability that strips out non-cash expenses (depreciation and amortization), taxes, and interest expenses, which depend on the company’s capital structure. It aims to display cash profit that is generated by the company’s operations. This article covers the definition, calculation, and insights EBITDA offers into a company’s financial well-being.
What is EBITDA?
EBITDA is a financial metric used extensively by companies to measure their financial performance. It provides a distinct idea to investors and lenders about a company’s profitability. However, EBITDA can be misleading as it does not reflect the company’s cash flow.
EBITDA assesses a company’s operating profitability by stripping away the influence of financing decisions, tax implications, and non-cash accounting expenses. This offers a clearer picture of a company’s ability to generate cash flow from its core business activities.
Imagine a company’s profitability as a tree. The core business activities, like selling products or services, represent the roots that generate the company’s lifeblood – cash. EBITDA helps us understand the strength of these roots, independent of how the company finances its operations (interest), the tax environment it operates in (taxes), or how it accounts for the gradual decline in asset value over time (depreciation and amortization).
Calculation of EBITDA
There are two primary ways to calculate EBITDA:
1. The Net Income Approach
This method starts with the company’s net income, which is the profit after accounting for all expenses. Non-cash expenses (depreciation and amortization) and financing costs (interest and taxes) are added back to arrive at EBITDA.
EBITDA = Net Income + Interest Expense + Taxes + Depreciation + Amortization
Example Calculation: Company ABC accounts for their 15,000 depreciation and amortization expense as a part of their operating expenses. Calculate their Earnings Before Interest Taxes Depreciation and Amortization:
This approach utilizes the company’s operating income, which represents the profit before interest and taxes. Since operating income already excludes these factors, we simply add back the non-cash expenses (depreciation and amortization) to reach EBITDA.
EBITDA = Operating Income + Depreciation + Amortization
EBITDA as a Financial Metric
EBITDA shows a company’s financial performance without considering capital investments, such as plant, property, and equipment. It does not account for expenses related to debt and emphasizes the firm’s operating decisions. All these reasons highlight why it may not be an accurate measure of profitability. Additionally, it is often used to conceal poor financial judgment, like availing of a high-interest loan or using fast-depreciating equipment that comes with a high replacement cost. Nevertheless, it is still considered to be an important financial metric. It offers a precise idea of a company’s earnings before financial deductions are made or how accounts are adjusted.
What is EBITDA Margin?
EBITDA margin is a key profitability ratio that measures a company’s earnings before interest, taxes, depreciation, and amortization as a percentage of its revenue. It provides insight into how much cash profit a firm can generate in a year, which is particularly useful for comparing a firm’s performance to that of its contemporaries within a specific industry.
However, EBITDA is not registered in a company’s financial statement, so investors and financial analysts are required to calculate it on their own. It is calculated using the formula below –
EBITDA Margin = EBITDA / Revenue
Notably, a firm with a relatively larger margin is more likely to be considered a company with significant growth potential by professional buyers.
For instance, the EBITDA of Company A is ascertained to be ₹800,000, while their aggregate revenue is ₹7,000,000. On the other hand, Company B registered ₹900,000 as EBITDA and ₹12,000,000 as their aggregate revenue. So as per the formula:
Company Name
EBITDA
Total
Revenue
EBITDA Margin Calculation
EBITDA Margin
A
₹800,000
₹7,000,000
₹800,000 / ₹7,000,000
11.43%
B
₹900,000
₹12,000,000
₹900,000 / ₹12,000,000
7.50%
Therefore, despite having a higher EBITDA, Company B has a lower EBITDA margin when compared to Company A. This means Company A is financially more efficient and hence more likely to be favored by potential investors.
Importance of EBITDA
EBITDA serves as a valuable metric for several reasons:
Operational Efficiency: By focusing solely on a company’s core operations, EBITDA helps assess its operational efficiency and profitability without the impact of financing decisions, tax rates, or accounting methods.
Comparability: Since EBITDA eliminates non-operating expenses, it allows for comparisons between companies within the same industry or sector thereby evaluating investment opportunities or conducting industry benchmarks.
Financial Health: EBITDA provides insights into a company’s financial health and its ability to generate cash from its core business activities. A consistently positive EBITDA indicates robust operational performance, while negative EBITDA may signal underlying operational challenges.
Valuation: EBITDA is often used in financial modeling and valuation techniques such as the EBITDA multiple or Enterprise Value (EV) to EBITDA ratio. These methods help investors estimate the intrinsic value of a company and determine whether a company is overvalued (high ratio) or undervalued (low ratio) relative to its earnings potential.
Example of EBITDA Used in Valuation (EV/EBITDA Multiple):
Company X and Company Y are competing consulting companies that operate in Mumbai. X has an enterprise value of 5,00,000 and an EBITDA of 25,000, while firm Y has an enterprise value of 6,00,000 and an EBITDA of 50,000. Which company is undervalued on an EV/EBITDA basis?
Company X
Company Y
EV
5,00,000
6,00,000
EBITDA
25,000
50,000
EV/EBITDA
20x
12x
On an EV/EBITDA basis, company Y is undervalued because it has a lower ratio.
Limitations of EBITDA
While EBITDA offers valuable insights into operational performance, it has limitations:
Exclusion of Important Expenses: By excluding interest, taxes, depreciation, and amortization, EBITDA overlooks crucial expenses that impact a company’s overall financial health. Ignoring these expenses may give an overly optimistic view of profitability, particularly for heavily leveraged or capital-intensive businesses.
Disregard for Capital Expenditures: EBITDA does not account for capital expenditures (CAPEX) required to maintain or expand a company’s asset base. Ignoring CAPEX can distort cash flow analysis and lead to inaccurate assessments of a company’s long-term sustainability and growth prospects.
Susceptibility to Manipulation: Since EBITDA is a non-GAAP (Generally Accepted Accounting Principles) measure, companies have some discretion in its calculation, which can be exploited to portray a more favorable financial picture. Investors should exercise caution and scrutinize EBITDA figures, considering additional metrics and financial indicators for a comprehensive analysis.
Conclusion
EBITDA serves as a valuable tool for evaluating a company’s operational performance, providing insights into its profitability and financial health. By excluding non-operating expenses, EBITDA offers a clearer view of a company’s core business operations, making it easier for investors, analysts, and stakeholders to assess its performance and compare it with industry peers. However, it’s essential to recognize the limitations of EBITDA and complement its analysis with other financial metrics to gain a comprehensive understanding of a company’s financial position and prospects.
Frequently Asked Questions (FAQ) on EBITDA
1. What is the Difference Between EBITDA and Profit (Net Income)?
Answer: EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) focuses on a company’s core operational performance by excluding non-operational costs like interest, taxes, and depreciation. In contrast, profit, or net income, accounts for all expenses, including financing costs, taxes, and depreciation/amortization. EBITDA offers a clearer view of a company’s ability to generate cash flow from its day-to-day operations, making it a valuable metric for investors and analysts.
2. How to Calculate EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)?
Answer: To calculate EBITDA, start with a company’s operating income (EBIT), then add back depreciation and amortization expenses. These figures are typically available in a company’s income statement or financial reports. The formula is:
EBITDA = Operating Income (EBIT) + Depreciation + Amortization
This calculation helps assess a company’s operational profitability without the impact of non-cash expenses and financing costs.
3. What Does EBITDA Tell You About a Company’s Financial Health?
Answer: EBITDA provides insight into a company’s operational efficiency and its capacity to generate cash flow from its core business activities. By excluding interest, taxes, and depreciation, EBITDA allows investors and analysts to evaluate a company’s profitability regardless of its capital structure. This makes it easier to compare companies across industries and identify those with strong operational performance, regardless of tax rates or asset depreciation schedules.
4. What Are the Limitations of EBITDA as a Financial Metric?
Answer: While EBITDA is a useful measure of operational performance, it has limitations. It doesn’t account for interest payments, taxes, or depreciation, which are crucial to a company’s overall financial health. Furthermore, EBITDA can be manipulated through accounting practices, and it may not reflect cash flow accurately. Investors should always consider other financial metrics, such as net income and free cash flow, to get a full picture of a company’s financial condition.
5. Is a Higher EBITDA Always a Good Sign for a Business?
Answer: Not necessarily. A higher EBITDA can indicate strong operational performance, but it doesn’t guarantee profitability or financial stability. To assess whether a company is truly performing well, you need to consider other metrics, such as net income, debt levels, and cash flow. For example, a company with a high EBITDA but significant debt may still face financial challenges. Always analyze EBITDA in context with other financial data.
6. What’s the Difference Between EBITDA and EBIT?
Answer: EBIT (Earnings Before Interest and Taxes) measures a company’s profitability from operations before interest and tax expenses. EBITDA is similar but provides a broader view by adding back depreciation and amortization expenses, which are non-cash items. EBITDA is often preferred for assessing cash flow potential and operational efficiency, while EBIT focuses more on operating income before non-operational costs are considered.
7. Why Do Investors Use EBITDA to Evaluate Companies?
Answer: Investors use EBITDA because it provides a clear picture of a company’s core operational performance without the distortion of financing costs, taxes, and non-cash expenses like depreciation. It allows for easier comparison between companies in the same industry, particularly in sectors with significant capital expenditures. EBITDA is a common metric for evaluating a company’s cash flow potential, profitability, and overall business health.
8. Where Can I Find a Company’s EBITDA in Financial Reports?
Answer: You can find a company’s EBITDA in its income statement, often under the operating income section, or in the financial footnotes of its annual report (10-K or 10-Q). Many companies provide EBITDA figures directly on their investor relations websites. Additionally, financial data platforms like Yahoo Finance, Google Finance, and Morningstar also list EBITDA for publicly traded companies.
India’s Space Technology Sector: An Industry Overview
The Indian space sector is currently undergoing a significant transformation, driven by increased private sector participation and substantial government support. With over 523 private companies and research institutions now actively contributing, India’s space economy is projected to reach $44 billion by 2033, capturing nearly 10% of the global market. This manual aims to provide comprehensive insights into the industry overview, investment landscape, legal considerations, tax incentives, and intellectual property rights essential for stakeholders in the space tech ecosystem.
Government Initiatives and Investment Landscape
The government has allocated nearly $1.6 billion for the Department of Space (DoS), which oversees the Indian Space Research Organisation (ISRO) and other space-related activities. Since 2014, there has been a notable increase in private investments, particularly in satellite manufacturing and launch services, amounting to $233 million across more than 30 deals by July 2023.
Key Participants and Activities
The Indian spacetech ecosystem comprises a mix of public and private entities working collaboratively to advance the country’s space capabilities. Key activities include:
Satellite manufacturing
Launch services
Space research
Space-based applications
Space exploration
Space debris management
Commercial spaceflight
Development of space law and policy
Regulatory Framework
India’s space sector operates under a comprehensive legal and regulatory framework designed to promote innovation and facilitate private sector participation.
Key regulatory bodies and agencies include:
Department of Space (DoS)
Indian Space Research Organisation (ISRO)
Indian National Space Promotion and Authorization Center (IN-SPACe)
NewSpace India Limited (NSIL)
Antrix Corporation Limited (ACL)
Foreign Direct Investment (FDI) Policy
The existing FDI policy allows up to 100% foreign investment in satellite establishment and operation through the government route. Proposed amendments aim to further liberalize the sector, but gaps and ambiguities remain, particularly regarding compliance with sectoral guidelines and definitions of key terms.
Tax Incentives and Government Schemes
To encourage private participation, several tax measures have been implemented, including GST exemptions for satellite launch services and income tax exemptions for R&D expenditures. Key government schemes supporting the sector include:
Startup India Seed Fund Scheme
Technology Development Fund under DRDO
iDEX (Innovations for Defence Excellence)
Atal Innovation Mission (AIM)
GIFT City IFSC: A Gateway to Global Markets
GIFT City (Gujarat International Finance Tec-City) provides a favorable regulatory environment, cutting-edge infrastructure, and a robust ecosystem for space tech companies. It facilitates funding, international collaboration, and regulatory support, making it an ideal gateway for scaling operations and innovation.
Anticipated Developments
The Indian space tech sector is poised for significant growth, driven by increased FDI, public-private partnerships, advanced technologies, and upcoming incentives. The development of reusable launch vehicles and the Gaganyaan mission, slated for 2025, are set to showcase India’s capabilities and bolster its position in the global space community.
Conclusion
India’s space technology sector is at a pivotal moment, characterized by unprecedented growth, innovation, and collaboration. This report serves as a comprehensive guide for industry players, investors, policymakers, and legal professionals navigating the landscape of India’s space tech ecosystem. The combined efforts of public and private entities are driving the sector’s ascent, positioning India as a major player in the global space economy.
In line with the consultation paper issued by SEBI in August 2023, the SEBI and IFSCA have now permitted 100% participation of NRIs, OCIs, and RIs individuals for certain funds set up as SEBI registered FPIs based in IFSC.
This amendment marks a significant enhancement in facilitating the involvement of the NRI community in the Indian financial markets.
However, it is important to note that the formal amendment to the SEBI FPI Regulations is yet awaited.
Let us know your thoughts in the comments below or reach out to us at [email protected] for a detailed discussion.
As we navigate the complexities of tax season, ITR Filing is crucial for individuals and businesses alike.
Here’s what we cover in our detailed guide: 1. Understand why filing ITR is essential 2. Who needs to file an ITR 3. Filing requirements 4. Benefits of timely filing & more
