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Introduction

In June 2007, tech giant Infosys Ltd. introduced non-compete agreements for its employees¹. The clause, which was subsequently made part of the employment agreements, required that post termination of an employee, such employee agrees to not accept any offer of employment from: (i) any Infosys customer (from the last 12 months); and (ii) a named competitor of Infosys (including TCS, Wipro, Accenture, Cognizant and IBM) if the employment would require work with an Infosys customer (from the last 12 months), for a period of 6 months.

Following an increased attrition rate in Q4 of Financial Year 2022, the company began to implement this clause², leading to the Nascent Information Technology Employees Senate (NITES), an IT workers union based out of Pune, filing a complaint with the Union Labour Ministry in April 2022³. Deeming the application of the clause post exit of an employee from Infosys to be “illegal, unethical and arbitrary”, NITES demanded the removal of such clauses from the employment agreement. Defending the clause, Infosys issued a statement claiming that the non-compete clause was a “standard business practice in many parts of the world for employment contracts”, to include “controls of reasonable scope and duration” to protect the “confidentiality of information, customer connection and other legitimate business interests”⁴. 

While there is limited public information available on the outcome of the discussions between NITES, Infosys and the competent labor authorities, this throws light on an issue that has been the subject of legal discourse in India time and again: enforceability of non-compete contracts.

In this piece, we break down what non-compete is; the legal framework governing such contractual provisions; and practical considerations for employers and employees, to facilitate informed decision making at all levels. 

What is a Non-compete Clause?

Non-compete clauses are a contractual provision whereby a person exiting a business typically agrees to not start a new business, take up employment in or otherwise engage in any manner with a competing entity. Also termed as “negative covenants”, these clauses impose a contractual obligation on the person to not undertake certain activities. Consequently, failure to abide by these contractual restrictions would result in a breach of the contract: 

• Duration: Non-compete clauses can be for the duration of the employment relationship but also are typically contemplated for a specific period post termination, i.e., post exit of the individual from the business. 
• Limitations to Restrictions: These contractual restrictions are usually limited by geographical location or for a fixed period of time having the effect that the said person would be in breach of the non-compete agreement if they were to start a new business/engage with a competing entity within the same geographical area and within such time period.
• Who is Restricted: These clauses are typically built into employment agreements (particularly of founders and key managerial personnel) where access to confidential and proprietary information pertaining to a business (including with respect to intellectual property) is to be considered; if such information is used by the departing employee/founder/key employee, the likelihood of an unfair business advantage is increased.
• M&A perspective: Non-compete clauses are also seen in transaction documents executed in mergers and acquisitions, where the value of the investment can be impacted if exiting founders/key employees start or join a competing business, leading to loss of competitive advantage to the acquirer.

Can non-compete contracts be enforced in India?

Once a breach of contract is determined, the parties to such contract would have the appropriate remedial measures built in, which can typically include compensation for any loss suffered as a result of the breach. However, in order to be able to enforce such remedial measures, it is critical for the underlying contractual obligation itself to be enforceable. It is against this backdrop that the provisions of the Indian Contract Act, 1872 (“ICA”) become relevant. Section 27 of the ICA stipulates that any agreement in restraint of trade is void. In other words, any agreement that restricts a person from exercising a lawful profession, trade or business of any kind is to that extent void⁵. Stemming from the fundamental right to practice any profession or occupation protected by Article 19(1)(g) of the Constitution of India, the intent 

behind Section 27 of the ICA is to guard against any interference with freedom of trade even if it results in interference with freedom of contract. 

However it is important to note that even within the Constitution, the freedoms protected by the fundamental rights are not absolute and can be limited within specified circumstances. Historically, the Supreme Court of India and various high courts across the country have consistently adopted the following approach towards enforceability of such negative covenants: 

• Reasonableness: The enforceability will be limited to the extent that such a negative covenant is reasonable⁶; and
• Legitimacy: The purpose of the negative covenant is to protect the legitimate business interests of the buyer. The restraint cannot be greater than necessary to protect the interest concerned⁷. 

In light of the above, the Indian courts have adopted the approach that these restrictions during the period of employment are valid, as they can be considered legitimate for the protection of the business interests of the company. Against this reasoning, Section 27 would not be violated⁸. However, such obligations cannot be unconscionable, excessively harsh, unreasonable or one-sided, i.e., satisfying the requirement of reasonableness and legitimacy..

The controversy associated with such negative covenants arises when they are sought to be enforced beyond the period of employment. In a high profile ruling, the Supreme Court held that a media management company’s non-compete clause that prevented a prominent Indian cricketer from joining their competitor for a specific period of time after their agreement had terminated, could not be enforced⁹. The principle that enforcement of non-compete beyond the period of employment is void under Section 27 has been well-settled¹⁰. In a pattern followed by high courts across the country, post-termination non-compete clauses have generally not been enforced on the rationale that the right to livelihood of a person must prevail over the interests of an employer¹¹.

However, this is not to say that all non-compete clauses are automatically unenforceable. For instance, the Delhi High Court held that while employees who had already accepted the offer of employment with the competitor could not be injuncted against (as the same would read a negative covenant into their employment contracts which would violate Section 27), an injunction against future solicitation could be granted on the grounds it was a legitimate and reasonable restriction¹².

Given the uncertainty over enforcement of non-compete clauses, employers have adopted a novel approach of inserting a “garden leave” clause, during which the employee is fully paid their salary for the period in which they are restricted by such negative covenants. While such a concept has been held by the Bombay High Court to be a prima facie restraint of trade affected by Section 27¹³, it is a popular solution practiced widely by employers. Additionally, restrictions on non-disclosure of confidential information and non-solicitation of customers and employees have been previously enforced¹⁴. Non-compete obligations are also often found in mergers and acquisitions transactions, with the courts permitting such restrictions on the basis of specified local limits that are reasonable to the court, having regard to the nature of business/industry concerned¹⁵. 

Practical Considerations

Despite the trend of non-enforceability of non-compete contracts, such negative covenants are commonly found in employment and M&A contracts. These restrictions are still seen as soft deterrents, with employees preferring to comply rather than bear litigation costs and the burden of being sued by a former employer¹⁶. Here are some practical considerations for employers and employees when considering a non-compete contract: 

• Legitimacy: Employers should carefully consider whether the non-compete restriction is necessary to protect business interests. It would be prudent for employers to undertake a reasonable calculation of quantifiable harm and risk from such a breach and inform the employees of the same. 
• Reasonableness: The clause should consider: (i) the duration of restriction and geographical scope; (ii) nature of the employees position and exposure to trade secrets, proprietary information, etc.; (iii) availability of alternative employment; and (iv) compensation in terms of salary, etc. for the duration of restriction.  
• Review Impact: It is critical that employees are made fully aware of the extent to which such negative covenants are applicable and the legitimacy and reasonableness of the same arising from the impact of the employee’s departure from the organization.  

Conclusion

Non-compete clauses continue to face enforceability challenges, with the most recent example being Wipro’s lawsuit against its former CFO for violating the restriction in his employment contract and joining Cognizant as a competitor in December 2023¹⁷. India’s judicial approach to enforceability of post-termination non-compete clauses is clear: if it is not permissible within the scope of Section 27, it would not be enforceable. This differs from jurisdictions such as the United Kingdom, where post-termination restrictions that are designed to protect a proprietary interest of an employer or buyer are enforceable provided there is a material risk and the restriction is itself reasonable, are enforceable; and the United States, where the US Federal Trade Commission recently banned non-compete clauses for US workers¹⁸. The clear conclusion is that a uniform approach to enforcement of negative covenants cannot be adopted.  

Frequently Asked Questions (FAQ) on Non-Compete Clauses

1. What is a non-compete clause?

A non-compete clause is a contractual restriction that prevents an employee from joining a competitor or starting a competing business after leaving a company. It may include specific limitations on time, geographic location, and types of activities.

2. Are non-compete clauses legally enforceable in India?

In India, enforceability of non-compete clauses is limited. Section 27 of the Indian Contract Act deems any restraint of trade to be void. While certain in-employment restrictions may be valid, post-employment restrictions are generally not enforceable, as they can interfere with an individual’s right to livelihood.

3. Why do companies use non-compete clauses if they are often unenforceable?

Despite legal limitations, companies may still include non-compete clauses to act as deterrents. Many employees prefer to comply rather than face potential legal disputes.

4. What are some exceptions where non-compete clauses may be enforceable?

Non-compete clauses may be enforceable if they are reasonable in scope and necessary to protect legitimate business interests, such as confidential information or trade secrets. Courts may uphold them if they are limited to the duration of employment or for protecting specific business interests.

5. How does India’s approach compare with other countries?

India’s approach to non-compete clauses is more restrictive compared to countries like the UK, where reasonable post-termination restrictions are often enforceable if they protect a legitimate proprietary interest. In the US, non-compete laws vary by state, and recently, the Federal Trade Commission proposed a ban on non-competes for American workers.

6. What is a “garden leave” clause, and how does it relate to non-compete agreements?

A garden leave clause allows employees to remain on payroll after they resign or are terminated, but restricts them from joining competitors during this period. Although some Indian courts view it as a restraint of trade, it’s a popular alternative to non-compete clauses.

7. Can non-compete clauses be included in M&A agreements?

Yes, non-compete clauses are common in mergers and acquisitions (M&A) to protect the buyer’s investment and maintain competitive advantage. Courts may allow such clauses if they are reasonable and necessary for the protection of business interests.

8. What are the practical considerations for employees facing a non-compete clause?

Employees should assess the reasonableness and impact of any non-compete clause, including its duration, scope, and potential limitations on future employment opportunities.

9. What options do employees have if they disagree with a non-compete clause?

Employees may negotiate the terms before signing or, if already in effect, seek legal advice to understand the likelihood of enforceability based on Indian law and precedent cases.

1. [1] https://economictimes.indiatimes.com/news/company/corporate-trends/infy-asks-staffs-to-sign-pact-against-joining-rivals/articleshow/2101866.cms?from=mdr ↩︎
2. [2] https://www.businesstoday.in/latest/corporate/story/infosys-served-notice-by-union-labour-ministry-over-its-non-compete-clause-in-employee-contract-331508-2022-04-27 ↩︎
3. [3] https://nites.co.in/nites-submits-complaint-against-infosys-illegal-non-compete-agreement-to-labour-ministry/#:~:text=The%20employee’s%20covenants%20should%20be,clause%20from%20the%20employment%20agreements. ↩︎
4. [4]  ibid, 2 above. ↩︎
5. [5] The Indian Contract Act, 1872 exempts such restraint of trade contracts for transactions where the goodwill of a business is sold. ↩︎
6. [6] As laid down by the Supreme Court in Niranjan Shankar Golikari v Century Spinning and Mfg. Co. (1967) 2 SCR 378. ↩︎
7. [7] As laid down by the Supreme Court in Gujarat Bottling Co Ltd v The Coca Cola Co & Ors. (1995) SCC (5) 545. ↩︎
8. [8] As laid down by the Supreme Court in Niranjan Shankar Golikari v Century Spinning and Mfg. Co. (1967) 2 SCR 378. ↩︎
9. [9] As laid down by the Supreme Court in Percept D’Mark (India) Pvt. Ltd. v Zaheer Khan and Ors. Appeal (Civil) 5573-5574 of 2004. ↩︎
10. [10] As laid down by the Supreme Court in Superintendence Company of India (P) Ltd. v Krishan Murgai 1981 2 SCC 246. ↩︎
11. [11] Trend observed in rulings of: (i) Bombay High Court in VFS Global Services Pvt. Ltd. v Mr. Suprit Roy 2008 (3) MhLj 266; and (ii) Delhi High Court in Affle Holdings Pte. Ltd. v Saurabh Singh 2015 SCC OnLine Del 6765, and Wipro Limited v Beckman Coulter International S.A. 2006 (3) ARBLR 118 (Delhi). ↩︎
12. [12] As laid down by the Delhi High Court in Wipro Limited v Beckman Coulter International S.A. 2006 (3) ARBLR 118 (Delhi). ↩︎
13. [13] In VFS Global Services Private Limited v Mr. Suprit Roy 2008 (3) MhLj 266, the Bombay High Court reasoned that the payment of salary during garden leave does not renew the contract of employment and therefore amounted to a prima facie restraint of trade. ↩︎
14. [14] As held by: (i) Madras High Court in E-merge Tech Global Services Private Limited v M. R. Vindhyasagar and Ors. C.S. No. 258 of 2020; and (ii) Bombay High Court in Zee Telefilms Limited v Sundial Communications Private Limited 2003 (5) BOM CR 404. ↩︎
15. [15] As held by the Delhi High Court in Ozone Spa Pvt. Ltd. v Pure Fitness & Ors. 2015 222 DLT 372. ↩︎
16. [16] https://economictimes.indiatimes.com/jobs/c-suite/non-compete-clauses-unenforceable-under-law-but-companies-love-them/articleshow/109633571.cms?from=mdr ↩︎
17. [17] https://economictimes.indiatimes.com/jobs/c-suite/non-compete-clauses-unenforceable-under-law-but-companies-love-them/articleshow/109633571.cms?from=mdr ↩︎
18. [18] https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf ↩︎

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The 2024 U.S. presidential election was a highly anticipated and fiercely contested affair, with the outcome having far-reaching implications globally. As the nation grappled with a range of pressing issues, from the economy and healthcare to climate change and social justice, the political landscape was marked by a clash of ideologies and the continued influence of money and celebrity in the electoral process. Here are 10 fascinating facts about the 2024 US elections:

1. Historic Comeback: Former President Donald Trump became the second U.S. president, after Grover Cleveland, to serve non-consecutive terms since 1897. His comeback bid was fueled by a loyal base and a message of “America First” policies.
2. Divided Electorate: The 2024 U.S. election polls painted a picture of a deeply divided electorate, with the race for the White House too close to call. The Republican ticket of Trump and Ohio Senator JD Vance campaigned on a platform of limited government and a hardline stance on immigration, while the Democratic duo of Vice President Kamala Harris and Minnesota Governor Tim Walz put forward a progressive agenda.
3. Record Voter Turnout: The 2024 election saw unprecedented voter participation, with over 160 million Americans casting their ballots. This high level of engagement underscored the profound political polarization and the high stakes involved in the outcome.
4. Battleground States: As in previous elections, the 2024 U.S. election results hinged on the performance of the candidates in the key battleground states, such as Arizona, Georgia, Michigan, Nevada, North Carolina, Pennsylvania, and Wisconsin. On US election day, these states, with a combined 88 electoral votes, proved crucial in determining the overall outcome.
5. Popular Vote vs. Electoral College: The 2024 election once again highlighted the discrepancy between the popular vote and the Electoral College system. While Harris and Walz secured a narrow majority in the Electoral College, Trump received the most votes nationally, with 74 million votes (50.8%) compared to Harris’ 67 million votes (47.5%). Trump becomes the first Republican candidate to win the popular vote in 20 years.
6. Youth Voter Engagement: One of the notable trends in the 2024 election was the increased voter turnout among individuals aged 18-29, which saw an 8% increase compared to the 2020 election. This younger generation of voters played a significant role in shaping the outcome.
7. Celebrity Endorsements: High-profile figures, including musicians and actors, actively endorsed various candidates, underscoring the increasingly blurred lines between popular culture and the political sphere.
8. Campaign Expenditures: The combined spending by both campaigns exceeded $5 billion, making the 2024 election one of the most expensive in U.S. history. This further highlighted the outsized influence of wealthy donors and special interests in the electoral process.
9. Early Voting: Over 100 million votes were cast before Election Day through early and mail-in voting, accounting for more than 60% of the total votes. This trend, driven in part by the ongoing COVID-19 pandemic, reflected the evolving nature of the electoral process.
10. Midnight Voting Tradition: Dixville Notch, a small New Hampshire town, continued its tradition of being the first to vote at midnight on US Election Day, showcasing the enduring commitment to the democratic process.

These 10 fascinating facts from the 2024 U.S. elections provide a glimpse into the complex and dynamic landscape of American politics. As the nation moves forward, the key challenge will be to find ways to bridge the deep partisan divides and address the pressing issues facing the country.

The success or failure of the incoming administration in navigating these challenges will have far-reaching implications for the future of American democracy. The 2024 election has once again demonstrated the resilience and adaptability of the U.S. electoral system, as well as the enduring passions and loyalties that shape the political landscape.

As the nation looks ahead, the 2024 U.S. elections will undoubtedly be remembered as a pivotal moment in the country’s history, one that will continue to shape the course of the nation for years to come. The path forward will require a renewed commitment to bipartisanship, civic engagement and preservation of democratic norms.

Startups in India are experiencing rapid growth, fueled by individuals with unique ideas eager to address high-demand services. The Government of India has, through its Startup India Action Plan launched in 2016, implemented clear regulations to streamline the process of incorporating startups in the country. Additionally, tax regulations have been introduced to foster the growth of companies for whom a heavy tax burden in the early-growth stage can prove challenging. It’s essential for startups to familiarize themselves with these government regulations, as they can greatly benefit during income tax filing in India.

India offers a variety of appealing tax benefits aimed at encouraging and supporting startups. These benefits can substantially alleviate financial burdens, allowing startups to concentrate on their growth and innovation. Ranging from complete tax exemption for the initial 3 years to the recent 2024 abolishment of the angel tax, these incentives play a crucial role in promoting the financial stability and expansion of emerging businesses. The government consistently endeavors to provide tax benefits to entrepreneurs, particularly startups, recognizing their significant potential contribution to the Indian economy. This blog comprehensively deals with the intricacies of tax exemptions enumerated in contemporary legislations in India.

What is a Startup?

A startup is a fledgling business venture established with the aim of offering a single product or service deemed to be in demand by its founders. However, for the purpose of determining legal eligibility for taxation and to access government benefits, startups must meet the specific criteria set out in the Ministry of Commerce and Industry Gazette Notification No. G.S.R. 127(E) dated 19 February 2019 (“Startup Notification”). As outlined therein, an entity is recognised as a startup upon satisfaction of the following requirements:

• The entity’s age must be under 10 years, indicating that it has been in operation for less than a decade from its date of incorporation or registration.
• The entity must be registered as either a private limited company, limited liability partnership, or partnership firm to avail of startup-related advantages.
• Its annual turnover for any financial year since its incorporation/registration should not exceed ₹100 crores.
• The entity should actively engage in the innovation, development or improvement of products, processes or services; or if it is a scalable business, should have a high potential of employment generation or wealth creation.
• The entity must not be established through the reconstruction or division of an existing business. 

Once determined that an entity satisfies the relevant criteria above, an application is required to be made to the Department for Promotion of Industry and Internal Trade (“DPIIT”) to obtain recognition as a startup (“Eligible Startup”). It is crucial to note that if an entity completes 10 years from the date of its incorporation/registration or if the turnover in any previous year exceeds ₹100 crores, the entity will no longer be considered an Eligible Startup. 

Tax Exemptions for Startups in India

Tax exemptions for startups are a constantly evolving regulatory space in India. Once recognised as an Eligible Startup, the Startup Notification further prescribes the processes to be followed to avail certain tax exemptions under the Income Tax Act, 1961 (“IT Act”). For example, Eligible Startups could apply for and avail angel tax exemption under Section 56(2)(viib) of the IT Act until the angel tax itself was abolished in 2024. This evolution speaks to the government’s initiative to encourage entrepreneurship and foster the growth of new businesses under the Startup India Action Plan.

In India, a startup can avail the following tax exemptions:

Income Tax Exemption for the Initial Three Years

Eligible Startups can avail of a three-year income tax holiday under Section 80-IAC of the IT Act, which exempts them from paying income tax on profits for any 3 consecutive years out of their first 10 years from the year of incorporation. However, this is subject to certain further conditions:

• Business Type: The startup must be a limited liability partnership or a private limited company;
• Incorporation Date: The company or LLP must be incorporated between April 1, 2016, and April 1, 2025. We have seen past instances wherein the deadline for this sunset clause keeps extending with every budget; and
• Capacity Focus: The products, services or processes are undifferentiated, have potential for commercialisation and have significant incremental value for customers or workflow.
• Tax Calculation: When calculating the deduction under Section 80-IAC, only the profits from the eligible business (i.e., business carried out by an eligible startup engaged in innovation, development or improvement of products or processes or services, or a scalable business model with a high potential of employment generation or wealth creation) will be considered.
• Eligible Business Certificate: A certificate confirming the business as “eligible” issued by the Inter-Ministerial Board of Certification (IMBC) is necessary. This certificate will be published in the official government gazette.

Tax Exemption on Investment in Startups

Section 54GB has been amended to exempt tax on capital gains arising from sale of residential house or plot of land, if the net consideration amount is invested in prescribed stake of equity shares of eligible startups/companies to utilize the same for purchase of specified assets.

• Eligibility of Assessee: This exemption can be availed by Hindu Undivided Families or individuals. 
• Eligibility of Investee Company: The company is required to: (i) be incorporated in India; (ii) engaged in the business of manufacture of an article or thing or in an eligible business; (iii) ensure the assessee has more than 50% of the share capital/voting rights after subscription; (iv) be a small or medium enterprise or is an eligible startup.
• Timelines: The assessee claiming the exemption is required to subscribe to the equity shares before the due date for furnishing return of income; and the company has to utilize the subscription amount for purchase of an asset within 1 year from such subscription date. The assessee claiming exemption shall be required to hold onto the shares for a period of 5 years.

Tax Exemption on Long Term Capital Gains

There is a separate provision for startups and capital gains reinvestment under Section 54EE. This section allows any taxpayer  to claim exemption from tax on long-term capital gains (from any asset, not just residential property) if they reinvest the gains in a fund notified by the Central Government within 6 months from the sale. The government offers a tax break on long-term capital gains through Section 54EE of the IT Act. Following are the key requirements of for exemption under 54EE:

• Eligibility: All assessees may avail of this exemption if they invest in a specified fund notified by the Government. However, no such funds have been notified as on date.
• Tax Exemption: Startups can claim exemption on long-term capital gains from any asset (not just residential property).
• Investment Requirement: To be eligible for the exemption, capital gains from selling an asset must be reinvested in a government-approved fund within 6 months.
• Investment Limit: There’s a cap on the exempt amount – a maximum of ₹50 lakh can be invested.
• Holding Period: The funds must be held for at least 3 years. Early withdrawal cancels the exemption.

Tax Exemption for Eligible Incubators and Venture Capital Funds/Venture Capital Companies

Incubators recognized by the Government of India and registered Venture Capital Funds and Venture Capital Companies are eligible for tax exemptions on their income under Section 10(23FB) of the IT Act. The prescribed eligibility criteria for the exemption u/s 10(23FB) is expansive and involves stringent regulation through the Securities and Exchange Board of India (SEBI). This can include requirements that the entity cannot list their own shares on any public exchange and/or investment of at least two-thirds of its investible funds in unlisted equity-linked securities. Such VCF or VCC may also be subject to investment restrictions on sectors or asset classes, in accordance with the applicable regulations.

Conclusion

Conclusively, the tax exemption for startups in India serves as a vital catalyst for fostering innovation, entrepreneurship, and economic growth. By providing relief from certain tax burdens during the initial years of operation, the government encourages the emergence of new ventures, thereby stimulating job creation and technological advancement. However, it’s imperative for policymakers to continually evaluate and refine these provisions to ensure their effectiveness in nurturing a vibrant startup ecosystem. Overall, the tax exemptions for startups stand as a pivotal measure in propelling India towards becoming a global hub for innovation and entrepreneurship.

FAQs on Tax Exemptions for Startups in India

1. What is considered a startup for tax exemption purposes in India?
   A startup is defined as an entity that:
   Has been in operation for less than 10 years from its incorporation or registration date.
   Is registered as a private limited company, limited liability partnership, or partnership firm.
   Has an annual turnover not exceeding ₹100 crores for any financial year since incorporation.
   Engages in innovation, development, or improvement of products or services, or operates a scalable business model with high potential for job creation and wealth generation.
2. What are the key tax benefits available for startups in India?
   Startups can avail:
   A three-year income tax holiday under Section 80-IAC.
   Exemption on capital gains reinvestment under Sections 54GB and 54EE.
   Tax exemptions for eligible incubators and venture capital funds under Section 10(23FB).
3. How does a startup qualify for the income tax holiday under Section 80-IAC?
   To qualify, the startup must:
   Be a private limited company or an LLP.
   Have been incorporated between April 1, 2016, and April 1, 2025.
   Obtain certification from the Inter-Ministerial Board of Certification (IMBC).
4. What conditions must be met for the capital gains tax exemption under Section 54GB?
   Individuals or Hindu Undivided Families (HUFs) can claim this exemption if:
   The net consideration from the sale of a residential house or plot is invested in the equity shares of an eligible startup.
   The startup must use the funds to purchase assets within one year of the investment.
   The investor must hold the shares for at least 5 years.
5. Are there any limitations to claiming the long-term capital gains exemption under Section 54EE?
   Yes, the key conditions include:
   The exemption is capped at ₹50 lakh.
   The reinvestment must be made in a government-notified fund within 6 months of the asset sale.
   The investment must be held for at least 3 years to maintain the exemption.
6. Can all startups claim tax benefits under the Income Tax Act?
   No, only startups recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) as Eligible Startups can claim these benefits. Startups must meet specific criteria outlined in the Startup Notification and obtain necessary certification.
7. What happens if the turnover exceeds ₹100 crores or the startup completes 10 years?
   If a startup’s turnover exceeds ₹100 crores or it completes 10 years from the incorporation date, it will no longer be considered an Eligible Startup and will not qualify for the related tax exemptions.
8. What are the tax exemptions for venture capital funds and incubators?
   Registered venture capital funds and recognized incubators can claim tax exemptions on their income under Section 10(23FB), provided they meet stringent eligibility criteria set by the SEBI. 

When and Why to Shut Down a Startup?

While the startup journey can be exhilarating, as with any business venture, there may come a time when the path forward is a dead-end. Causes such as unsustainable business models, unforeseen market shifts, funding challenges, or a change in vision can impact the lifespan of a startup, leading to the difficult decision to shut down the business.  

Similar to setting up an enterprise, closing a business requires careful planning and execution, taking into account the applicable laws. This article aims to provide a quick reference guide to navigate the shutting down of an enterprise in compliance with the legal and regulatory framework in India. 

Shutting Down a Startup -Step by Step Process

The shutting down of an enterprise is a complex and layered process that not only requires strict compliance with the applicable legal framework but also requires structuring such that personal assets are protected and losses during the closure process are minimized.

1. Stakeholder Management

Making the decision to shut down an enterprise requires a thorough evaluation of the company’s financial health and obligations, and consultation with key stakeholders (including shareholders and investors). Investors brought into the company as part of the funding process will typically have exit requirements that are contractually negotiated and recorded in the relevant transaction documents. The closure of the company will accordingly have to take into account any contractually agreed liquidation distribution preference.

2. Labour Law Compliance

Labour disputes in India are largely governed by the Industrial Disputes Act, 1947 (“IDA”). Subject to the applicability of the IDA to the concerned employee, the company will be required to adhere with strict conditions stipulated by IDA in the event of closure^[1] of business. Accordingly, the company will be required to apportion for severance pay and settlement of any outstanding salary or social security contributions that are due and payable by the company. Compliance with the applicable labor laws may also impact the timelines set out for closure of the enterprise. For example, subject to the conditions set out in the IDA, the company may be required to obtain approval for the closure from the competent governmental authority and send prior notice of 60 days intimating employees of the intent of closure. Further, the amount of compensation payable to the employee is also impacted by the circumstances leading to closure.  

3.Financial Management

In the event of closure, it is mandatory that the creditors of the company (both contractual and statutory) are apportioned for. In this regard it is critical to note that the Indian courts have previously held that funds raised through a share subscription agreement bore the nature of a commercial borrowing, making a claim for unachieved exit/buyback admissible under the Insolvency and Bankruptcy Code, 2016^[2]. As such, a clear resolution plan that settles all statutory (including taxation and social security contributions) and contractual liabilities of the company will be required.

4. Closure Option under Company Law – Winding Up

The Registrar of Companies (“ROC”) maintains records of incorporation and closing of companies (considered “juristic persons” in law). As such, closure of an enterprise attracts certain statutory processes dependent on the circumstances leading up to the closure. For companies that are yet to settle all liabilities, and further to the introduction of the Insolvency and Bankruptcy Act, 2016 (“IBC”), the companies can close their businesses under the Companies Act, 2013 (“CA”), through a  winding up petition submitted to the National Company Law Tribunal (“NCLT”). This process requires a special resolution of the shareholders approving the winding up of the company. 
The company (and such other persons as expressly permitted by the CA) will need to file a petition before the NCLT under Section 272 along with specified supporting documentation such as a ‘statement of affairs’ (format prescribed in the law). The petition will be heard by the NCLT, during the process of which the company will be required to advertise the winding up^[3]. Once the winding up is satisfied, the NCLT will pass a dissolution order, which dissolves the existence of the company and strikes off its name from the register of companies. This process is largely left up to the discretion of the NCLT, and the tribunal is empowered to appoint a liquidator for the company (through the IBC) or reject a petition on justifiable grounds. The company would be bound by the order of NCLT to complete the winding up and consequent dissolution.

5. Closure Option under Company Law – Strike Off

For companies that are not carrying on any business for the two preceding financial years or are dormant, an application can be made directly to the ROC for strike off, thereby skipping the winding up process. However, this is subject to the conditions that the company has extinguished all liabilities and obtained approval of 75% of its shareholders for the strike-off. A public notice is required to be issued in this regard, and unless any contrary reason is found, the ROC will thereafter publish the dissolution notice in the Official Gazette and the company will stand dissolved. Startups are able to avail of a fast-track model implemented by the Ministry of Corporate Affairs, which would allow these companies to close their business within 90 days of applying for the strike-off process. This allows companies to achieve closure quickly, save on unnecessary paperwork and filings and avoid prolonged expenses. 

6. Closing Action

While the disposal of assets is often built into the resolution of creditor and statutory dues, it is crucial that the company also take steps to close all bank accounts maintained in its name, ensure that applicable registrations under tax and labor laws be canceled, and complete all closing filings with the ROC and competent tax authorities to record the closure and dissolution of the company. This will ensure that the company’s closure is sanctioned and appropriately recorded by the competent governmental authorities.

Retaining for Future Legal Compliance

Mere closure of the business does not alleviate data security obligations under the law. All sensitive data must be properly backed up, archived, or securely destroyed following data privacy regulations. Essential business records must be maintained for a specific period as required by law and in compliance with the NCLT orders.

Conclusion

Closure of an entity or startup has far-reaching implications, most critically of all, over its employees and its creditors (both contractual and statutory). As such, the legal framework mandates that the employees and creditors are taken care of in the closure process. Typically, where a plan has not been realized for settlement of these obligations, the company enters into the winding up stage, where such liabilities are settled. The final stage of this closure process is the dissolution of the entity itself, – akin to a “death” for the company as a juristic person. However, the framework is designed to ensure that the closure of the enterprise does not absolve the obligations of the company and its officers in charge to settle the outstanding liabilities. 

As more and more entrepreneurs go on to build billion dollar companies, the Indian startup ecosystem has evolved to embrace failure. As PrivateCircle Research claims, “this isn’t just about success, it’s about resilience, learning from failure, and leveraging those experiences to scale greater heights. Serial entrepreneurs come into their second or third ventures with insights, experience and often better access to networks or capital.” This rings true in the trend of venture capitalists and investors looking for founders who have experienced failure and come back stronger, associating the difficult decision to declare a venture a failure as a mark of grit, adaptability and flexibility.

FAQs on Shutting Down a Startup

1. What does it mean to shut down a startup?

Shutting down a startup involves formally closing the business, which includes settling debts, complying with legal requirements, and ensuring proper stakeholder management.

2. What are the primary reasons startups may need to shut down?

Common reasons include unsustainable business models, market shifts, funding challenges, and changes in the founders’ vision or strategy.

3. What are the first steps to take when deciding to shut down a startup?

The first steps include evaluating the company’s financial health, consulting with stakeholders (like investors and employees), and developing a clear plan for the closure process.

4. How should a startup handle its employees during the shutdown?

Compliance with labor laws is crucial. This may include notifying employees, providing severance pay, and settling any outstanding salaries or benefits as per the Industrial Disputes Act, 1947.

5. What legal requirements must be fulfilled to shut down a startup in India?

Legal requirements include filing for winding up or strike-off with the Registrar of Companies (ROC), ensuring compliance with the Companies Act, and settling all statutory and contractual liabilities.

6. What is the difference between winding up and strike-off?

Winding up is a formal process for companies with outstanding liabilities, requiring a petition to the National Company Law Tribunal (NCLT). Strike-off is a quicker process available for dormant companies without liabilities, allowing them to be dissolved directly through the ROC.

7. What financial obligations must a startup fulfill before shutting down?

A startup must settle all outstanding debts, including those owed to creditors, employees, and statutory obligations (such as taxes and social security contributions).

8. What data security measures should be taken during a shutdown?

Companies must ensure sensitive data is backed up, archived, or securely destroyed in compliance with data privacy regulations. Essential business records should be maintained as required by law.

References

[1]  “Closure” defined under Section 2(cc) of the Industrial Disputes Act, 1947 as the “permanent closing down of a place of employment or part thereof”.
[2] https://nclt.gov.in/gen_pdf.php?filepath=/Efile_Document/ncltdoc/casedoc/2709138051512024/04/Order-Challenge/04_order-Challange_004_172804362182744265066ffda65dd44f.pdf
[3] The NCLT winding up process under the earlier provisions required:
Three copies of the winding up petition will be submitted to NCLT in either Form WIN-1 or WIN-2, accompanied by a verifying affidavit in Form WIN-3. Two copies of the statement of affairs (less than 30 days prior to filing petition) will be submitted in Form WIN-4 along with an affidavit of concurrence of statement of affairs in Form WIN-5. NCLT will take the matter up for hearing and issue directions for advertisement. Accordingly, copy of petition is to be served on every contributory of the company and newspaper advertisement to be published in Form WIN-6 (within 15 days).

What is Spacetech and What does it comprise? 

Space technology, often shortened to spacetech, refers to the application of engineering and technological advancements for the exploration and utilization of space. It encompasses a vast array of disciplines, from designing and launching satellites to developing advanced propulsion systems for efficient space travel. Ground infrastructure, robotics, space situational awareness, and even life sciences for human spaceflight all fall under the umbrella of space-tech.^[1]

Spacetech comprises:

• Upstream Segment: activities involving design, development and production processes necessary for creating space infrastructure and technology. This additionally encompasses material supply to the integration and launch of space vehicles, ensuring successful deployment and operation of spacecraft and satellites.
• Downstream Segment: activities involving utilization and application of space-based data and services, focusing on the development and deployment of satellite-based products for various sectors.
• Auxiliary Segment: activities related to space insurance services, space education, training and outreach programs, collaborations and technology transfers, and commercialization of spin-off products. 

The space technology sector in India operates under a comprehensive legal and regulatory framework designed to promote innovation, facilitate private sector participation, and protect national interests. This framework is governed by several key regulatory bodies and policies that ensure the sector’s growth and compliance with both national and international standards. This handy overview aims to provide a quick reference guide to understand the complex legal and regulatory framework governing India’s space sector. 

Key Regulatory Bodies of Spacetech in India

Key Legislations and Policies

International Treaties

India is a signatory to several key space treaties, ensuring compliance with international norms for peaceful space exploration:

Contractual Agreements for a Space Company in India

Establishing and operating a space company in India involves various contractual agreements ^[2] to protect intellectual property, and manage commercial relationships effectively.

Intellectual Property (IP) for Space Tech Companies in India

The legal framework for Intellectual Property Rights (IPR) in India provides robust protection for space tech companies by protecting innovations, fostering creativity, and encouraging investment. The Indian government has established a legal framework to safeguard IPR in the space industry, ensuring that companies can secure and monetize their innovations.

S. No.	Types of IP	Description	Example
1	Trademark	Function: Companies can register trademarks for their brands, logos, and other identifiers. This helps in building brand recognition and protecting against unauthorized use or infringement. Registration: Trademarks registration is optional but advisable, and once granted will be valid for 10 years, renewable every decade.	Names, word-marks, logos, symbols, tag-lines, short sound marks, and more.
2	Copyright	Function: Space tech companies can protect their software, technical manuals, and marketing materials under copyright law. Prevents unauthorized reproduction and distribution of proprietary content. Registration: The creator owns the copyright 60 years from creation before the work becomes public.	Software code, satellite imagery, technical documentation, mission designs, manuals, and more. Example – Satellite mission documentation, control software
3	Patent	Function: Space tech companies can file patents for new inventions related to space technology, including satellite components, launch vehicles, and software algorithms.  Registration: The Act provides protection for 20 years from the date of filing, allowing companies to exclusively exploit their inventions.	Rocket designs, propulsion systems, satellite components, drastically unique or different technology, and more. Example – ISRO’s cryogenic engine patents
4	Design	Function: Companies can register designs for components and products used in space technology, such as satellite bodies and ground station equipment. Registration: The Designs Act offers protection for registered designs enumerated as follows:  Initial validity: A registered design certificate is valid for 10 years from the date of registration. Extension: The protection can be extended for an additional 5 years by filing an application and paying the prescribed fee.	Satellite structures, rocket exterior designs, space module configurations, and more. Example – Exterior design of the GSLV Mk III rocket
5	Trade Secret	Function: Trade secrets are confidential, commercially valuable information known to a limited group and protected by the rightful owner through reasonable measures,  typically including confidentiality agreements. Provisions: Although there is no specific legislation for trade secrets in India, they are protected under common law principles of confidentiality and contract law. Companies can use non-disclosure agreements (NDAs), confidentiality clauses, and other contractual arrangements to protect their trade secrets.	Manufacturing processes, proprietary algorithms, satellite data processing techniques, and more. Example- Proprietary algorithms for satellite data compression and transmission

India’s Foreign Direct Investment (FDI) Policy in the Space Sector

In line with the vision of the Indian Space Policy 2023 and further to the Union Budget 2024-25, the Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 (“NDI Rules”) were amended by way of Gazette notification dated 16 April 2024^[3] to prescribe liberalized FDI thresholds for various sub-sectors/activities in India’s spacetech ecosystem. This is seen as a welcome change as the erstwhile policy was restrictive, requiring significant government oversight and limiting avenues for private sector participation. 

FDI Policy and amendment to NDI Rules, 2024

Existing foreign investment limits in the space sector are provided under Chapter 5 of the Consolidated FDI Policy Circular of 2020^[4], which are yet to be updated to reflect the amendment to the NDI Rules. The NDI Rules recognize “space” as a sector in itself in Schedule I, and the crux of the policy lies in the categorization of space-related activities and the corresponding FDI thresholds. Here’s a breakdown of the key categories and their investment limits:

The investee entity is required to adhere to sectoral guidelines issued by the Department of Space from time to time. The amended NDI Rules also incorporate definitions for the purpose of identifying the applicable FDI threshold and route:

(i) “Satellites – Manufacturing and Operation”: end-to-end manufacturing and supply of satellite or payload, establishing the satellite systems including control of in-orbit operations of the satellite and payloads;

(ii) “Satellite Data Products”: reception, generation or dissemination of earth observation or remote sensing satellite data and data products including Application Interfaces (API);

(iii) “Ground Segment”: supply of satellite transmit or receive earth stations including earth observation data receive station, gateway, teleports, satellite Telemetry, Tracking and Command (TTC) station and Satellite Control Centre (SCC), etc.;

(iv) “User Segment”: supply of user ground terminals for communicating with the satellite, which are not covered in Ground Segment;

(v) “Launch Vehicles and Associated Systems or Sub-systems”: vehicle and its stages or components that is designed to operate in or place spacecraft with payloads or persons, in a sub-orbital trajectory, or earth orbit or outer space;

(vi) “Manufacturing of components and systems or sub-systems for satellites Ground Segment and User Segment”: comprises the manufacture and supply of the electrical, electronic and mechanical components systems or sub-systems for satellites, Ground Segment and User Segment.

Gaps in the FDI Policy 2024 for Space-Tech

The amendments to the NDI Rules proposed to also be carried out to the existing FDI Policy 2020 aim to liberalize the spacetech sector, but certain gaps and ambiguities still exist that need to be addressed for it to be fully effective.

1. Requirement to Comply with Sectoral Guidelines: The policy mandates that investee entities must comply with sectoral guidelines issued by the Department of Space, which counteracts the intended liberalization.
2. Clarity on “Satellites – Manufacturing & Operation”: The term “satellites – manufacturing & operation” does not explicitly cover spacecrafts that may not be categorized as satellites, creating potential ambiguity.
3. Definition of “Satellite Data Products”: The term “satellite data products” conflicts with the Geospatial Guidelines, which allow up to 100% foreign investment under the automatic route for similar data products, which might lead to regulatory overlaps and conflicts.
4. Overlapping Activities: Companies engaged in activities spanning multiple categories (e.g., manufacturing components for both satellites and launch vehicles) must restrict foreign investments to the stricter category thresholds. This may necessitate business restructuring to comply with the new regulations.
5. Grandfathering Existing Investments: The policy does not clearly address how existing investments, made under previous interpretations of the FDI rules, will be treated. Companies that received investments without explicit government approval may  require post-facto government approval.

Concluding Thoughts

Given the national contribution advancements in space tech bring about, it is natural that a degree of government oversight is still built into the legal and regulatory framework. While the amendments to the NDI Rules signify an exciting turn of events for the space tech sector in India, the significant nature of it is still required to be captured across applicable legislations. Further, the proposed 2024 FDI policy does not completely do away with the requirement to comply with sectoral guidelines, or provide complete clarity on critical terms commonly used in the industry. Further, the nature of overlapping business activities could trigger restructuring of businesses, with no clarity provided on grandfathering existing investments. These are likely to be the subject of any clarificatory orders from the Ministry of Finance (Department of Economic Affairs).

References:

[1] https://it.telangana.gov.in/initiatives/spacetech

[2] In addition to the above agreements, space companies may also need to enter into other agreements, such as marketing agreements, sponsorship agreements, and international collaboration agreements. The specific agreements that a space company needs to enter into will depend on its specific business model and operations.

[3] https://egazette.gov.in/WriteReadData/2024/253724.pdf

[4] https://dpiit.gov.in/sites/default/files/FDI-PolicyCircular-2020-29October2020_0.pdf

Introduction

In June 2007, tech giant Infosys Ltd. introduced non-compete agreements for its employees¹. The clause, which was subsequently made part of the employment agreements, required that post termination of an employee, such employee agrees to not accept any offer of employment from: (i) any Infosys customer (from the last 12 months); and (ii) a named competitor of Infosys (including TCS, Wipro, Accenture, Cognizant and IBM) if the employment would require work with an Infosys customer (from the last 12 months), for a period of 6 months.

Following an increased attrition rate in Q4 of Financial Year 2022, the company began to implement this clause², leading to the Nascent Information Technology Employees Senate (NITES), an IT workers union based out of Pune, filing a complaint with the Union Labour Ministry in April 2022³. Deeming the application of the clause post exit of an employee from Infosys to be “illegal, unethical and arbitrary”, NITES demanded the removal of such clauses from the employment agreement. Defending the clause, Infosys issued a statement claiming that the non-compete clause was a “standard business practice in many parts of the world for employment contracts”, to include “controls of reasonable scope and duration” to protect the “confidentiality of information, customer connection and other legitimate business interests”⁴. 

While there is limited public information available on the outcome of the discussions between NITES, Infosys and the competent labor authorities, this throws light on an issue that has been the subject of legal discourse in India time and again: enforceability of non-compete contracts.

In this piece, we break down what non-compete is; the legal framework governing such contractual provisions; and practical considerations for employers and employees, to facilitate informed decision making at all levels. 

What is a Non-compete Clause?

Non-compete clauses are a contractual provision whereby a person exiting a business typically agrees to not start a new business, take up employment in or otherwise engage in any manner with a competing entity. Also termed as “negative covenants”, these clauses impose a contractual obligation on the person to not undertake certain activities. Consequently, failure to abide by these contractual restrictions would result in a breach of the contract: 

• Duration: Non-compete clauses can be for the duration of the employment relationship but also are typically contemplated for a specific period post termination, i.e., post exit of the individual from the business. 
• Limitations to Restrictions: These contractual restrictions are usually limited by geographical location or for a fixed period of time having the effect that the said person would be in breach of the non-compete agreement if they were to start a new business/engage with a competing entity within the same geographical area and within such time period.
• Who is Restricted: These clauses are typically built into employment agreements (particularly of founders and key managerial personnel) where access to confidential and proprietary information pertaining to a business (including with respect to intellectual property) is to be considered; if such information is used by the departing employee/founder/key employee, the likelihood of an unfair business advantage is increased.
• M&A perspective: Non-compete clauses are also seen in transaction documents executed in mergers and acquisitions, where the value of the investment can be impacted if exiting founders/key employees start or join a competing business, leading to loss of competitive advantage to the acquirer.

Can non-compete contracts be enforced in India?

Once a breach of contract is determined, the parties to such contract would have the appropriate remedial measures built in, which can typically include compensation for any loss suffered as a result of the breach. However, in order to be able to enforce such remedial measures, it is critical for the underlying contractual obligation itself to be enforceable. It is against this backdrop that the provisions of the Indian Contract Act, 1872 (“ICA”) become relevant. Section 27 of the ICA stipulates that any agreement in restraint of trade is void. In other words, any agreement that restricts a person from exercising a lawful profession, trade or business of any kind is to that extent void⁵. Stemming from the fundamental right to practice any profession or occupation protected by Article 19(1)(g) of the Constitution of India, the intent 

behind Section 27 of the ICA is to guard against any interference with freedom of trade even if it results in interference with freedom of contract. 

However it is important to note that even within the Constitution, the freedoms protected by the fundamental rights are not absolute and can be limited within specified circumstances. Historically, the Supreme Court of India and various high courts across the country have consistently adopted the following approach towards enforceability of such negative covenants: 

• Reasonableness: The enforceability will be limited to the extent that such a negative covenant is reasonable⁶; and
• Legitimacy: The purpose of the negative covenant is to protect the legitimate business interests of the buyer. The restraint cannot be greater than necessary to protect the interest concerned⁷. 

In light of the above, the Indian courts have adopted the approach that these restrictions during the period of employment are valid, as they can be considered legitimate for the protection of the business interests of the company. Against this reasoning, Section 27 would not be violated⁸. However, such obligations cannot be unconscionable, excessively harsh, unreasonable or one-sided, i.e., satisfying the requirement of reasonableness and legitimacy..

The controversy associated with such negative covenants arises when they are sought to be enforced beyond the period of employment. In a high profile ruling, the Supreme Court held that a media management company’s non-compete clause that prevented a prominent Indian cricketer from joining their competitor for a specific period of time after their agreement had terminated, could not be enforced⁹. The principle that enforcement of non-compete beyond the period of employment is void under Section 27 has been well-settled¹⁰. In a pattern followed by high courts across the country, post-termination non-compete clauses have generally not been enforced on the rationale that the right to livelihood of a person must prevail over the interests of an employer¹¹.

However, this is not to say that all non-compete clauses are automatically unenforceable. For instance, the Delhi High Court held that while employees who had already accepted the offer of employment with the competitor could not be injuncted against (as the same would read a negative covenant into their employment contracts which would violate Section 27), an injunction against future solicitation could be granted on the grounds it was a legitimate and reasonable restriction¹².

Given the uncertainty over enforcement of non-compete clauses, employers have adopted a novel approach of inserting a “garden leave” clause, during which the employee is fully paid their salary for the period in which they are restricted by such negative covenants. While such a concept has been held by the Bombay High Court to be a prima facie restraint of trade affected by Section 27¹³, it is a popular solution practiced widely by employers. Additionally, restrictions on non-disclosure of confidential information and non-solicitation of customers and employees have been previously enforced¹⁴. Non-compete obligations are also often found in mergers and acquisitions transactions, with the courts permitting such restrictions on the basis of specified local limits that are reasonable to the court, having regard to the nature of business/industry concerned¹⁵. 

Practical Considerations

Despite the trend of non-enforceability of non-compete contracts, such negative covenants are commonly found in employment and M&A contracts. These restrictions are still seen as soft deterrents, with employees preferring to comply rather than bear litigation costs and the burden of being sued by a former employer¹⁶. Here are some practical considerations for employers and employees when considering a non-compete contract: 

• Legitimacy: Employers should carefully consider whether the non-compete restriction is necessary to protect business interests. It would be prudent for employers to undertake a reasonable calculation of quantifiable harm and risk from such a breach and inform the employees of the same. 
• Reasonableness: The clause should consider: (i) the duration of restriction and geographical scope; (ii) nature of the employees position and exposure to trade secrets, proprietary information, etc.; (iii) availability of alternative employment; and (iv) compensation in terms of salary, etc. for the duration of restriction.  
• Review Impact: It is critical that employees are made fully aware of the extent to which such negative covenants are applicable and the legitimacy and reasonableness of the same arising from the impact of the employee’s departure from the organization.  

Conclusion

Non-compete clauses continue to face enforceability challenges, with the most recent example being Wipro’s lawsuit against its former CFO for violating the restriction in his employment contract and joining Cognizant as a competitor in December 2023¹⁷. India’s judicial approach to enforceability of post-termination non-compete clauses is clear: if it is not permissible within the scope of Section 27, it would not be enforceable. This differs from jurisdictions such as the United Kingdom, where post-termination restrictions that are designed to protect a proprietary interest of an employer or buyer are enforceable provided there is a material risk and the restriction is itself reasonable, are enforceable; and the United States, where the US Federal Trade Commission recently banned non-compete clauses for US workers¹⁸. The clear conclusion is that a uniform approach to enforcement of negative covenants cannot be adopted.  

Frequently Asked Questions (FAQ) on Non-Compete Clauses

1. What is a non-compete clause?

A non-compete clause is a contractual restriction that prevents an employee from joining a competitor or starting a competing business after leaving a company. It may include specific limitations on time, geographic location, and types of activities.

2. Are non-compete clauses legally enforceable in India?

In India, enforceability of non-compete clauses is limited. Section 27 of the Indian Contract Act deems any restraint of trade to be void. While certain in-employment restrictions may be valid, post-employment restrictions are generally not enforceable, as they can interfere with an individual’s right to livelihood.

3. Why do companies use non-compete clauses if they are often unenforceable?

Despite legal limitations, companies may still include non-compete clauses to act as deterrents. Many employees prefer to comply rather than face potential legal disputes.

4. What are some exceptions where non-compete clauses may be enforceable?

Non-compete clauses may be enforceable if they are reasonable in scope and necessary to protect legitimate business interests, such as confidential information or trade secrets. Courts may uphold them if they are limited to the duration of employment or for protecting specific business interests.

5. How does India’s approach compare with other countries?

India’s approach to non-compete clauses is more restrictive compared to countries like the UK, where reasonable post-termination restrictions are often enforceable if they protect a legitimate proprietary interest. In the US, non-compete laws vary by state, and recently, the Federal Trade Commission proposed a ban on non-competes for American workers.

6. What is a “garden leave” clause, and how does it relate to non-compete agreements?

A garden leave clause allows employees to remain on payroll after they resign or are terminated, but restricts them from joining competitors during this period. Although some Indian courts view it as a restraint of trade, it’s a popular alternative to non-compete clauses.

7. Can non-compete clauses be included in M&A agreements?

Yes, non-compete clauses are common in mergers and acquisitions (M&A) to protect the buyer’s investment and maintain competitive advantage. Courts may allow such clauses if they are reasonable and necessary for the protection of business interests.

8. What are the practical considerations for employees facing a non-compete clause?

Employees should assess the reasonableness and impact of any non-compete clause, including its duration, scope, and potential limitations on future employment opportunities.

9. What options do employees have if they disagree with a non-compete clause?

Employees may negotiate the terms before signing or, if already in effect, seek legal advice to understand the likelihood of enforceability based on Indian law and precedent cases.

1. [1] https://economictimes.indiatimes.com/news/company/corporate-trends/infy-asks-staffs-to-sign-pact-against-joining-rivals/articleshow/2101866.cms?from=mdr ↩︎
2. [2] https://www.businesstoday.in/latest/corporate/story/infosys-served-notice-by-union-labour-ministry-over-its-non-compete-clause-in-employee-contract-331508-2022-04-27 ↩︎
3. [3] https://nites.co.in/nites-submits-complaint-against-infosys-illegal-non-compete-agreement-to-labour-ministry/#:~:text=The%20employee’s%20covenants%20should%20be,clause%20from%20the%20employment%20agreements. ↩︎
4. [4]  ibid, 2 above. ↩︎
5. [5] The Indian Contract Act, 1872 exempts such restraint of trade contracts for transactions where the goodwill of a business is sold. ↩︎
6. [6] As laid down by the Supreme Court in Niranjan Shankar Golikari v Century Spinning and Mfg. Co. (1967) 2 SCR 378. ↩︎
7. [7] As laid down by the Supreme Court in Gujarat Bottling Co Ltd v The Coca Cola Co & Ors. (1995) SCC (5) 545. ↩︎
8. [8] As laid down by the Supreme Court in Niranjan Shankar Golikari v Century Spinning and Mfg. Co. (1967) 2 SCR 378. ↩︎
9. [9] As laid down by the Supreme Court in Percept D’Mark (India) Pvt. Ltd. v Zaheer Khan and Ors. Appeal (Civil) 5573-5574 of 2004. ↩︎
10. [10] As laid down by the Supreme Court in Superintendence Company of India (P) Ltd. v Krishan Murgai 1981 2 SCC 246. ↩︎
11. [11] Trend observed in rulings of: (i) Bombay High Court in VFS Global Services Pvt. Ltd. v Mr. Suprit Roy 2008 (3) MhLj 266; and (ii) Delhi High Court in Affle Holdings Pte. Ltd. v Saurabh Singh 2015 SCC OnLine Del 6765, and Wipro Limited v Beckman Coulter International S.A. 2006 (3) ARBLR 118 (Delhi). ↩︎
12. [12] As laid down by the Delhi High Court in Wipro Limited v Beckman Coulter International S.A. 2006 (3) ARBLR 118 (Delhi). ↩︎
13. [13] In VFS Global Services Private Limited v Mr. Suprit Roy 2008 (3) MhLj 266, the Bombay High Court reasoned that the payment of salary during garden leave does not renew the contract of employment and therefore amounted to a prima facie restraint of trade. ↩︎
14. [14] As held by: (i) Madras High Court in E-merge Tech Global Services Private Limited v M. R. Vindhyasagar and Ors. C.S. No. 258 of 2020; and (ii) Bombay High Court in Zee Telefilms Limited v Sundial Communications Private Limited 2003 (5) BOM CR 404. ↩︎
15. [15] As held by the Delhi High Court in Ozone Spa Pvt. Ltd. v Pure Fitness & Ors. 2015 222 DLT 372. ↩︎
16. [16] https://economictimes.indiatimes.com/jobs/c-suite/non-compete-clauses-unenforceable-under-law-but-companies-love-them/articleshow/109633571.cms?from=mdr ↩︎
17. [17] https://economictimes.indiatimes.com/jobs/c-suite/non-compete-clauses-unenforceable-under-law-but-companies-love-them/articleshow/109633571.cms?from=mdr ↩︎
18. [18] https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf ↩︎

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

1. 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.
7. 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.
8. 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.

Introduction

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).

[11] https://inc42.com/buzz/at-5-3-bn-indian-startup-funding-stays-flat-yoy-in-h1-2024/#:~:text=According%20to%20Inc42’s%20’H1%202024,the%20first%20half%20of%202024.

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 incentivise 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.

IFSCA’s Consultation Paper: Mitigating Greenwashing

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.

Refer link for consultation paper: https://ifsca.gov.in/ReportPublication?MId=8kS3KLrLjxk= 

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.

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.

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.