Reasons for Poor corporate governance in Financial Institutions: an analysis

Introduction

Corporate Governance is main for each & every financial institution. An increase in the integrated financial system, risks arise quickly in different aspects of financial institution system and have a real impact on the real sector of the country. Any downfall in the corporate governance that’s effect the financial institutions to operational risk which quickly impact in the credit, market, liquidity or the reputation decreased in the society. Therefore, the financial institutions and their regulators have put in their systems, controls and processes to ensure the standards of corporate governance. These processes have changed over a period of time and are continuously keeps changing in the internal, external and supervisory management. However, the instances of corporate governance are failures and would result in bad corporate behaviour have recurred not only in India but across the whole world. In the context of India, the financial system has witnessed instance of the system or governance failures in banks, NBFCs and the market intermediaries with the different dimensions and aspects. Common threads across are such as managerial misconduct, the concentration of power is misused, the lack of market discipline and inadequacies of external oversight. The emergence of corporate governance failures from time to time indicates that certain changes in the internal control systems, governance processes, audit mechanisms and regulatory structured could not be out.

Corporate governance in financial institutions

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Corporate governance refers to the sets of structures, processes and relationships between the management of the company, its board member, its shareholders and the stakeholders, through which the objectives are achieved and processes are a set of achieving this objective along with the tools that are monitored. The primary objective of the corporate governance is to safeguard the interest of the stakeholder’s interests in an effective manner by ensuring that helps in undertaken in an effective, efficient, responsible and ethical manner. The banks and the financial institutions that’s takes the deposits from the people to kept in their account. It provides a comprehensive guide for the purpose of developing suitable corporate governance systems with the size, complexity, importance of the system, substitutability, interconnected of banks and the financial institutions.

Corporate governance in financial institutions: In the context of India

Financial sector regulators in India are RBI, SEBI, IRDAI and PFRDA have put the regulatory aimed at strengthening governance with the regulated entities. These regulations remain same and the conduct of the board and senior management such as the chair and meetings of the board, the composition of the certain committees of the board, audit, nomination and remuneration, risk management, age, tenure, qualification and the appointment of the directors etc.  These regulations it has its own prescribed code of conduct and code of ethics and proper norms and reporting structures. The regulatory provisions are put the limit to the directors should not interfere in the day-to-day functioning and prevent from influencing the employees not to be directly involved in the function of appointment and promotion of employees.

Reasons for the failure of corporate governance in financial institutions

As we discussed above the boards of financial institutions strengthened with the independent directors and with the well-structured committees and supported by the compliance, risk and audit functions have its own primary responsibility. The corporate governance is fails not only in India but across the world to look closure at the reasons for corporate governance and the reasons of the failure control.

The following points are the reasons for the corporate governance

1. Lack of Transparency:

Lack of transparency is one of the main drivers for poor corporate governance in financial institutions. Transparency is the basis of trust, and when financial institutions do not make clear information on their operations, both financial health and risk exposures for stakeholders are left in obscurity. Lack of transparency could stem from murky reporting practices, inappropriate disclosure channels or deliberate acts to mask unsavoury information. In such an environment, it becomes hard for investors, regulators and even internal stakeholders to ascertain dominance or the true state of the institution thus breaking down trust.

• Weak Board Oversight:

The board of directors does play a critical role in ensuring that the standards for corporate governance are upheld within such an institution. However, weak board oversight may play a sizeable role in the failure of governance. This can appear in several forms including not enough independent directors, weak skills among board members or a deficit of commitment to tough calls on management. However, in certain instances the boards may get involved into conflicts of interest thus compromising personal gains as opposed to what is best for institution. Such poor supervision often leads to ineffective strategic choices, negligent risk management and a loss of shareholder value.

• Inadequate Risk Management:

Risk management is critical for the sustainability of financial institutions, and in its absence one can readily identify poor corporate governance. This can result in institutions that do not implement adequate risk management frameworks, which overlook stress testing or underrating the potential impact of new risks. This negligence can cause disastrous results, and this is evidenced from the events that followed the global financial crisis of 2008 where poor risk management practices brought down leading banks. Negligent risk management not only harms the financial health of an institution but also puts stakeholders at needless risks.

• Short-Term Focus:

The long-term sustainability can be compromised by operation of financial institutions that adopt a myopic, short-term perspective. Pressures from shareholders, analysts and even management remunerations linked to result based on short-term performance metrics might lead in making decisions that promote gains at the cost of long-term health for organisation. Such emphasis on immediate profitability is known to result in reckless risk-taking, lack of the necessary investment towards fundamental infrastructure and mere neglect of long-term strategic planning. As a result, the financial institutions become exposed to external shocks and may fail in adjusting themselves with changing circumstances of market.

• Regulatory Capture:

Regulatory capture refers to a situation where regulatory authorities mandated with the responsibility of supervising and monitoring financial institutions become too close to its stakeholders hence compromised in carrying out their roles. Various forces can produce this alignment, including revolving doors between regulatory agencies and industry or the insufficient funding of regulators as well lose their independence due to lobbying by influential firms. If regulators do not act with independence and thorough enforcement of governance standards, financial institutions will look to exploit the gaps in regulation causing an erosion on checks that must be present for a sound functioning system.

Conclusion

The corporate governance standards are a main regulatory function for the financial institutions. A set of governance processes, control systems, audit mechanisms, supervisory oversight and regulatory structures are put in the place of the financial institutions. The failure of the corporate governance has been a recurring in the global. All the corporate governance is failed due to the structures, board member, audit and external evaluation take place. Poor corporate governance in financial institutions is a complex phenomenon that has far-reaching consequences to the integrity and stability of the entire system. These challenges need to be met head on through a multipronged strategy which seeks intensify transparency, fortifies board oversight, enhances risk management practices and encourages long-term perspective whilst ensuring regulatory independence. By dealing upfront with these problems, financial institutions can recapture trust; reduce potential risks and support systemic resilience. All the stakeholders, shareholders and executives should note the importance of effective corporate governance in order to implement it for protection the interests of all concerned parties.

Author : Bhaskar Pandey, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at IIPRD

Evolution of India’s Corporate Law Development

MAIN BLOG

History of corporate law in India has changed a lot to meet the emerging needs of the business environment of the country. Critical scrutiny of the evolution of corporate law in India which focuses on the significant turning point and the impact on innovative business strategies.

1. Historical Evolution of Indian Corporate Law: The history of company law in India dates back to 1850, when the Companies Act was enforced based on English law. Subsequent acts, such as the Companies Act of 1913 and the Companies Act of 1956, were drafted to govern companies in India.

2. The Companies Act of 2013: In 2013, this act marked a significant impact in corporate governance laws of India. It introduced several new provisions with objectives to increase obligation, transparency and shareholders’ rights. For example, appointment of independent directors to have an audit committee for a corporation.

3. Judicial decisions’ effect on corporate law: Judicial decisions have significantly shaped the corporate law in India. For example, the Supreme Court in its historic decision in the famous case of Tata Consultancy Services v. State of Andhra Pradesh where the court reaffirmed the federal character of corporate law in by stating that it is the Central Government that has the exclusive power to incorporate companies.

4. Current Corporate Law Trends: Strong focus on simplifying rules and enhancing ease of doing businesscan be seen from the last few years in India. Insolvency and Bankruptcy Code, 2016 improved the credibility of Indian business environment, which fast tracks resolution process for financially troubled firms.

Case Laws Influencing Indian Corporate Law

• Salomon v. Salomon & Co. Ltd. (1897): This landmark ruling had introduced the notion of corporate personhood, which lies at the heart of modern corporation law.

• State of West Bengal v. Associated Contractors (2015) – This case influenced company governance standards in India by emphasizing duty and transparency in public procurement processes.

CONCLUSION

Evolution of corporation in India can easily identify how focused US is to make a business-friendly environment. India has positioned itself as a desirous place for investment and business expansion by taking global best practices and adjusting to change realities.

Author : Shashank Shekhar, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at IIPRD

REFERENCE

• Companies Act, 2013
• Insolvency and Bankruptcy Code, 2016
• Chakrabarti, Rajesh and Kagade, Mandar, Corporate Governance — Evolution and Challenges in the New Companies Act (June 21, 2018), https://ssrn.com/abstract=3200708 (last visited- 0104/2024)
• Emerging Trends in Corporate and Commercial Laws of India (2019), https://cbcl.nliu.ac.in/wp-content/uploads/2019/11/Emerging-Trends-in-Corporate-and-Commercial-Laws-of-India.pdf (last visited- 1/04/2024).
• Institute of Company Secretaries of India, Corporate Law Study (Institute of Company Secretaries of India, 2018). https://www.icsi.edu/media/webmodules/publications/FinalCLStudy.pdf (last visited- 31/03/2024)

Legality Of Non-Compete Clauses In The Employment Contract In India

Introduction

The Constitution of India, in accordance with Article 19 (1)(g)[1], confers on each and every citizen with the fundamental right to practice any profession, or to carry on any occupation, trade or business. This right, however, is not absolute in nature and is subject to reasonable restrictions. One such restriction is the non-compete clause in employment agreement. In today’s highly competitive world, every employer seeks to take preventive steps or safeguards for the anticipated threat they hold from their competitors. However, the most anticipated threat employers hold is from their employees themselves.

An employee of a company holds much confidential and crucial information, disclosure of which is certain to cause irreparable harm to the company. Hence, it has become imperative for an employer to take some preventive measures. The non-compete clause is one such defence that seeks to curtail this threat to some extent. This clause carries a condition that says, in case the employee does not want to continue with the company, he cannot directly or indirectly engage in the same kind of activity which the company carries and neither can join its competitor for a certain period of time. Furthermore, the employee is restrained to disclose any confidential information to any competitor of the employer.  Therefore, it is a common practice by companies to include a non-compete clause in the employment agreement with their employees in order to ensure the protection of their business.

Types Of Non-Compete Clauses

Pre-termination non-compete clause – Where the restraint is only applicable during the subsistence of the employment of contract, for instance, if a worker entered into a contract of 10 years with the company, so during the term of the contract i.e. 10 years, the employee cannot join any other rival company of the employer.

Post-termination non-compete clause – Where the restraint clause is added in the contract that prohibits an employee from working in a rival industry or profession for a set length of time or in a defined geographic region, with the goal of protecting the employer’s company after the term of employment has ended.

Enforceability

The Indian Contract Act, 1872[2], which provides a framework of rules and regulations, governing the formation and performance of a contract in India deals with the legality of such non-compete covenants. It stipulates that an agreement, which restrains anyone from carrying on a lawful profession, trade or business, is void to that extent. Under section 27[3] of the Indian Contract Act, 1872 agreements in restraint of trade are void Section 14[4] of The Specific Relief Act, 1963, is another relevant provision in this context. It is important to note that non-Compete clause shall be valid only if it is for specific period of time say 1 year or so.

Civil Remedies for Breach of Non-Compete Clauses

If an employee breaches a non-compete clause in their employment agreement, the employer may seek civil remedies such as:

1. Injunction (Stay): The employer may seek an injunction from a court, prohibiting the employee from engaging in any activities that breach the non-compete clause.
2. Damages: The employer may also seek damages from the employee, as compensation for any losses suffered as a result of the breach of the non-compete clause. The amount of damages will depend on the actual harm suffered by the employer as a result of the breach.

Further in Gujarat Bottling Co. Ltd. v. Coca Cola Co. (1995),[5] the Supreme Court of India held that a non-compete clause that prevented the employee from engaging in any business that was similar to the employer’s business for a period of five years after leaving the job was reasonable and necessary to protect the employer’s trade secrets and confidential information.

Criminal Remedies for Breach of Non-Compete Clauses

In some cases, the breach of a non-compete clause may be deemed to be fraudulent or dishonest, and the employer may choose to pursue criminal remedies.

In the landmark case of Pepsi Foods Ltd. & Or’s. v. Bharat Coca Cola Holdings Pvt. Ltd. & Ors. (1999),[6] the Delhi High Court held that an employee who had misappropriated confidential information and trade secrets belonging to his former employer and used it for the benefit of his new employer, in violation of a non-compete clause, could be held liable for criminal breach of trust and cheating under the Indian Penal Code.

The Court observed that the employee’s actions had caused substantial harm to the former employer’s business interests, by enabling the new employer to gain an unfair advantage in the market. The Court held that the employee’s actions amounted to a deliberate and dishonest breach of his contractual obligations, and that criminal sanctions were warranted.

Conclusion

Non-compete clauses can be an effective way for employers to protect their business interests, but they must be drafted carefully and reasonably to be enforceable under Indian law. Employers should ensure that their non-compete clauses are tailored to the specific circumstances of their business, and that they do not impose undue hardship on employees. The enforceability of a non-compete agreement is a contentious issue. The enforceability of the Indian judiciary system is not as broad as in other countries. As a result, non-compete clauses have become a matter of disagreement in a number of cases. Unless it is coupled by certain reasonable restrictions, a non-compete is totally valid during employment and afterward. Therefore, it should be kept in mind that while drafting post termination non-compete clauses, be it for any employment contract or any other commercial transaction, it is only the bare minimum interest of the employer which should be protected. There should not be a harsh imposition of restraint of employment post termination since that would be detrimental towards the interest of the employee and thus may lead to rendering such clauses void.

Author : Minal Raut, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at IIPRD.

References:

[1] Article 19 (g) of the Indian Constitution, 1950

[2] The Indian Contract Act, 1872.

[3] The Indian Contract Act (1872), §27 (India).

[4] The Specific relief act (1963), § 14 (India).

[5] Gujarat Bottling Co.Ltd. & Ors vs The Coca-Cola Co. & Ors 1995 AIR 2372, 1995 SCC (5) 545.

[6] Foods Ltd. and Others v Bharat Coca-Cola Holdings Pvt. Ltd. 1999 VAD Delhi 93 (India)

NCLT (POWERS AND FUNCTIONS)

The Company Law Board and the Board for Industrial and Financial Corporation handled the companies’ rights and responsibilities prior to the creation of the National Company Law Tribunal and National Company Law Appellate Tribunal. In accordance with Companies Act of 2013, Section 408 of the Central government established NCLT. It was established based on the Justice Eradi Committee’s recommendations, and it went into effect on June 1, 2016.

What is NCLT?

The National Company Law Tribunal (NCLT) was established as a quasi-judicial body to settle disagreements pertaining to Indian companies. It is the Company Law Board’s replacement. The Central Government has formulated the regulations that govern it. Cases pertaining to civil court have been excluded from the jurisdiction of NCLT, a special court.

Powers and functions:

• DEREGISTRATION:

According to Section 7(7) of the Companies Act of 2013, the tribunal may make any of the following orders if it learns that the company provided false or incorrect information at the time of incorporation or by hiding any material facts, information, or declarations that the company filed:

•Give any orders it deems appropriate.

•Give directives to wind up the business.

•Members’ direct liability will never expire.

• RE-OPENING OF ACCOUNTS::

The Companies Act of 2013 specifies this in Section 130.

•The company will not be permitted to open its accounts or recast its financial statements unless directed to do so by the central government, income tax authorities, SEBI, statutory bodies, or a court of competent jurisdiction. In the following situations, the company may be permitted to do so:

*Previous accounts were prepared fraudulently.

*The company’s affairs were improperly handled, raising questions about the accuracy of the financial statements.

*The tribunal will notify the relevant authorities prior to making any such orders.

REFUSAL TO TRANSFER THE SHARES

According to the Companies Act of 2013, Section 58:

•A public company or a private company restricted by shares that declines to record the transfer of the transferor’s shares must notify the transferor and transferee of the refusal within thirty days of the transfer.

•In exchange, the transferee must file an appeal with the tribunal within thirty days of receiving the notice; if the transferee does not receive a notice from the company, they must file an appeal with the tribunal within sixty days of the transfer document.

•After hearing the orders, the tribunal will either reject the appeal or give the company instructions.

*within ten days of receiving an order, to transfer the shares.

*Immediately correct the register and order the aggrieved party’s damages, if any, to be reimbursed.

*Anyone found to be in violation of the order faces a minimum one-year prison sentence, which can be extended to three years, as well as a fine that can be as much as INR 5 lakh.

INVESTIGATION POWERS:

According to the Companies Act of 2013, Section 213:

*When one of the following parties files an application with the tribunal:

•Company with share capital; Members holding at least one hundred shares or more of the company’s total voting power;

•A business without share capital is one that has at least one-fifth of the individuals listed on its membership roster.

*When a non-member of the company applies to the tribunal citing one of the following circumstances:

• the company’s operations have only been carried out with the intention of defrauding its creditors, members, or any other person.

•The purpose of the business operation is either fraudulent or illegal.

•Members are subjected to oppression in the way that business is being conducted.

•A business is only being formed with the intention of committing fraud or other illegal acts.

•Individuals involved in the establishment of the company or overseeing its operations were found to have committed fraud, mismanagement, or other wrongdoing against the company or any of its members.

•After providing the parties with a reasonable opportunity to respond, the tribunal may determine that the company’s affairs should be looked into. For this reason, the central government will designate an inspector. If members of the company have neglected to provide the company with all the information they are required to provide regarding the company’s affairs, including the information relating to the calculation of commission payable to the managing director, director, or any other manager of the company.

OPPRESSION AND MISMANAGEMENT:

According to Section 241 of the Companies Act of 2013, any employee of the company who is entitled to file a complaint with a tribunal under Section 244 of the Act of 2013 must do so by stating the following:

•The way the business conducts its affairs may be detrimental to the public interest, oppressive to him or any other member, or detrimental to the business itself.

•A substantial shift in the company’s management or control has been implemented by the company, going against the interests of the company’s shareholders, debenture holders, and creditors. This change has occurred in:

*modification of the manager,

* Modification of the member,

* Modification of the board of directors,

*or for any other cause.

Due to these factors, the company’s members believe that its operations have been handled in a way that is detrimental to its interests.

When the Central Government believes that a company’s operations have been carried out in any of the following ways, and the tribunal determines that these actions have been oppressive or detrimental to the public interest:

*a company member has been found guilty of fraud, misfeasance, persistent negligence, breach of trust, or defaulting on legal obligations and functions;

*the management of the company has not been carried out in accordance with sound principles or prudent commercial practices;

*or the company is being operated in a way that seriously harms trade, business, or industry.

A company must file an application with the tribunal to request a remedy when its management is solely focused on defrauding its members or creditors, or when its actions are illegal or fraudulent and go against the interests of the public.

CONCLUSION:

What was once the Company Law Board is now NCLT. With the creation of NCLT, disputes pertaining to company law will now have a quick remedy and can be resolved quickly. A party that feels wronged by a decision or order made by NCLT may file an appeal with NCLAT within 45 days of the party receiving the order or decision. In addition, the NCLAT renders a decision six months after the appeal is received. When NCLT and NCLAT are empowered to make decisions, no civil court has the authority to do so.

Author: Mr. Aman Sethi, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at IIPRD.

An Analysis Of The Industrial Relations Code, 2020

Introduction

The Industrial Disputes Act, 1947 was aimed towards providing the workers a path that would help them get a relief against wrongful dismissal, layoffs, and related matters. The Trade Unions Act, 1926 was brought into force to focus on the working conditions, safety, and better wages for the workers, while ensuring a fair share in the profits of the company and lastly, to educate the workers regarding their right to form associations and to protect themselves. The last puzzle piece in the Code is the Industrial Employment (Standing Orders) Act, 1946 which only aimed towards standardizing the working conditions of the workers.

The Code was brought into existence to bring about better laws for protecting the rights of the workers and their unions, while ensuring that the disputes do not result is what can turn out to be a stormy incident. Before the enactment of the Industrial Relations Code, 2020, the country had a plethora of rules governing the functioning of industrial disputes, working conditions, social security, and wages. The new regulation is a step ahead to untangle the disputes between the various State laws. Besides this, the Code also ensures that the words and phrases are well defined and compiled under a single regulation. The division of the law under various categories such as (i) industrial relations; (ii) wages; (iii) social security; (iv) safety; and (v) welfare and working conditions, brings about a proper understanding of the regulation for the general public.

Analysis

As stated above, an important facet of the Code is the definitions that provide for better understanding. Focusing on the provisions dealing with ‘Trade Unions’, the Act defines ‘trade unions’ to be a group – not necessarily permanent in nature, which has been formed to regulate the relations between workers and their employers, however, restricting their interference in matters that are born out of any agreement or arrangement between the employers’ and/or the employees.

It is not a hidden fact that India has among the highest number of trade union strike rates in the world. It was therefore necessary to restrict such possibilities, which in a lot of cases, are unnecessary. The industrial establishments shall be receiving a fourteen day notice prior to any call of strike. While doing so, special attention has been given to recognizing of the trade unions. The code ensures that only registered trade unions indulge in negotiations with the business entities and industrial establishments. Furthermore, only one trade union shall be functioning with one industrial establishment, unlike the older times when multiples trade unions would come together and focus on one single entity. In a situation that more than one trade union is registered, the one having atleast 51% of the support of the muster roll, shall be considered as the negotiator. However, the major concern that goes behind the role is the fact that there is nothing more than mere registration that goes into appointment of a negotiator. Another aspect is the recognition of Central and State Trade Unions by the Centre and respective State Authorities, without providing for any criteria or procedure for the same.

Mentioned previously is the instance where there exists the possibility of having more than one trade union involved in an industrial matter. This gives rise to a situation of disputes amongst the trade unions. Such a dispute, as defined in the Code, can also arise between members of a trade union. These matters shall be dealt with by the Industrial Tribunal only and the civil courts shall have no jurisdiction over such disputes. The issue revolving around the section is total bar of civil courts and any appeal shall lie with only those authorities that are appointed by the government. Besides, no guidelines have been provided for the same, neither have been any regulations formulated for the same till date.

Apart from focusing on trade unions, the Code brings about grievance redressal mechanism which is a mandate for every industrial establishment under Section 4 of the Code. The establishment shall have equal numbers of employers and workers to certify that equal opportunity is given to both the parties and the principles of fairness is brought into play. Matters of lay-offs, retrenchments and closure are also taken into consideration under the Code–  

• A notice period of sixty days is to be issued to the government before complete closure of an establishment alongside providing for compensation to the affected workers’, who have been in complete service for a minimum period of one year;
• Non – seasonal establishments are to pay 50% of the basic allowance to the workers and a prior notice of one month. Furthermore, a non-seasonal establishment having over 300 employees shall be required to take approval from the Centre or State government before closure, lay-off or retrenchment.
• Retrenchment of workers shall require a three month notice and also provides for procedure for re-employment of retrenched workers.

The above analysis brings us to the improvement in the jurisprudence of the Labour Laws in India, which was long overdue. Trade unions have been playing a significant role in the betterment of the unequal relationship shared between the employees and the employers. The advancements brought forward in the working of these unions have brought with it, a legal backing to the steps taken towards the well-being of the workers. Lastly, the Code has very correctly, brought in it, the concept of ‘fixed term’ employees which had been missing in the previous laws and has taken a positive approach by removing the inequalities that prevailed amongst the employees in terms of wages and working hours alongside recognizing term contracts and settlement options. The old regime nevertheless, provided for a better collective bargaining, where state abstention and state intervention was provided for, as opposed to the new Code, which abandons the same and links it to the deregistration of trade unions.

Conclusion & Suggestions

Though it cannot be conclusively stated that the strike rate and lockouts have reduced drastically since the formulation of the Code, it however, provides for a better approach towards handling the matters – both internal and external. Apart from the grievance redressal mechanism and negotiation unions, the Code provides for alternate dispute resolutions such as conciliation mechanism. The Code seems to be a step towards bettering the conditions of the industries in India, however, they do suffer from major loopholes which require major changes as analyzed above. Matters of sexual harassment, which is a stagnant issue, has not been spoken of in the Code and there is a dire need for changing the scenario. The fixed term contracts and recognition of such employees do not come with regulations on such contracts and tenure, which again, might end up bringing the uneducated masses of the workers’ under the grip of their employers. A positive outlook, on the other hand, is the multiple approvals and notices mandated by the Code, which shall prove to be beneficial in the coming future. The question pertaining to the effect of the Code on the call of strikes, despite the various provisions, continues to be a matter of concern. To sum up, the Code is a mix of few positives, but bigger loopholes in terms of drafting and unrealistic approach undertaken in the industrial jurisprudence. A simple cut – copy – paste from past legislations, without proper arrangement vitiates the very essence of the Code – simplification of labour laws in the country.

Author: Vanshika Poddar – a Student of Symbiosis Law School (Pune) in case of any queries please contact/write back to us via email vidushi@khuranaandkhurana.com or contact us at IIPRD.

Franchise Agreements – Needs and Advantages

Franchise agreement – Introduction

With the advent of globalization and liberalization, businesses have taken many business models for sustenance and prosper. Franchising has been one of the profitable business models that involve the domestic players as well as foreign businesses.There are various types of franchising systems are in place, which includes the dealer arrangement, marketing arrangement, trademark-usage arrangement, product distribution arrangement, manufacturing arrangement, etc.

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Franchising can be regulated by the negotiation, drafting and agreement on the terms of the contract created by mutual understanding of the franchisee and franchisor.

A Franchise Agreement is a legal document mutually agreed by the franchisee and franchisor, which binds both on the franchisor and franchisee. Itcreates the legal obligations to be fulfilled by both the franchisor and the franchisee, and also the clear expectation of the franchisor from the franchiseefor running a mutually beneficial business.

Basic Requirements of Franchising Agreement:

Basic features of the finely crafted franchise documents includes the following features, but not limited to:

1. Nature of the relationship between the parties, obligations and the business methodologies
2. Term of the franchise agreement including the termination details, succession details, etc.
3. Cost associated with the franchising, including the fee to be paid at the starting point and the fee that needs to be paid for continuing the franchise.
4. Since each of the franchisors can provide franchising rights to more than one franchisees, the agreement must take care in drafting the regulations related to territorial franchising rights, so that one franchisee does not infringe the rights that of the other. It must define the limits of the territory assigned and the violation of territorial rights
5. Most of the time, franchising involves a reputed brand name. Hence, the agreement should define the obligations related to the marketing / advertisement of the brand name in the given territory, by the franchisee.
6. Process for selection and approval of the sites for running the business and obligations related to the creation designs & brands in the said sites to the standards set by the franchisor
7. Usage / licensing of intellectual properties including the trademarks, know-hows, trade secrets, business-specific processes and systems, and other IP rights to the franchisees and the limitations to using the same
8. Training associated with the businesses
9. Other clauses including governing laws / principles, termination, indemnification, dispute resolution, payment terms, rights to exclude, etc.

Advantages of Franchise Agreements:

1. Being a legally valid document, it binds all the parties binding and requires adherenceto the proviso of the agreements
2. Helps in enforcing the obligations set-out in the agreement in a mutually agreeable way
3. They offer to enforce the terms of the contract without any misunderstandings that lead to a longstanding relationship between the parties
4. Enables to avoid the complex and costly litigations in case of a dispute
5. Serves as legally valid evidence, since the terms and conditions are meticulously drafted and agreed beforehand

IPLF and Franchise Agreements:

A franchise agreement must be crafted to the mutual benefits of both the franchisor and the franchisee, which should also be valid to be enforced. Further, they should be crafted in a way that improves the understanding and to avoid costly disputes.Further, there are various clauses to be included in the franchise agreements based on the business obligations, which also requires legal prowess to draft a comprehensive agreement.

Our team comprises highly skilled and trained legal professionals to assist in the negotiation and drafting of various types of contracts including franchise agreements, which are not only mutually beneficial to all the parties involved but also protect your business interests.

Author: Govindhaswamy Srinivasan, a Principal Associate – Patents at IP & Legal Filings.  In case of any queries please contact/write back to us at support@ipandlegalfilings.com

Joint Ventures (JVs) and Vitality of JV Agreements

Joint Ventures:

Joint ventures (JVs) are the business formations arising by the collaboration formed by two or more individuals, companies, or corporations, to form a separate business / legal entity. Normally, a JV is created with the intention of achieving a specific / common purpose related to a particular business interest. JV may be set up with shared resources like properties, human resources, investments, etc. contributed accordingly by the participants.This will not only help to reduce the monetary burden of the participants but also helps in sharing the sophisticated systems / machines / technologies, which might reduce the investment requirements otherwise a costly affair. However, this type of business entity protects the other business interests of the collaborator’s other business interests.

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The JV arrangement can further be strengthened by the creation of JV agreements / contracts between the parties involved and they can form a Limited Liability Partnership (LLP), Corporation or Limited Liability Company (LLC) based on the requirements and understanding.

Vital requirements for a JV Agreement:

1.Details related to the purpose of creating the JV

2. Parties involved in the contract: Includes the names (person name, entity name, etc.), addresses (place of business, place of residence, etc.) and other details of the parties

3. Performance of the obligation of the involved parties and the contribution mechanisms

4. Details of the members, governing / management members; and structure for the management team and the details related to the said team

5. Ownership related information: Principal contribution by each party, percentage of ownership

6. Governing rules and principles as agreed by the parties

7. Profit loss statements and the details related to the

8. share of profit / loss among the parties

9. Information related to the protection / utilization of intellectual property created through the JV

10. Terms and termination details

11. Governing laws and Dispute resolution systems as agreed by the parties, including the alternate dispute resolution (ADR) mechanisms like arbitration, mediation, etc.

Some Advantages of JVs & JV Agreements:

1. Exploitation of resources through legally valid contract: Not every business or participant will be made available with such a vast level of resources including finance, technology, instrumentation, technology, etc. as a JV offers especially by the co-operation of participants who are exemplary in any given field.

2. Sharing of liabilities and costs through a mutually agreed contract: When two or more participants are involved in a business, the costs and liabilities associated with each of the participants are distributed in a convenient way, which would reduce the burden on any of the participant otherwise would become a herculean agenda.

3. Shared knowledge and expertise: parties to a JV have their own strengths and expertise in their own way, which would become a synergistically combined strength for running the business or scrupulously achieving the specified goal.

4. Marketing advantage: when a business that needs to establish a market in an unknown turf, a JV with a market leader would reap the benefits with ease and the reachability of the business is proved to be far more successful.

5. Increase in the production / service capacity as a result of an easy understanding of requirements through the mutually agreed contractual obligations.

6. Opportunities to learn a new business and offers the advantages of diversification of business in mutually beneficial terms accorded by the JV agreements.

7. The participants may decide the length of the JV based on the outcome / purpose for which the JV was created and they can agree on the sharing of the profit / loss arise out of the collaboration.

8. Creation and sharing of additional intellectual properties (IP) as agreed by the IP sharing clauses.

9. JV offers the parties involved in sharing the costs associated with the marketing of a product / service, which would help in increased spending capacity and engaging enhanced marketing strategies.

IPLF and JV Agreements:

JVs have contributed significantly to the technical advancements and global socio-economic progress through beneficial co-operation among the businesses, corporations and organizations. Eventually, the welfare of the parties involved in the JV should be guarded by the complete understanding of the legal obligations to be honored by each of the parties. Further, there are various clauses to be included in the JV agreements based on business obligations, which also requires legal prowess to draft a comprehensive agreement.

Our team comprises highly skilled and trained legal professionals to assist in the negotiation and drafting of various types of contracts including JV agreements, which are not only mutually beneficial to all the parties involved but also protect your business interests.

Author: Govindhaswamy Srinivasan, a Principal Associate – Patents IP & Legal Filings.  In case of any queries please contact/write back to us at support@ipandlegalfilings.com

Winding Up/ Liquidation process under the Companies Act, 2013 vis-à-vis Insolvency And Bankruptcy Code, 2016

A firm (for convenience sake called “CD”) regularly supplies certain raw materials to a partnership firm (for convenience sake called “QR”) carrying out its business of manufacturing geysers. After 6 months of regular supply of goods, QR fails to clear the outstanding dues of “CD” amounting to principal amount of Rs.1,25,00/- with interest accrued thereon.

An individual (for convenience sake called “XY”) lends his fleet of trucks to a Company (for convenience sake called “AB”) used for transporting goods to and fro from the factory of AB; despite repeated demands AB fails to pay to XY the accumulating dues of Rs.3,50,000/- payable for the fleet of trucks lent to AB with interest accrued thereon.

In both the cases, CD and XY are advised to initiate winding up process of QR and AB. What does it mean? What does it entail? What are the implications? Will CD and XY get their dues back? Keeping the amended provisions of the Companies Act, 2013 and the Insolvency and Bankruptcy Code, 2016 in mind, let’s examine and understand the current scenario relating to dues of CD and XY.

First, let us understand what winding up means. Earlier, neither the Companies Act, 1956 nor the Companies Act (Second Amendment) Act 2002 defined the term “winding up”. Under the Halsburys Laws of England, winding-up is defined as a proceeding by means of which the dissolution of a company is brought about and in the course of which its assets are collected and realized: and applied in payment of its debts; and when these are satisfied, the remaining amount is applied for returning to its members the sums which they have contributed to the company in accordance with Articles of the Company. In the Indian context, definition of “winding up” was introduced by the Indian Companies Act, 2013 whereby Section 2(94A) was inserted which stated that it means “winding up under this Act or liquidation under the Insolvency And Bankruptcy Code, 2016, as applicable”.

In simple terms, winding up is a legal process by which the life of a company is brought to an end by taking over the reins of management of the Company from the Board of Directors of the Company, selling off its assets and the money realized from such sale is then used for clearing off its debts and the surplus amount, if any, is then distributed amongst the members of the Company.

It is also important to understand that winding up of the Company does not result in ending “the legal existence” of the Company i.e. despite winding up process initiated against the company, it continues to exist as a “legal corporate entity” – in as much as its name continues to remain on the Register of Companies. This legal existence comes to an end only when the Court orders dissolution of the Company – which is initiated post completion of winding up process. The effect of such an order of dissolution is that the affairs of the Company come to a halt and no business can be conducted in its name and its name is struck off the Register of Companies – thus bringing an end to the “legal corporate entity”.

In the year 2016, the Insolvency And Bankruptcy Code, 2016 (referred to as “the Code”) came into effect by which the Parliament sought to consolidate a single law for insolvency and bankruptcy in India. The Code basically provides for a mechanism, within a time-bound manner, to deal with and resolve the non-payment of debt to various debtors in a time bound manner by utilizing the value earned from the sale of its assets, at the same time balancing the interest of all the stakeholders.

With the coming into effect of the Code, it brought about certain changes in the laws relating to winding up of Companies:-

(i) Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) was repealed – this Act applied only to Industrial Companies whereas the amendments introduced by the Code brought all kinds of Companies, partnership firms, proprietorship firms within its fold.

(ii) It completely over-hauled the winding-up provisions under the Indian Companies Act, 2013 such as:

(1) Section 270 which dealt with modes of winding up was deleted;

(2) Section 271 of the Act was amended to exclude the term “unable to pay its debts” as a ground available and specified following 5 grounds available, for persons authorized by Section 272, to invoke the winding up jurisdiction of the National Company Law Tribunal (“NCLT” for short) under the Companies Act:

• Company by special resolution resolves that it be wound up by the Tribunal –  Petition by the Company;
• If the Company has acted against the interest of the sovereignty and integrity of the Country, security of the state, friendly relations with foreign states, public order, decency or morality – Petition by the Registrar, Central Government or State Government;
• an application whereupon the Tribunal comes to a conclusion that the affairs of the Company are being conducted in a fraudulent manner or the company was formed for fraudulent and unlawful purposes or that the concerned in the formation or management of its affairs have been guilty of its affairs have been guilty of fraud, misfeasance or misconduct in connection therewith and that its proper that the Company be wound up – Petition by Registrar or any person authorised by the Central Government;
• If the Company has defaulted in filing its financial statements or annual returns with the Registrar for immediately preceding 5 consecutive financial years – the Registrar
• If the Tribunal is of the opinion that it is just and equitable that the company should be wound up.

(3) Section 304 and related sections (304-323) which dealt with voluntary winding-up were deleted.

Thus post the amendments, no creditor of a Company is entitled to invoke the winding up power of the NCLT provided under the Companies Act, 2013. Hence CD and XY, who are creditors, are out of the purview of the Companies Act, but have the option to invoke provisions under the Code to initiate Corporate Insolvency Resolution Process (“CIRP” for short) – a recovery mechanism created for the Creditors whereby defaulting debtor is assessed whether it is capable or not of repaying its debt, failing which the debtor is either restructured or else liquidated and finally dissolved. 

Part II of the Code brings all kinds of Companies, partnership firms, proprietorship firms, or any other person incorporated with limited liability under any law, who have defaulted to pay their debt, within its fold – minimum amount of debt payable being Rs.1 Lakh.  A combined reading of definition of the words “Corporate debtor”, “Corporate person” and “person” under Sections 3(8), Section 3(7) and 3(23) of the Code makes it clear that apart from a Company registered under the Companies Act, the Code also applies to an individual, a Hindu Undivided Family, a trust, a partnership, a limited liability partnership and any other entity established under a statute.

A creditor, i.e. a person to whom a debt is owed, can invoke provisions contained in Part II Chapter II of the Code. Such a creditor is broadly classified into 2 categories:

(a) a “Financial Creditor” – a person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to [Section 5(7)] – banks and financial institutions come within its ambit;

• Recently a 3 judge bench of Supreme Court in the matter of Pioneer Urban Land and Infrastructure Limited & Ors. Vs Union Of India & Ors[1] upheld the constitutional validity of amendments made to the Code whereby the allottees of real estate projects were deemed to be “financial creditors” so that they can invoke the provisions of Section 7 of the Code against any real estate developer.

(b) an “Operational Creditor” – a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred [Section 5(20)]; Section 5(21) further clarifies that any debt arising out of operation of the Company/ Corporate Debtor – such as goods and services provided to the Company, dues of employees or any amount due and payable to the government – come within the purview of an “operational debt”.

Under Section 6 of the Code, a financial creditor and an operational creditor can file an application before the NCLT seeking initiation of CIRP. The process to be followed in respect of a financial creditor and an operational creditor are different and are specified under Section 7 and 8-9 respectively.

Before we proceed further, it is relevant to state that the constitutional validity of various provisions of the Code, including that of Section 7, 21 and 24 of the Code, were challenged before the Supreme Court in the matter of Swiss Ribbons Pvt. Ltd. & Ors. Vs Union of India & Ors.[2] The Supreme Court while upholding the validity of distinction drawn by the Code between financial creditors and operational creditors, relied upon the distinction between the 2 classes of creditors and held that “most financial creditors, particularly banks and financial institutions, were secured creditors whereas most operational creditors were unsecured, payments for goods and services as well as payments to workers not being secured by mortgaged documents and like… Financial creditors generally lend finance on a term loan or for working capital that enabled corporate debtor to either set up and/or operate its business. On other hand, contracts with operational creditors were relatable to supply of goods and services in operation of business. Financial contracts generally involve large sums of money. By way of contrast, operational contracts had dues whose quantum was generally less. In running of a business, operational creditors can be many as opposed to financial creditors, who lend finance for the set up or working of business. Also, financial creditors had specified repayment schedules, and defaults entitled financial creditors to recall a loan in totality. Contracts with operational creditors did not have any such stipulations.”

In the present case, our very own CD and XY fall in the category of Operational Creditors and thus steps to be followed, as prescribed under the Code are as under:

A. Issuance of Demand Notice: Operational Creditor to issue and deliver a demand Notice [Form 3 – Rule 5 of the Insolvency And Bankruptcy (Application To Adjudicating Authority) Rules, 2016 – “Rules” for short][3] to the debtor demanding payment of the unpaid debt

• Accompanied by a copy of the invoice;
• Demand notice to be delivered at the registered office
• by hand, or
• registered post or
• speed post AD or
• by electronic mail addressed to whole time director or designated partner or key managerial personnel of the debtor

B. Within 10 days of receipt of demand notice, the debtor is required to bring to the notice of the Operational Creditor of the debt being disputed or of the amount paid with proof of same;

C. Filing of Application before NCLT: After expiry of 10 days from the date of delivery of demand notice, if payment is not received, Operational Creditor to file application under Section 9 of the Code (prescribed Form 5 – Rule No.6) before NCLT for initiating CIRP alongwith a proposal for appointment of Interim Resolution Professional, if required, accompanied by following documents and keeping following points in mind:

• Annex. I – Copy of the invoice / demand notice as in Form 3 served on the corporate debtor;
• Annex. II – Copies of all documents referred to in this application.
• Annex. III – Copy of the relevant accounts from the banks/financial institutions maintaining accounts of the operational creditor confirming that there is no payment of the relevant unpaid operational debt by the operational debtor, if available.
• Annex. IV – Affidavit in support of the application
• Annex. V – Written consent from the proposed insolvency professional in prescribed Form 2 (Rule No.9) (Wherever applicable) [may or may not be suggested by the Operational Creditor);
• Annex. V – Proof that the specified application fee has been paid.
• Application to be filed alongwith a Certificate confirming eligibility of the proposed insolvency professional for appointment as a resolution professional (Rule No.9);
• Application and accompanying documents to be filed in electronic form (Rule No.10);
• An advance copy of the application filed before NCLT is required to be sent by registered post or speed post to the debtor at its registered office (Rule 6).

D. NCLT Order On Application: Within 14 days of receipt of the application, NCLT is required to pass an order admitting or rejecting the application.

• If admitted, a moratorium is declared prohibiting various acts by or against the debtor (Sections 13-14 of the Code). It shall also appoint an interim resolution professional [Section 16 R/w Section 16(3)of the Code – in office till the Committee of Creditors appoint a resolution professional under Section 22(2) of the Code], who replaces the Board of Directors and takes over the administrative reins of the corporate debtor (Section 17 of the Code) and also perform, amongst others, following duties:
• Make a public announcement about the CIRP in respect of the debtor concerned alongwith inviting submission of claims against the said Corporate Debtor, and thereafter collate all claims submitted by various creditors (under Section 15 of the Code); [It is here that CD and XY will step in and submit their claims against QR and AB alongwith supporting documents]
• Constitute a Committee of Creditors (Section 18(1)(c) and 21 of the Code) consisting of all the financial creditors of the Corporate Debtor.
• Monitor, manage, take control and custody of the assets of the Corporate Debtor and manage its operations as a going concern till the Committee of Creditors appoints a Resolution Professional.

E. Appointment of Resolution Professional: Within 7 days of constitution, the Committee of  Creditors by majority vote (not less than 66% of voting share) are required to either confirm the interim resolution professional as a “Resolution Professional” or appoint a fresh “Resolution Professional” who then takes over the reins of the Corporate debtor from the interim resolution professional and conduct the entire CIRP as well as manage the operations of the debtor during such period;

F. Preparation of Resolution Plan: The resolution applicant, appointed by the Resolution Professional, prepares a resolution plan (Section 25(2)(h) of the Code) – which covers the management of affairs of the Corporate Debtor post approval of the resolution plan alongwith provision for payment of insolvency resolution process costs in priority to other debts of the corporate debtor as well as payment of debts of operational debtors (Section 30(2)(b) of the Code);

• National Company Law Appellate Tribunal in the matter of Binani Industries Ltd. & Ors. Vs Bank of Baroda & Ors.,[4] held that a resolution plan is not a sale of the debtor, nor a plan for recovery of dues of the creditor or a plan for liquidation of the debtor (which brings the life of the Corporate to an end) but infact is a plan to rescue a failing but a viable business as a going concern and should aim to maximize the value of assets of the ‘Corporate Debtor’, and should promote entrepreneurship, availability of credit, and balance the interests of all the stakeholders. With regard to the dues of the Operational Creditors, the Appellate Tribunal was of the opinion that the liabilities of all creditors who are not part of committee of creditors must also be met in the resolution plan – although the financial creditors can modify the terms of existing liabilities and take their dues in future, the Operational creditors cannot take the risk of postponing payment for better future prospects and need to be paid immediately – as the Operational Creditors need to provide goods and services. If they are not treated well or discriminated, they will not provide goods and services on credit and thus the objective of promoting availability of credit will be defeated [@para 17(3)(e)]. 

G. Approval of Resolution Plan by COC – to be accepted by atleast 66% of voting share of the financial creditors, the Committee of Creditors;

H. Approval of Resolution Plan by NCLT – After approval by the Committee of Creditors, NCLT may either approve or reject the Resolution plan, which shall be binding on the corporate debtor and its employees, members, creditors, as well.

I. Liquidation Process: In the event

• no resolution plan is presented for approval within the time period prescribed for completion of CIRP, or
• if the resolution plan is rejected by NCLT, or
• if the COC recommends liquidation of debtor, or
• if the Corporation debtor contravenes the resolution plan, or

its mandatory for NCLT to order liquidation of the debtor (Under Chapter III of the Code – Section 33).

J. Appointment of Liquidator: Thereafter NCLT appoints a liquidator (Section 34 of the Code) who is required to verify and consolidate claims of all creditors (Section 38 of the Code), to take into its custody all assets of the debtor and settle claims of all the creditors and distribute the proceeds in the order of preference specified under Section 53 of the Code (Section 35 of the Code).

Post initiation of Liquidation process, CD and XY will be required to submit their claims to the Liquidator alongwith all proof in support of the same.

K. Distribution of Assets – Secured Creditor can realize it dues either in full or in part from the security in its favour (Section 52 of the Code). Rest of the creditors will receive their dues in the order of preference as stated in Section 53 of the Code.

(a) the insolvency resolution process costs and the liquidation costs to be paid in full;

(b)the following debts shall rank equally between and among the following:—

• workmen’s dues for the period of twenty-four months preceding the liquidation commencement date; and
• debts owed to a secured creditor in the event such secured creditor has relinquished security in the manner set out in section 52;

(c) wages and any unpaid dues owed to employees other than workmen for the period of twelve months preceding the liquidation commencement date;

(d) financial debts owed to unsecured creditors;

(e) following dues shall rank equally between and among the following:—

• any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the liquidation commencement date;
• debts owed to a secured creditor for any amount unpaid following the enforcement of security interest;

(f) any remaining debts and dues;

(g) preference shareholders, if any; and

(h)equity shareholders or partners, as the case may be

Thus in the case of CD and XY, whofall in the category of Operational Creditors – unsecured creditors – their dues will be ranked 4^th in line and will be paid from the sale proceeds of assets of the debtor, after the dues of workmen, secured creditors, and wages and unpaid dues of employees are paid off. 

L. Dissolution of Corporate Debtor: Once the assets have been completely liquidated, NCLT, upon application by the Liquidator, shall order dissolution of the debtor from the date of the said order. Within 7 days, copy of said order shall be sent to the authority with which the debtor is registered for appropriate action (Section 54 of the Code).  

Thus bringing an end to the entire process and resolution of a debt ridden corporate debtor.

Author: Meenakshi Ogra Mukherjee a Principal Associate in Litigation, at Khurana & Khurana, Advocates and IP Attorneys.  In case of any queries please contact/write back to us at litigation@khuranaandkhurana.com .

References:

[1] Pioneer Urban Land and Infrastructure Limited & Ors. Vs Union Of India & Ors., AIR 2019 SC 4055: 2019 (8) SCC 416, Decided on 09.08.2019

[2] Swiss Ribbons Pvt. Ltd. & Ors. Vs Union of India & Ors., AIR 2019 SC 739: 2019 (4) SCC 17

[3] The Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016

[4] Binani Industries Ltd. & Ors. Vs Bank of Baroda & Ors., 2019 (3) Comp LJ 53: MANU/NL/0284/2018, decided on 14.11.2018

Advisory on Conducting Legal Audit to Review Legal Aspects / Functions Related to Business Operations

Amid Covid-19 outbreak, our Hon’ble Prime Minister of India while addressing the nation dated 24.03.2020 announced 21 days precautionary lockdown to break the chain of the existing pandemic situation. The step is indeed commendable; however, the same will surely have an economic impact on the businesses. With travel restrictions, cancellations of all types of transport, business hibernation, it is very obvious for all businesses to worry a bit as it will directly impact the economy with each passing day. While everything has its downside and upside; it is our duty being responsible citizen of India to duly abide the lockdown advisories and there is no point in dismaying about the business hibernation; rather it is the right time to utilize this time to revamp the strategies and prepare for a powerful comeback with increased efficacies and help re-build the economy of our country in shortest possible time.

In view of the same, while it is quite easy for employees and students to subscribe for certain online courses to upgrade their skills; however, at the very same time, business owners are not helpless either. It is imperative for all the employers and business owners, be it a proprietary or incorporated company to utilize this time in analysing, revamping and introspecting the existing business modus and legal issues involved thereto. In view of the same, carrying out legal audit of the businesses would certainly help the businesses to get the things right which are generally gets inadvertently ignored in day to day business activities.

The term “Legal Audit” per se seems a very complex term; however, it simply means routine health check-up of your business. The general assumption in India as to Audits is limited to Tax Audits only; however, in the era of immense research and development, Globalization of the businesses; there are other things that indeed need to be timely audited and necessary upgrades to be done to the traditional practices to keep aligned with the changing business practices. Thus, besides financials and taxes, there are other things that need close monitoring to be in proper alignment with the changing needs and practices. However, such things gets inadvertently ignored in day to day hustle and this would be the right time to introspect such aspects; as the business owners now have got ample time to do the same and get the things right.

Legal audit is a systematic review of a company’s assets and related risks and opportunities. Legal audits, also interchangeably referred to in the instant note as Comprehensive Due-Diligence, can help assess, preserve, and enhance the company’s efficacy; correct defects in the existing process; identify risks as to following the existing process and policies; and implement best practices for effective management. A thorough Legal audit involves comprehensive review of a company’s agreements, policies and procedures, and other legal strategies to be followed for better and smooth administration.

Now the question arises, what sort of things that need close monitoring besides financials and tax part of the business. The same is very subjective and largely depends upon the business modalities of the respective businesses. However, there are certain things that largely apply to each and every business; be it a small scale or large scale, start up or established company. 

1. Contract/Agreement/Documentation Review:

Any business day in and day out, enters into one or more agreement with their vendors, employees, business partners, channel partners inter alia. All such agreements are required to be updated and upgraded with the change in practice or personal experience; as the agreement that you may have drafted few years back may not be aptly protecting your business in view of changes in practice or otherwise for any other reasons whatsoever. Hence, regular audit to check the same is indeed a need of the day and this hibernation can certainly be used for such introspection.

Moreover, it cannot be denied that many times businesses do not have any agreements or contracts ready with them and whenever any new transaction comes, the company need to invest time and efforts negotiating the agreement from scratch. Thus it is not only imperative to get the contracts reviewed/audited; but also there is need to evaluate the vacuum and need of certain agreements absence of which may have exposed the business at risk. It is also pertinent to mention here that when we say the term Contracts, it essentially includes Purchase orders, Invoices formats, Vendor Agreements, Employment agreements, IP related Agreements, Company policies, Agreements related to Third Party/outsourcing and any such documents that govern the rights of the parties.

Any business is indeed incomplete with the competent employees and thus agreements with the Employees who are real asset for your business definitely need a regular audit with two fold perspective; first employee retention and second protection of Employers’ rights in case of termination or resignation.

In today’s era, employees are thoroughly engaged in research and development for the employer and therefore, it is imperative to have a right contract at hand that protects employers and the intellectual property created by the employee for its employer and any discrepancy or loophole in the employment agreement with respect to such protection; may lead to serious issues for any business. Therefore, it is mandatory to introspect and review such agreements and make sure that such agreement is intact and water tight.

To conclude, Contracts have always formed a critical part of business. In this era of commercialisation, all businesses need and intend to enter into perfect contracts, ones that are clear enough to be easily understood by a person of ordinary prudence and at the same time detailed enough so that it cannot be willfully misinterpreted. Thus, it requires a timely audit of contract to ensure that they incorporate the stipulations of the parties, in order to meet the object of such contract with precaution and to minimize the legal and business risk resulting from the inconsistent language. Time and resources spent on such audit of Contracts / Agreements can save Corporations and Businesses from several legal issues.

2. Regulatory Compliances:

Regulatory compliances are another domain that need to be introspected and timely reviewed to ensure that the business are in compliant with the applicable rules and regulations governing the same.

3. Litigation matters:

It is also important to make sure that all litigations with respect to the businesses are managed properly and the same are aligned with your expectations with the outcome.

Moreover, it is imperative to note that many times company faces issues pertaining to recovery of unpaid dues and thus it would be right time to analyse pending dues from various entities and get the groundwork/homework done with respect to strategizing the legal actions to be taken for such recovery under Insolvency and Bankruptcy Code, 2016 or through Civil route in case of individual or proprietorship firms and this time of hibernation would be better utilized liasoning with experienced lawyers and getting the legal notices ready to be immediately served post hibernation and set the action in motion.

4. Domain name issues and other common law rights:

In this era of digitization, every business is now online rejoicing the power of worldwide web. However, there are certain entities that take undue advantage of the reputation and goodwill of the established business and they purchase a domain name similar to your company’s domain name and ride on your established goodwill and divert or attempt to divert your consumers to their website; however, many a times these infringers escape from the attentions of the rightful owners and rightful owner did not even realize loss that being caused by such entities. Thus one part of legal audit is to ensure that you have adequate domain name registered for your business, products and services and at the same time the same is not being infringed by any third party. Such audit exercise is required to be carried out at timely interval so that any loss or damage to the reputation gets timely restrained.

5. Intellectual Property Audits:

It is indisputable proposition that a company’s intellectual property is its most valuable asset. From its Trade Marks to the product or services themselves, making sure that no one is riding on their goodwill in order to gain illegitimate gains is of the utmost importance. Further, similar protection is required to the inventions in terms of Patents, aesthetic features of the product in terms of Designs along with other intellectual property protection. Therefore, an essential component of the legal audit, intellectual property monitoring and review needs to be carried out with the help of IP attorney to ensure proper alignment and adequate protection is secured.

An IP audit is a systematic review of a company’s IP assets and related risks and opportunities. IP audits, also interchangeably referred to in the instant note as IP Due-Diligence, can help assess, preserve, and enhance IP; correct defects in IP rights; put unused IP to work; identify risks that a company’s products or services infringe another’s IP; and implement best practices for IP asset management. A thorough IP audit involves not only a review of a company’s IP assets, but also the company’s IP-related agreements, policies and procedures, and competitors’ IP.

For companies with a sophisticated knowledge of IP, the discussions can begin with a survey of the company’s IP portfolio and competitive position in the marketplace, followed by a more focused analysis of IP issues of particular interest. The most comprehensive audits include estimates of the IP’s monetary value, and protocols and detailed recommendations for dealing with IP in the future.

6. Audits of Other Legal Functions:

Apart from above-mentioned legal functions, depending on the desired scope of work, Audits/reviews can also be focused on any other legal aspect such as review of Corporate Law Practices, Environmental and Labour Law Compliances, Tax Compliances, Banking Practices, Exposure on IT/Software Compliance Aspect, among any other aspect where potential Legal Proceedings that can initiated by/against a business operation/function.

Thus, it would be prudent for all businesses irrespective of its size and reach to utilize such time in getting the legal audits done from an experienced firm and set the things aligned and get ready for a powerful comeback once the lockdown situation resulting the business hibernation gets over.

We at Khurana & Khurana, Advocates have a team of dedicated professionals who are techno-legal experts and take care of such Legal Audits as required for businesses. Business owners only need to get in touch with us and our team shall carry out all such activities in swift manner. Businesses only need to share the required documents/information as sought by the team and everything is done virtually with no actual need of physical inspection/audit at the Client’s place. Therefore, such exercise can surely be carried out during the lockdown period making complete use of this time of hibernation. 

Author: Abhijeet Deshmukh – Associate Partner, and  Abhishek Pandurangi – Partner,  at Khurana & Khurana, Advocates and IP Attorneys.  In case of any queries please contact/write back to us at abhishekp@khuranaandkhurana.com.

Vertical Overlaps in Merger Control

Introduction

Indian Competition Law permits the Competition Commission (CCI) to consider the nature and extent of Vertical Integration in the market, in order to determine whether a combination will (or would be likely to) cause an Appreciable Adverse Effect on Competition (AAEC).[1]In this article, we discuss the compliance and reporting requirements applicable to parties to a combination,involved in different stages of the supply chain for a product or service, above a certain threshold, and compare the same with the disclosures to be made in case they do not surpass the threshold.

In India, in cases where a vertical overlap of more than 25% exists, the Acquirer (in case of an acquisition) or both parties jointly (in the case of a Merger) are required to file Form II,[2] which requires more detailed submissions and is used essentially in schemes of a large scale that would have a greater impact on the market. The fee payable along with the form is Rs. 50 Lakh.[3]

The parties must also give information, in requisite detail about all market segments involved in the transaction. When there are one or more markets where the overlaps are in excess of the thresholds, even if there are other markets where the thresholds aren’t met, information with respect to them must be filed in Form II.[4]

Summary of the Content of Forms I and II:

Form 1:

1. Basic Info

2. Proof of Payment of Fee

3. Authorisation regarding communication

4. Meeting the Thresholds (Assets + Turnover)

5. Summary in accordance with regulations 13 (1A & 1B)

6. Description of combination:

           a. Name of parties

           b. Structure

             i. Steps + Timelines

             ii. Structure ownership control

             iii. Value of transaction

          c. Purpose of combination

          d. Other jurisdictions

          e. Approval by board of directors

          f. Details and justification for Non-compete (if any)

7. Details about parties

          i. List of regd. entities in India

          ii. Name of group

          iii. Trading/Brand names in India

          iv. Activities worldwide

          v. Activities in India

             a. List of Products and Services

             b. Identical/Substitutable Products (Y/N) (Details if Y)

             c. Vertical Linkage (Y/N) (Details if Y)

             d. Horizontal/Vertical Linkage with another enterprise, which a party to the combination Has shareholding in.

             e. Brief overview of the sector

8. Relevant market (RM)

          a. Relevant Product + Geographic Market

          b. Whether the parties are engaged in business in the same RM

          c. Estimated size of RM

          d. Value of sales and the market share of each party in the RM

          e. Names of 5 Largest Competitors

f. If there is a vertical linkage:

             i. Market size of upstream & downstream market

             ii. Market share of each party in both

             iii. Market share of 5 largest competitors in the Upstream/Downstream market

             iv. Existing supply arrangements between the parties and its share in the relevant market

Form 2 Summary:

1. Summary

          a. rationale, objectives, strategy, and likely impact.

          b. Parties, Nature, Area of Activities, Market impacted, info relevant for 20(4), timeframe of combination.

2. Purpose

          a. Business Objectives – What & How

          b. Economic Rationale and Impact

3. Details of Payment

4. Personal (Contact) Details

5. Details about Combination

          a. Which clause u/s 5 of the Act

          b. Details about nature of comb.:

             i. Number + Percentage of Shares/Voting rights Acquired; whether the same would lead to control.

             ii. Value of Assets; whether leading to control

             iii. Details of constituent transactions in the comb.

6. Supporting docs.

          a. Docs supporting board approval of the scheme

          b. Docs analysing impact of acquisition on the market, competitors etc. after the comb.

          c. MoA, AoA of parties

          d. Annual Reports of parties (if section 5(b) is applicable, also of competing enterprises already controlled by acquirer)

          e. List of holders of 5% or more shares/voting rights in each party.

          f. Organisational chart and details of KMP

7. Size of Combination

          a. How are the criteria for filing notice for the combination met.

          b. Audited accounts of the immediately preceding two, as well as the currentfinancial year, separately for all parties (includes value of assets and aggregate turnover, in India and Worldwide)

          c. Aggregate audited and unaudited accounts for the proposed combination (in a similar way as above)

          d. Accounts of the Group to which the post combination entity would belong (in the same way as above)

8. Ownership & Control

          a. List of all enterprises in the group to which the parties belong; details of all enterprises controlling the parties.

          b. Whether a party to the combination controls another entity/group (Details if Yes)

          c. Details of Horizontal Linkages, if any.

          d. Details of Vertical Linkages, if any.

          e. Details of intended structure of ownership and control of parties and combined enterprise post completion.

9. Details about Products/Services

          a. Details of:

             i. List Products and Services

             ii. Characteristics; End use

             iii. Are the Parties Competitors in same RM?

             iv. Market Shares of parties and their competitors  (within RM)

             v. In-house consumption, if any

             vi. Existence/availability of other specialised producers

             vii. Industrial Classification of Products/Services

          b. Any Law/Regulation/Specification that:

             i. Restricts the operation of like products/services as the parties, in the RM.

             ii. Local specification applicable to the like products.

             iii. Licensing Requirements to set up production facilities; special technical knowledge

             iv. Govt. Procurement policies that offer special dispensation

          c. Importance and details of distribution channels

          d. Details of transportation (modes, cost etc.)

          e. Define limits of Product and Geographical RM and demarcate competitive products not included in the same.

          f. Manner in which the parties produce, price and sell their product; all documents related to the pricing for the previous two years and price forecasts post-combination.

          g. Pricing details for major competitors and imports

          h. Details about the minimum viable scale, minimum and optimum plant size, utilisation rate, available cost savings etc.

10. Information on Market Structure

          a. Market Sizein terms of value and volume, 5 Largest Competitors, Costumers, Suppliers.

          b. Market share of parties in the product RM.

          c. List of main competitors in RM

          d. List of all competitors having market share > 5% in the RM.

          e. Description of the state of competition in the RM

          f. Level of Concentration in RM before and after combination (HHI)

          g. List of enterprises which attempted entering or exiting (last 5 years) or are likely to enter (next 2 years) RM.

          h. If either party entered the RM in last 5 years, faced any barrier to entry?

   Factors influencing entry in the market:

             i. Total cost of entry

             ii. Non-recoverable investment on entry

             iii. Legal/regulatory barriers

             iv. IPR restrictions

             v. Details of IPRs developed by parties

             vi. Importance of economies of scale in RM

             vii. Access to sources of supply

          j. Information regarding volume and market share etc. of imports; details of potential imports to start in next 2 years; cost difference in domestic and imported products.

          k. Details of exports and their proportion in the RM for last 3 years; top 5 exporters.

          l. Details of largest suppliers to parties.

          m. Details of products/services in the pipeline for parties and competitors and its impact on market share.

          n. Details of Large buyers

          o. Demand structure in the RM; roles of product differentiation and switching costs.

          p. Language compliance requirements.

          q. Importance and details of R&D activities carried out by parties (present)

          r. Intended R&D activities subsequent to combination

          s. Details of ground-breaking technology or business models used by parties/competitors in RM

11. Compliance and filing in other jurisdictions

          a. Any order passed by any Competition/ State Authority involving the parties, in the last 5 years.

          b. Any bankruptcy/winding up petition filed by any party in last 5 years.

          c. Details and copies of the documents filed before other tribunals/ regulators with respect to the combination and the orders passed.

          d. If filing has to be done in jurisdictions other than India, details and copies of relevant documents including order/decision.

12. Any other information that could help the commission in this assessment.

Case Studies

In Alok Industries and Grabal Alok Impex[5], the commission found that “The Parties to the Combination are engaged in activities which are at different stages or levels of the production chain in the textile business and, in addition to providing products/services to other customers, sometimes provide products/ services to others also. It is however, observed that the sales and purchase of products/services of parties to the combination to/from each other is very small and out of the total sales and purchase of products and services of each of the parties to the combination, the sales and purchase of each to/from each other is also insignificant.” The Commission observed that the combination was not likely to have any “adverse competition concern.”

In Bayer’s acquisition of Monsanto, the commission passed an order under Section 31(7), accepting the proposed amendments to the Proposal for Modification issued by the CCI and approving the acquisition.[6] A quick look through some of the important observations in the order, would be worthwhile. It was noted that the Proposed Combination would create one of the largest vertically integrated player in the agricultural market globally.[7]

Resultantly, the commission observed that the acquisition could lead to AAEC in 8 Relevant Markets. Most importantly, Monsanto held a 95-100% of the upstream market for Bt. Cotton Trails in India and had a presence in the Downstream market too. Bayer was one of the very few competitors for Monsanto in the said upstream market and the acquisition would allow the combined entity to substantially foreclose access for other downstream seed companies.[8]The CCI approved the acquisition subject to a series of divestments to be made by both Bayer and Monsanto. They also required the licensing of certain products on FRAND terms. They were required not to bundle their products and commit to maintain non-exclusive distribution channels.[9]

Conclusion

The Competition Commission of India has set up a robust mechanism to differentiate combinations that would have or be likely to have an appreciable adverse effect on competition, from the ones which wouldn’t. When talking about restructuring schemes which involve significant (>25%) vertical overlaps, the process becomes much more onerous, and the regulator requires a multitude of disclosures and analyses, for the past present and future of the companies.

While it is critical to prevent certain Mergers & Acquisitions from impairing the competition between enterprises, the regulator, like many other instrumentalities of the state could make its process more conducive to business. Ample powers have been given to this statutory body, including carrying out an assessment of the anti-competitive agreements or abuse of dominant position, at any point, even on its own motion and impose penalties, in case the enterprises manage to get away with a devious combination.It should replace the existing system of approval with something much less burdensome, and make the process quicker, to not end up causing an appreciable adverse effect on the free market.

Author: Mr. Anant Joshi, Associate – Corporate & Commercial Law Practice at Khurana & Khurana, Advocates and IP Attorneys. In case of any queries please contact/write back to us at anant@khuranaandkhurana.com. 

References:

[1]Section 2(4) (j) of the Competition Act, 2002.

[2]https://cci.gov.in/sites/default/files/cci_pdf/Form_II.docx.

[3]https://www.cci.gov.in/sites/default/files/whats_newdocument/FAQ%27s_Combinations.pdf.

[4]GE Company, GE Industrial France SAS, Alstom, Alstom Holdings (C-2015/01/241).

[5] No. C-2012/01/28.

[6]No. C-2017/08/523.

[7] Id, para 19. 

[8] Id, para 82.

[9] Id, paras 210,211.