Author: Dhruv Suri, http://www.psalegal.com/
After successfully having set up a company, the operation of the newly founded entity will have to comply with further legal provisions. These include company internal matters, such as how the bodies within the company are structured and how the relationship between the shareholders is organized. This article also provides a brief overview of Indian laws that should aid German startups to evaluate their India strategy from a legal and compliance perspective viz. post incorporation compliances relating to intellectual property, labour, data protection and competition.
The Memorandum of Association (“MoA”) and the Articles of Association (“AoA”) regulate the conduct of a company as its charter documents and are publicly available for inspection on the payment of a nominal fee. Shareholder agreements (“SHA”) regulate the relationship between shareholders and the company and are private documents. While it is not mandatory to execute SHAs, we highly recommend this, should German companies look to partner with their Indian counterparts.
MoA is one of the charter documents of the company. It predominately details the authorized capital and the main business objects that the company can carry out. The business objects must be broadly worded so that the activities carried out by the company are never outside its scope. If there is any lapse, the directors of the company can be made personally liable for losses incurred by the company while running any “unauthorized” business.
AoA is the other charter document which captures all governance related provisions. It regulates the internal management of the company. For instance, it details how meetings ought to be held, how decisions ought to be approved, what happens in instances of a deadlock, whether certain actions taken by the board would be permissible or not, etc. In essence, it is important for the directors to ensure that any decision or the manner of taking any decision is consistent with the AoA of the company. Key terms of any SHA also have to be incorporated in the company’s AoA to make them legally enforceable.
There are two types of shareholders meetings: a) Annual General Meeting (“AGM”) and b) Extraordinary General Meeting (“EGM”).
Companies are under a statutory obligation to hold an AGM every year. The first AGM has to be convened within nine months from the date of closing the first financial year of the company i.e. March 31st. Subsequently, the AGM must be conducted in such manner that a period of not more than fifteen months lapses between two AGMs and within six months from the closing of every financial year. A notice informing the date, place and agenda of the meeting has to be given to the members, directors and the auditors of the company.
The board of directors are authorized to call an EGM on their own or on a requisition made by the members, provided the members demanding the requisition hold not less than one-tenth of the paid-up capital of the company. The board has to call the meeting within twenty-one days of deposition of valid requisition. If the board fails to do so, then the requisitionists may call upon the meeting themselves.
The Act lays down specific provisions with respect to managing the affairs of a company so as to protect the interest of its shareholders and investing public.
Directors are trustees and agents of a company and are obliged to act in the company’s interests. Board of directors has the power to take decisions on behalf of the company provided these decisions are compliant with the AoA. Consequently, all directors are collectively responsible for a company’s non-compliance. However, a director is absolved of liability if the non-compliance has occurred without his or her consent or knowledge. In fact, as per the Act, a director may be imprisoned for certain non-compliances such as failures in (i) filing annual returns, (ii) maintaining true and fair financial accounts, (iii) obtaining approval from board of directors prior to entering in transactions with related parties and (iv) disclosing interest in another entity.
Unlike a lot of other jurisdictions, there is no mandatory requirement for Indian companies to appoint a Managing Director, Chief Executive Officer, etc. However, if and when such persons are appointed, it is important that the provisions of the Act are followed.
Upon incorporation, a company must hold its first board meeting within thirty days from the incorporation date. Thereafter, board meetings are required to be held at least once in every one-hundred and twenty days and at least four such meetings must be held in every year. Directors can convene board meetings by giving a seven-day notice to all directors detailing the time, place, venue and the business to be transacted at the meeting. Directors can participate and vote in Board Meetings through video-conferencing or other audio-visual means. Decisions at board meetings are through a simple majority, unless the AoA provides otherwise.
The board can exercise a number of powers at a meeting, by way of a resolution, namely: make calls on shareholders in respect of money unpaid on their shares and to forfeit shares in case of non-payment; make contracts, execute negotiable instruments and borrow money on behalf of the company; invest up to specified limits in the shares of other companies; authorize buy-back of company’s shares; declare interim dividend; issue debentures; invest the funds of the company; make loans, guarantee or provide security for loans; approve amalgamation, merger, takeover or reconstruction; diversify business of the company; make political contributions; appoint or remove key managerial personnel or take note thereof; appoint internal and secretarial auditor; note disclosure of director’s interest and shareholding; buy or sell investments of the company up to prescribed limits; invite or renew public deposits and review or change existing terms and approve quarterly, half-yearly and annual financial statements and results of the company.
The board may delegate its powers to borrow, invest funds and make loans up to certain specified limits and subject to conditions, as it may deem fit, to the committee of directors or the managing director or any principal officer of the company.
It is a formal expression of an opinion adopted by votes and a formal record of the action taken by the shareholders and the board of directors of a company. Resolution at a board meeting is passed by simple majority. Resolution is passed at a shareholders meeting as either an ordinary or a special resolution.
Ordinary resolution, to be passed, requires a simple majority of members who are present and entitled to vote on the resolution. This shall also include the vote of the chairman of the company, if appointed. Voting on this resolution is generally done by show of hands (voting by poll is the other option that can be exercised) by the members present personally or by proxy and each member has one vote irrespective of the shareholding. The resolution passed by the majority is legally binding upon the minority and the company.
A resolution is a special resolution when the notice calling the general meeting or other intimation given to the members specifically mentions the same. Such a resolution, in order to get passed, requires that the number of votes (whether on show of hands or poll) cast by the members in favour of the resolution (by voting or by proxy) exceed three times the number of the votes, if any, cast against the resolution. Some of the actions which require a special resolution are alteration of the memorandum/articles of the company, change of name of the company and reduction of share capital.
For cases where certain important resolution(s) has / have to be passed urgently for effective functioning of a company and it is not convenient for the directors to hold a board meeting, the option of passing of a board resolution by circulation has been provided for under the Act.
Audit of accounts
Auditors of a company are appointed for a term of five years in the AGM through an ordinary resolution. Subsequently, their appointment is ratified in every AGM during the five-year term. The company, in a general meeting, may remove auditors before the expiry of their term by circulating a special notice, passing a special resolution and seeking prior approval from the Central Government. Auditors are required to make a report to the members of the company in respect of the financial statements (balance sheet, profit and loss account, cash flow statement, statement of changes in equity if applicable and notes) examined by them at the end of each financial year.
The various tools of IPR used to protect innovations are copyrights, patents, trademarks, industrial design, geographical indications, and layout designs for integrated circuits. There are differences in the degree of protection for each of them. Intellectual Property Law is an important aspect for marketing a startup and ensuring that their investments reap exclusive benefits. India has weak intellectual property rights enforcement mechanisms. Therefore, registration of intellectual property rights is even more important in such environment as it facilitates the enforcement process. Trademarks, patent and copyright laws are discussed briefly in the following chapters.
Trademark registration is an evidence of ownership, a sort of limited exclusive right to use the mark in relation to the goods or services the mark represents. The law of trademarks is contained in the Trademarks Act, 1999 and its corresponding Trademarks Rules. According to the Trademarks Act, 1999, registration of trademarks for goods and services including multi-class applications are also permissible.
India and Germany are both part of the Madrid Protocol. Therefore, a trademark application can first be made to the International Bureau under the Madrid Protocol, from where it is transferred to the Indian trademark registry. While obtaining a trademark registration may take 1 or 2 years, the initials “TM” are instantly available for use. A German startup is well advised to initiate the process of obtaining trademarks through this route prior to entering into the Indian market. This step shall ensure that the German startup has the legal right to do business under its designated name.
A patent is an exclusive monopoly granted by the government to an inventor over his invention for limited period. The legislation governing the patents in India is the Patents Act, 1970 as amended from time to time.
India and Germany are signatories of the Patent Cooperation Treaty (“PCT”). The PCT essentially facilitates filing of a single application for grant of patent rights in various countries. However, the patent office of the country where the application is made is solely responsible for grant of patent in that jurisdiction. PCT applications must be made within thirty-six months from the date priority is claimed. A foreign applicant is required to give a local address in India, which would also decide the jurisdiction where an application is required to be made.
A new product or process having an inventive step and capable of industrial application can be patented by any person who is the true and first inventor or his / her assignee or his / her legal representative upon his / her death. Inventive step is a feature of an invention that involves technical advancement as compared to existing knowledge or economic significance or both and which is not obvious to a person skilled in the art.
The Copyright Act, 1957, supported by the Copyright Rules, 1958 is the governing law for copyright protection in India. The Copyright Act provides that a copyright subsists in an original literary, dramatic, musical or artistic work, cinematograph films, and sound recordings. A computer programme is treated as a “literary work” and is protected as such. Under Indian law, registration is not a prerequisite for acquiring a copyright in a work. A copyright in a work is created when the work is created and given a material form, provided it is original. However, registration of a copyright allows for its easier enforceability. A German entity may apply for registration of copyright with the Indian copyright office. Registration of a copyright typically takes up to 2 to 3 months.
India and Germany are signatories of the Berne Convention, Phonograms Convention, Universal Copyright Convention and WTO’s Trade Related Aspects of Intellectual Property Rights Agreement. As per India’s International Copyright Order, 1999, works that have been made or published in Germany are eligible for copyright protection in India, regardless of any registration.
The term of copyright is, in most cases, the lifetime of the author plus 60 years thereafter.
The Competition Act, 2002 bars “anti-competitive agreements”. Anti-competitive agreements which (i) determine purchase or sale prices; (ii) limit or control production; (iii) allocate geographical markets between enterprises and (iv) facilitate bid rigging; are per se against the law. Further, anti-competitive agreements which (i) require purchaser of goods to purchase some other goods as a pre-condition; (ii) determine the price at which a good may be resold etc; are illegal if they cause an appreciable adverse effect on competition in India. The Competition Act, 2002 also prohibits an Indian enterprise from abusing its dominant position in its relevant product or geographical market and the Competition Commission of India’s approval is required if valuation of a merger of two entities crosses certain financial thresholds.
If the Indian entity violates the Competition Act, 2002, a penalty may be levied which is 10% of its average turnover for the last 3 preceding financial years.
Loans provided by the German entity to its Indian counterpart are called External Commercial Borrowings (“ECB”). Depending on the facts and circumstances, such loan may require prior permission from the RBI through the approval route or may be routed through the automatic route. Therefore, it is critical no amount is disbursed as loan from outside India without consulting the Indian company’s bank and lawyers.
The Indian Data Protection regime is on the cusp of an extensive overhaul. The legislative proposals for the Indian data protection framework suggest that India shall soon move to a General Data Protection Regulation (“GDPR”) inspired data protection regime. Thus, it becomes relevant to understand both the current framework and the proposed overhaul.
Currently, India does not have a specific legislation dedicated to data protection. India provides data protection through the Information Technology Act, 2000. Indian law regulates and protects sensitive personal data and information (“SPDI”) relating to (i) password; (ii) financial information such as bank account, credit card, debit card or other payment instrument details; (iii) physical, physiological and mental health condition; (iv) sexual orientation; (v) medical records and history; and (vi) biometric information. An entity is allowed to collect SPDI only if collecting the information is required for the performance of its lawful functions. Prior written consent must be obtained for collecting SPDI. Such consent shall be valid only if the person concerned is informed about the reason for collection of SPDI and the intended recipients of such SPDI. Further, a body corporate has to ensure that reasonable security practices and procedures in consonance with international standards for protecting data are in place. A corporate body is mandated to provide compensation to an individual whose sensitive personal data and information is leaked causing wrongful loss or wrongful gain to any other person.
The Government of India has released the Personal Data Protection Bill, 2018 (“Draft Bill”) on July 30, 2018. The Draft Bill imposes obligations regardless of the market standing of the company, therefore if this bill goes into effect, even initial stage startups shall be burdened with high compliance costs. The Draft Bill provides mandatory registration requirements on data processors who conduct high risk processing. Such processors are required to implement trust scores, data audits as well as data protection impact assessments. Further, the draft bill provides that a copy of all personal data must be stored in India; additionally, the government may notify certain types of personal data that should be mandatorily processed only in India. The Draft Bill provides penalties of up to 4% of global turnover in some cases. In limited situations, criminal penalties have also been prescribed.
Further, the government has released a draft version of the Digital Information Security in Healthcare Act (“DISHA”) for specifically regulating and protecting digital health data (“DHD”). DISHA aims to provide for privacy, confidentiality, security and standardization of DHD and associated personally identifiable information. It seeks to regulate the manner of generation, collection, storage and transmission of DHD. Contraventions of DISHA entail payment compensation to the owner of the DHD, however imprisonments of up to 3 to 5 years or fines have been prescribed for serious contraventions. German entities who propose to enter India’s healthcare sector must analyse their data security norms and practices in light of this proposed legislation.
In view of the government’s clear intent to move towards a GDPR inspired data protection regime, German entrepreneurs are well advised to enter the Indian marketplace with the same security mechanisms and degree of respect for protecting personally identifiable data with which they operate in the European Union.
Dispute resolution in India
In India, dispute resolution is costly and time-consuming. Indian courts are notoriously slow in adjudging disputes. The World Bank has reported that it takes an average of four years to enforce a contract in India. The average legal costs of the dispute amount to 1/3rd of the claimed amount. Further, Indian courts seldom permit recovery of legal fees from the losing party. However, there have been efforts to improve the system, such as recent amendments to Indian arbitration law which impose a one-year time limit within which arbitration proceedings have to conclude. The Indian entity must ensure that there are dispute resolution clauses within their contracts, specifying a manner through which disputes are to be resolved. In our experience, formal mediation through qualified mediator is fruitful and must be attempted prior to going for litigation/arbitration.