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Good housekeeping: a strategy for young companies

22 May, 2015

It is often hard for young companies to visualise the number of laws which their existence and operations attract. Ironically, as the scale of their operations increases, legal compliance becomes more relevant and also more difficult to organise. The difficulty is in part because the laws are designed to discourage delayed compliance—this is invariably not time and cost-efficient due to the mounting penalties and procedural difficulties encountered. Practically as well as legally therefore, it is advisable for young companies to address legal compliance (‘housekeeping’) requirements rather than find oneself in a situation where one has to retrospectively ‘correct’ prior non-compliances. Young companies (and old) are increasingly realising that it is more cost and time-efficient to ensure legal ‘housekeeping’ is achieved sooner rather than later, and well before a potential investment.

 Good housekeeping in particular is of value before (and not during) the due diligence process for an outside investment. Besides, non-compliances are implicitly priced in outside investments by way of, for example, stronger indemnities for the investor in investment agreements and in a higher perception of the corporate culture generally- which is then reflected (not expressly computed) in the economic value of the company securities, as well as quality and price of outside investment.

For various reasons, private limited company still remains the most popular form of incorporation for young companies. Even as young organisations grow, many often change to public status only just before their initial public offering and this is to comply with a securities law requirement. Indian corporate, labour and other laws, unfortunately, do not have significant relaxations in compliance standards for small or young private limited companies.

Following are just a few key housekeeping suggestions:

Labour-related laws

‘Labour’ is a misnomer as some of the laws equally apply to white-collar employees. These are probably the highest enforced legislations in India due to the demographic these laws intend to protect. A few important compliance areas are mentioned below:

  • A sexual harassment policy is required for every company that has even one female employee
  • A register of number of workers and remunerations is required to be maintained for a company having even one employee
  • Records of requisite maternity leave and related benefits, as well as annual returns, is required to be maintained for a company having ten or more employees where this number includes female employees
  • Records of employees and monthly provident fund contributions by the employers are required along with the registration of the company with the relevant authority (the assistant labour commissioner) for future gratuity payments if there are ten or more employees, and registration for provident fund code with the employee provident fund organisation if there are twenty or more employees in the company

The definition of ‘employees’ and ‘workers’ varies in each of the laws above. Given the onerous nature of labour laws and a strict enforcement ethic, the market has evolved structures (not all of which have been tested in court) for managing non-compliance risks-most commonly by structuring employment contracts in a certain way or by other sub-contracting structures typically involving a third party provider.

Meetings

Mandatory procedures, for both board and shareholder meetings, are critical. This is prone to be overlooked in early stages because of the comfort of “it is all among friends/family”. Later, in a contentious context- or in an investment due diligence process- such lapses can prove to have serious consequences. For instance, a corporate action (for example issue of shares or esops, and buy-backs) can be later avoided i.e. read in invisible ink or at least disputed, if made outside of mandatory procedures.  Illustrations of such procedures are:

  • Video conferencing for board meetings requires various compliances such as the responsibility of the chairman to record the proceedings; preparing the minutes of the meetings and ensuring that no person other than the concerned directors have access to such proceedings.
  • Draft minutes of the board meetings (including the meetings held by video conferencing) have to be circulated within 15 days of the meeting either in writing or by e-mail.
  • Certain corporate actions can only be conducted by general meetings (as opposed to just board meetings)—the notice to members for general meetings requires specified minimum disclosures such as disclosing  the nature of interest of key managerial personnel and directors in the proposed transaction. Timing-wise, this notice is required to be sent to shareholders atleast 21 days (through writing on e-mail) ahead of the meeting, with very limited exceptions.
  • Resolutions of the board and shareholders’ resolutions (including the notice of the meeting) have to be filed with the registrar of companies within 30 days of passing the resolution. This then becomes part of public domain and can be searched out and accessed by anyone electronically.

IT

Operation of a call center, BPO, vehicle tracking systems for instance requires registration with the department of telecommunication (‘DoT’) as ‘other service providers’. Further, the company is required to provide their rules and regulations, terms and conditions along with their privacy policy to the users or information providers in compliance with the Information Technology (Intermediaries Guidelines) Rules, 2011 and the Information Technology (Reasonable security practices and procedures and sensitive personal data or information) Rules, 2011 issued by DoT which also requires an audit of security procedures, once a year or as an when the company undergoes standard upgradations.

Miscellaneous

  • All companies are mandatorily required to include their name, registered offices address, CIN, telephone number, fax, email and website on their letterhead.
  • Appointment of a company secretary is mandatory for private limited companies with a paid-up share capital of Rs 5 crore or more.
  • All companies have to prepare annual returns to include, inter alia, particulars of its promoters, directors, key managerial personnel (‘KMPs’) and remuneration of its directors and KMPs.
  • All companies are also required by law to maintain a register of directors and KMPs, at their registered office, including the details of securities held by them in the company or its holding, subsidiary, subsidiary of company’s holding company or associate companies.

This article is intended to provide a flavor of good housekeeping and its strategic importance to young companies. Besides the areas covered here, there are other registrations required such as under the shops and establishments acts (which vary across states) which is generic across industries, industry-based registrations and compliances, tax aspects as well as compliances with foreign exchange laws. In foreign exchange laws, as a general rule, the primary compliance responsibility (such as filings after receiving investment/allotting shares to non-residents) rests with the Indian entity and not the foreign counter-party.

For the various reasons set out here, it is advisable for young companies to fine-tune housekeeping early. Another implication of historical non-compliances is disclosures in the ‘Risk Factors’ section draft red herring prospectus, red herring prospectus and prospectus.  Finally, post-Satyam and due to other factors, the business climate in India is rapidly shifting from the glorification of ‘jugaad’ (getting away by quick-fix means) or the indulgence of ‘chalta hai’ (complacency)—to greater respect for professionally managed companies. This is also often reflected in a higher market premium for companies which maintain best practices because better investors are more willing to pay a better price for a stake in better-managed companies.

Good compliance, among other benefits (and besides being a legal requirement) attracts good investors and over the medium and long term has all the advantage with being associated with good quality does.

(Srishti Ojha is Partner Mugdha Sharma is an Associate at Verist Law.)


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Good housekeeping: a strategy for young companies

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