Starting Up the Startups !

Preface 

Off lately..., I have been reading and have been inspired by the rampant mushrooming of the internet technology, techno-electrical goods and internet based service providing startups in metropolitan areas in India. Be it said, that some of them have come up with sparkling brand new and novel ideas while the others have made serious attempts to provide the same age old products, goods and services in tastefully fresh-painted and polished boxes. Proud owners of such old and new ideas insist being called - Entrepreneurs ! 

While all of them out there, bustling in and out of busy conference rooms are to be, almost always congratulated on account of novel idea or novel packaging or something of novelty of some sort, yet, I have been, on many occasions, part of not such a congratulatory setup. That's why the present Blawg!

What Lies Below the Skin ! 

For the purpose of the present exponent, I draw from my somewhat limited experience in dealing with startups, mostly based out of Bangalore, Hyderabad, Noida, Gurugram, Mumbai and Delhi among others, and in this section, I chose to discuss what were some of the most frequent problem which I had to troubleshoot: 

Ideas belong to individuals mostly, and expression and projection of such ideas are always a result of coordinated group/team undertakings. And that is where lies the conflict !

Being a student of anthropology and thereafter a student of law, I have come to realize that the strongest emotion in this world is a mother-child emotion, which may always not be true in the reverse order. The next strongest emotion of this world is the financial emotion. 

Financial emotion, in terms of the life cycle of a Startup traces its steps from the association of persons who are responsible for the day-to-day business of it. Such consenting adults running the business, nigh and day are called - Partners of Firm. Yes, there are Companies also, but mostly, Startups operate as partnership firms and entities. With Partners or Directors in the Company, there comes the issue related to profit sharing in some proportions, and that's the trouble everyone swims through. 

Business Partners - Laws related to them 

In India, the association of the partners in a firm, their rights, duties, to each and their obligations and responsibilities to third parties are contained in the Indian Partnership Act, 1932. 

The Indian Partnership Act, 1932 simply defines a partnership concern as an association wherein two or more persons agree to operate a trade or a business acting in a unison and agree to share profits and losses arising from the said business activities. The definitions are below: 

Section 4 - "PARTNERSHIP" is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Persons who have entered into partnership with one another are called individually, "partners" and collectively "a firm", and the name under which their business is carried on is called the "firm-name". 

Section 8 - "PARTICULAR PARTNERSHIP". A person may become a partner with another person in particular adventures or undertakings. 

At this stage, it may be clarified that it is, unambiguously speaking, essential and critical to have a partnership agreement. This document forms the heart and soul of the Firm or the Startup. In the said Partnership Agreement, it is essential to define what would be the role, responsibility and duty of each of the partner, what would be the Capital introduced by such partner and what shall be the ratio in which the profits and losses shall be divided inter se between the partners. In the same Partnership Agreement, it must essentially be recorded as to what activities can be undertaken by the Partners, and what activities are absolutely prohibited. This becomes important to arrest, contain and later ventilate disputes between the parties should the association turn out to be a sour wedding like event. The relevant provisions are mentioned below: 

Section 5 - "PARTNERSHIP NOT CREATED BY STATUS". The relation of partnership arises from contract and not from status; and, in particular, the members of a Hindu undivided family carrying on a family business as such, or a Burmese Buddhist husband and wife carrying on business as such are not partners in such business. 

Section 7 - "PARTNERSHIP-AT-WILL". Where no provision is made by contract between the partners for the duration of their partnership, or for the determination of their partnership, the partnership is "partnership-at-will".

What the above provisions mean is that the there cannot be any partnership between any number of persons unless there is a specific written document to that effect. The document has to contain the entire gamut of the rights and liabilities which one partner owes to the other partners. Though the above mentioned provisions do not specifically mention that the business activities and the shared capital and rations of division of profits and losses are to be contained in the Agreement, it however is always advisable to have one comprehensive document to that effect.

Section 59 - "REGISTRATION." (1) When the Registrar is satisfied that the provisions of section 58 have been duly complied with, he shall record an entry of the statement in a register called the Register of Firms, and shall file the statement. [19 On the date such entry is recorded and such statement is filed, the firm shall be deemed to be registered. (2) The firm, which is registered, shall use the brackets and word (Registered) immediately after its name.  

It may also be very clearly mentioned that all such documents must be registered with the office of the registrar. Reason being - the public must know who they are dealing with and what are the credentials of the said Firm or the entity. Also, it may be mentioned that UNLESS the Partnership entity is a registered one, it can not later sue either its partners on account of any of their unlawful conduct or fraud. Neither can the Firm or the Partner can sue any third party to redress any of its civil claim. The said bar has been cast upon by operation of the Law itself. 

Section 69 - "EFFECT OF NON-REGISTRATION". (1) No suit to enforce a right arising from a contract or conferred by this Act shall be instituted in any Court by or on a behalf of any persons suing as a partner in a firm against the firm or any person alleged to be or to have been a partner in the firm unless the firm is registered and the person suing is or has been shown in the Register of Firms as a partner in the firm.

(2) No suit to enforce a right arising from a contract shall be instituted in any court by or on behalf of a firm against any third party unless the firm is registered and the persons suing are or have been shown in the Register of Firms as partners in the firm. 

Of course, there are limited exceptions to the said principles, but those principles deserve to be dealt with in greater detail in another separate article and is outside the scope of the present writing. 

Some cases and illustrations relating to the provisions mentioned above: 

Startup Case - 1 @ Mumbai*

Lately, there was a very peculiar dispute, papers in relation to which were laid before me for legal help and advice. The matter was related to a multi-storied residential complex, located in the upmarket area of Mumbai. The complex was to first be demolished and thereafter to be reconstructed.

Initially, the Cooperative society awarded the whole demolition and construction project in favor of an individual (Mr. M). Mr. M, realizing that the said project is more than what he can bite and certainly more than he can chew or eschew, entered into a partnership with Mr.S and Mr.RI.

Mr. S, invested a huge pool of capital in the demolition, construction and then the rebuilding of the project. As is customary in most of the construction/real estate management contracts, the project finances, moneys and permissions were handled on behalf of the firm by one of the partners - Mr. RI. 

It so happened that monies changed hands, all under the benign or otherwise supervision of Mr.RI. This resulted in several disputes inter se between the parties and the construction came to a grinding halt. 

The documents, as were put before me for legal advice, revealed that there were gross under-declarations and embezzlement of the capital and assets of the Firm. Mr. RI certainly took advantage of the trust reposed upon him by the other partners of the Firm. 

The difficulty was - how to arrest the damage and salvage the losses. It was stark to note that from the very beginning, there was an overwhelming trust factor which filled the hearts of the partners towards each other and that resulted in the Partnership not being registered. It was manifestly clear that the civil proceedings for recover of any of the losses and misappropriations could not be instituted in the Court of Law, on account of the embargo, or the bar placed upon such civil suits by the provisions mentioned above. 

On account of some good fortune, the damages could finally be arrested. However, it became difficult to recoup the losses which were suffered not only by the firm but, by the partners also. 

*Though this case is not related to any startup dealing in the IT space, but, has been mentioned here as a text book example of what risks are present in case of an unregistered partnership. 

Startup Case - 2 @ Noida 

This was a Startup, operating in the internet space. The business was in relation to the supply of semi-stitched and finished garments on internet e-commerce platforms. The partnership was struck between the partners in very peculiar circumstances. 

It so happened that one of the partner in the Startup Firm pooled in the larger share of the capital and got away with certain special bargains. The special bargains were - he was put in charge and authority to control the banking transactions of the firm. Luckily, the said Firm was registered !

The marriage among the partners was a placid and happy one until lapse of 6 months. Then the dispute arose among the partners. One of the Partner Mr. SG unilaterally made large scale transaction from the partnership bank accounts to meet his personal obligations. Not only this, he unilaterally withdrew from the firm without assigning any reason. It must also be noted that the partnership was not at will, but was rather for a fixed period of 2 years. 

The withdrawal of one of the partner form the Startup firm precipitated huge crisis within the startup. Once - the Bank discredited all the transaction, unless was authorized by both the partners. Second, there was liquidity crunch within the Firm, thirdly, the raw material could not be purchased without the finds being processed and at least, the staff salaries were not paid on account of dishonored transactions.

Not just this, there were far grave consequences - which luckily were overcome. Those were - the cheques issued by the firm were dishonored and the Startup was served upon legal notices under Section 138 of the Negotiable Instruments Act, 1881. 

God willing, it was a registered partnership and a quick suit for declaration and mandatory injunction was instituted in the competent court of law. The tables turned when looking at the whole of the situation at hand, the court was pleased to rule interim relief in favour of the non-defaulting partner. This caused huge pressure to be mounted upon the defaulting partner, who then yielded in favour of the other partner. Ultimately, the partnership was dissolved.

Happy to share that the discussed Startup today continues as as a sole proprietorship concern of the diligent partner. Happy to note that the damages could be contained only on account of proper procedures being followed. Sheer foresight ! 

Startup Case - 3 @ Gurugram

This has been the most recent of matter which was laid before me by an industry association operating a startup incubation center. The facts which emerged after multiple rounds of questioning and cross questioning were - an oral agreement was struck between two swashbuckling young entrepreneurs sometime in 2016.

The Startup revolved around the idea of popularizing medical tourism in India and making buck out of it. Great ! 

An internet domain name was purchased by one of the partner in his name, which he entrusted unto the other partner for maintenance and regular updation. As chance would have it, the other partner initially regularly updated the content on the internet domain but soon, changed the dashboard details and gained absolute control over the same. 

Needless to say here that a lot of efforts, intellectual input and energy went in the way of popularizing the concept of Startup and also for advertising the domain name. May it also be said that the domain names in India and world over are recognized as a sub-species of a trademarks and derive the level of protection as is afforded to the trade marks themselves. Satyam Infoway Ltd. Sifynet Solutions Pvt. Ltd is the authority in this regard. 

The idea grew over leaps and bounds and invited eyeballs from investors and that is when trouble knocked their door. Disputes as to who is the owner of the domain name and the projection of the concept and idea arose between the start up initiators when the matter reached the stage of reaping the benefits. Thats when the papers were put before me on behalf of the industry association, and requested for my opinion. 

Naturally, I invited both the parties with the view to settle the matter amicably. Trunks and piles of papers indicating the development of idea , emails, payment sheets and sub contracts were laid by each of the partners. A quick recapitulation - the present was an oral arrangement of association between the two contesting partners !

Mr. SH, one of the claimed partner insisted that he was the owner of the domain name, since he from has been making payments regularly for the maintenance and upkeep of the trade domain name. He futher highlighted that the use of the said domain name was given up by the other partner and subsequently he (Mr. SH) acquired it. The other contesting partner, Mr. AS simply maintained that limited authority was simply given to Mr. SH to maintain and keep up with the domain name. 

Sadly, the Startup was unregistered Partnership, it being operative on oral agreement for which reason there was no possible window to resolve the disputes between the start up partners. Luckily, sense prevailed among them and they decided to find a mid way. Mr. AS agreed to let go off the domain name along with all the associated goodwill in lieu of some royalty payments. 

CONCLUSION ON STARTING UP

The examples are far and too many .. however what one needs to take home is that the first right step to start a start up is to meticulously do the initiation documentation and only then proceed forward. Through this article, I have made a limited attempt in the direction of educating the founding partners of many of the startups who at times and most of them are not aware of the legal jargon and are baffled into the world of bizarre ideas of either setting their foot towards the partnership concern or else found a company which could help them assuage their dreams. By no means, this article is intended to determine the advantages of one corporate structure over the other.

Views and comments are invited and appreciated. 

Avijit Sharma (https://patentlyjust.blogspot.com)