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Lessons from COVID for Start-ups...

From a Lawyer's Desk

Lessons from COVID for Start-ups...

Sunday April 26, 2020,

8 min Read

Lessons from COVID for Start-ups…. From a lawyer’s desk

Not only has COVID-19 outbreak hit the bigger businesses worldwide, it is the start-ups too who are bearing the brunt, and that too, very badly. Amidst issues such as financial crunch, pitching for funding, high degree of mismatch between the available resources and exponential business plans, when Start up’s business and operations were still amorphous, Covid came and crushed them flat.

 Start-ups boast of a high-risk appetite, and we laud them for that, but the downside here is that everything is put at risk. Talking about legal risk exposure, most often it is not put, but ‘plattered’. Start-ups tend to undermine the legal front; it is either dealt lackadaisically or with a “Cross that bridge when you come to it” approach. Though this article does not tend to impart gyan to fix that front (as that is already there!), what it tends to bring forth and adduce is that, from the Covid crisis, all businesses, especially start-ups, who are still learning the ropes, fix the ropes on the legal front, going forward. These are some lessons from the on going covid crisis which will definitely help sharpen the axes.

Lesson #1: Fix the force majeure clause in your contracts

Suddenly everyone is scrolling down to the often boiler plated force majeure clause in their contracts. A force majeure clause is inserted in a contract to relieve the contracting parties from performing their contractual obligations in situations over which they will have absolutely no control. The clause must lay down clearly, such situations. So, for instance, if A agrees to deliver certain raw material to B but could not reach the agreed delivery point owing to say, CAA protests, A can take recourse under the force majeure clause, if the clause excuses A from performance in case of anarchy due to protests. And, ideally, the clause should provide the next course of action and parties’ obligations during protests.

 What if the contract does not have a force majeure clause? Then, section 56 under the Indian Contract Act can come in play. As per Section 56, a contract becomes void when it is impossible and nugatory to perform it owing to occurrence of certain supervening events, which are beyond the control of contracting parties. But, this does not mean that if a such an event occurs, all contracts become void overnight. It is the courts that decide if the if the very basis of the contract got frustrated and shield of section 56 could be provided to declare it void. Unfortunately, mere commercial impossibility is not shielded under this section.

Getting a favorable order with respect to a contract being void is not always the desired and commercially suitable result. It is, therefore, advisable to have a force majeure clause in the agreement. A well-drafted force majeure clause can encapsulate provisions for partial suspension of contract, suggest alternative mode of performance, rescheduling payments and waiver of interest on late payments, reference to severability clause or an obligation to mitigate the losses.

Let us illustrate the need to have a well-drafted force majeure clause:

Illustration 1: A has agreed to render certain software development related services to B, along with certain support services. Now, in the current lock down scenario, B would ideally want to continue to procure at least those support services, which are possible for A to provide, say, telephonic assistance. Those which A cannot provide, could be suspended for the time being and resumed once the lock down is over. B can make pro rata payments and A should be good with that. But, things do not happen ideally if the are not put in black and white. Neither does section 56 fill in for that.  

Illustration 2: Contract between A and B has a force majeure clause, but it does not cover government notifications and pandemic as force majeure situations. A may, to its benefit, not acknowledge a Covid situation as force majeure and require B to perform and deliver. What should have been the ideal scenario here? The contract should have had an inclusive definition of force majeure instead of stating that only x, y and z will be considered as force majeure events. In fact, in abundant caution, A and B can reserve their right to refer the matter to court/arbitration on whether an event shall constitute force majeure event or not.

So, touch base with your lawyer and consider revisiting your existing contracts, if possible. Your lawyer is not God, but you can try to foresee and address every possible issue that you are facing today and be careful in your negotiations on force majeure clause. Analyze what all can impact the very basis of your contract (currency change, a bill graduating to law which may not be very favorable for parties, riots occurring in a riot sensitive zone, a cyber attack, terrorism etc.) and at the same time, unless you require otherwise, allow your clause to include incidents, which are not foreseeable. Ensure, if you deem fit, that parties reserve a right to part perform or suspend performance without unnecessary financial burden, but assess that for how long you would want such part performance or suspension.

Lesson #2: Fix your Lease Deed

With respect to lease deeds, as we read media reports, many big corporate houses are exploring the option of excusing themselves from rent payment for the lock down period. One can argue, as long as lessee’s inventory or remote servers are parked in the leased premises and possession lies with the lessee, lessor is very well performing part of its obligations. So, why shouldn’t the lessor be entitled to rent? As per Section 108(B)(e) of the Transfer of Property Act, a lessee can call off the lease if it demonstrates that there exists an irresistible force, owing to which the premises have been rendered unfit for use, substantially and permanently. As per author’s opinion, it would be tough to build up an argument to bring Covid under Section 108(B)(e). Again, the question arises if you are looking at determination of lease in times like these. It makes more commercial sense to construct clauses in your lease deed which provide for part payment, waiver of late payment charges and resuming business as usual once external situations, which are stopping you from utilizing the leased premises, settle.

Lesson #3: Fix your employee policy

Even if the lockdown is lifted in May 2020, not all businesses may be able to resume from where they left, from Day 1. Reasons being, the ripple effect of lockdown from other business partners or service providers, non-availability of support staff, obligation to clear back logs in a scenario when the quarter has recorded no or very low income. These are the problems, which almost every business will face, but the magnitude with which these problems will hit start-ups, will be much higher. In such a scenario, when the overall scope of business crunches, the tension cascades down to the key resource of any business- the employees. Rightly, so, if the business needs to cut down on resource utilization, it needs to. You have to take it with or without that pinch of salt. So, for situations like the current lock down, employers must retain rights to suspend employment, defer payment, implement pay-cuts for the top management and allow employee to resign without notice. In fact, this should be enshrined in employment policies. It will enable employees too to stay prepared on the slightest whiff of some major external event triggering. Having said that, to the extent possible, March 20, 2020 advisory of the Ministry of Labour and Employment should be taken as the law of the land. As the notification states, terminations and salary cuts will only deepen the crisis.

Lesson #4: Digitize

Start-ups are already tech savvy, and it should not be difficult for them to have systems in place to digitally execute contracts and hold both statutory and no statutory meeting as well as maintain e-registers. While the sentiment on investment may not be that favourable, but you must be all ready for due diligence. Have well secured digital lockers to park your key documents. This will bring in ease of business as well.

One way to learn to do something right is to do something wrong and the other is to learn from others’ mistakes. If you run a business, learn these lessons.