Abstract

Entrepreneurs must comply with a dense body of business regulation, and serious offences such as fraud rightly attract criminal consequences. The difficulty arises when technical or procedural defaults carry the same threat of imprisonment. A modern compliance system should distinguish culpable misconduct from errors that are better addressed through proportionate civil penalties.

Technical or procedural defaults should not automatically expose entrepreneurs to imprisonment. Accountability remains necessary, but proportionate civil penalties are usually better suited to minor compliance failures. Criminal sanctions should be reserved for fraud, deliberate concealment and conduct that causes serious public harm. This article argues for a modern, risk-based review of business offences.

The main argument is for the law to become simple, unambiguous and straightforward, so that it is easier to comply with rather than treading on thin ice.

Keywords

non-compliance, entrepreneur, business, lapses, imprisonment clauses, criminalization, re-examine

Introduction

India's entrepreneurial energy runs from neighbourhood shops to fintech companies. Regulation gives markets structure and protects workers, consumers and investors. Yet a compliance system that routinely threatens imprisonment for technical defaults can suppress legitimate enterprise. The central question is where deterrence ends and regulatory excess begins.

In the Observer Research Foundation (ORF) monograph, 'Jailed for Doing Business: The 26,134 Imprisonment Clauses in India's Business Laws', Avantis RegTech CEO Rishi Agrawal and ORF Vice President Gautam Chikarmane explore the root cause for bureaucratic rent-seeking, bribery and extortion. The report isolates imprisonment clauses that surround doing business in India, of which there are hundreds of anecdotes but no macro data. This report argues that the criminalisation of business laws violates Indian business traditions: from the Mahabharata to the Arthashastra, criminality was never a part of punitive action against businesses in ancient India- only financial penalties were.

Reforming these clauses is necessary to restore dignity to entrepreneurship in India.

This kind of a regulatory ecosystem is not conducive to a country like India that wants to unleash its full potential and young energy while create value for the folks, the communities and the country. Time has come to rethink India's business regulatory framework but more importantly it is the time to rethink the relationship between the state and businesses. "Amongst the most dangerous of populist rhetoric's that have hurt this country, I would argue that the one which demonizes the businesses and people involved therein is the most harmful. The rhetoric is both jaded and harmful.

It is jaded because the young people in India seek to partake in prosperity and creating value for their country, their community and for themselves and is dangerous because this rhetoric perpetuates the mosaic of compliances and regulations that make doing business a mere criminal endeavor", said Dr. Samir Saran, President, ORF.

This research article investigates the consequences faced by companies in India that fail to comply with legal requirements, even when such non compliance is unintentional or pertains to minor or technical breaches. Such companies may encounter a range of repercussions, including criminal prosecution, reputational damage, employment losses, monetary fines, penalties, imprisonment, legal costs, and psychological distress. Historically, every instance of default or violation whether it was procedural, technical, fraudulent, or intentional- was treated with significant severity, often resulting in the imprisonment of directors.

Legal Framework of Indian Startups

To run a business both ethically and effectively, it is essential to comply with different kinds of legal rules, regulations, acts and legislations. Failure to do so can result in severe legal consequences, making it crucial for businesses to adhere to these laws. Some of the essential laws that form the backbone of Indian business regulatory system are as follows- A. The Companies Act: The formation and operations of the corporate entities are governed by this legislation, including the specific rules and provisions that companies must follow to ensure their smooth functioning and successful operation.

B. (a) The Environment (Protection) Act of 1986: It is a crucial legislation concerning environmental and pollution control that businesses must give due consideration to.

(b) The Air (Preventions and control of Pollution) Act of 1981: Government passed this act to clean up air by controlling pollution and it also regulates certain businesses.

(c)The Water (Prevention and control of Pollution) Act of 1974: It aims to prevent the pollution of water by industrial, agricultural and household waste water thus forming business rules.

C. Labour Laws: Every business relies on manpower to continue with the operations and they are known as employees of such company. Appointing an employee requires specific provisions set by the labour laws to be followed.

Some certain statutory laws: The Factories Act, 1948 is a crucial statutory law that aims to protect the interests of workers by ensuring their safety, hygiene, and overall welfare while they are at work. This legislation places various responsibilities on the occupier of a factory and the factory manager to prevent exploitation and promote the well-being of workers. Additionally, amendments to the act and court rulings have broadened the definition of occupier, particularly in relation to hazardous processes within factories.

The act governs the working conditions and provides regulations for health, safety, welfare, annual leave, and special provisions for young persons, women, and children working in factories. The law provides for imprisonment of up to two years for an occupier or manager of a factory for any violation or contravention. The prescription is general and universal, which means that even the most minor offence will have a disproportionately high provision for imprisonment. The equivalent crime under the Indian Penal Code, 1860 is sedition. Consequently, the designation of 'factory manager' has had an extremely high level of risk embedded into it.

Regulatory Hurdles

One of the most significant challenges faced by entrepreneurs in India is navigating the complex regulatory environment. Starting and operating a business often involves dealing with multiple government agencies, obtaining various licenses and permits, and complying with numerous regulations. Bureaucratic red tape, lack of transparency, and delays in approvals pose significant barriers, especially for small and medium-sized enterprises with limited resources. The burden of compliance and regulatory uncertainty can stifle innovation, deter entrepreneurship, and hamper business growth. It acts as a stumbling block inviting unnecessary regulatory entanglement.

Mishra and Ghosh (2019) highlight the challenges posed by cumbersome regulatory processes, bureaucratic red tape, and ambiguous laws, which hinder entrepreneurial ventures in India. Rajan and Nagendra (2020) emphasize the need for regulatory reforms to streamline business registration processes, reduce compliance burdens, and enhance the ease of doing business for entrepreneurs. Navigating through complex regulations and bureaucracy can be a daunting task for founders, particularly in industries which are heavily regulated such as fintech, healthcare, and e-commerce.

Failure to comply with regulations can result in unpleasant outcomes such as imposition of hefty fines, legal complications, and reputational damage, making it imperative for them to stay abreast of the latest regulatory changes and ensure compliance at all times.

Research on enterprises in Chhattisgarh ranked regulatory and compliance risk second among major business risks, while legal risk arising from legislative change ranked fourth. The finding illustrates how heavily regulatory uncertainty weighs on business planning.

Table- Identification of business risks faced by entrepreneurs Major risks | Mean | Rank Capital market risk (capital constraints) | 4.10 | 1 Regulatory and Compliance risk | 3.95 | 2 Market risk (lack of contracts and demand) | 3.73 | 3 Legal risk (change in legislation) | 3.66 | 4 Operational risk (inability to handle process) | 3.52 | 5 Economic risk (economic reforms) | 3.15 | 6 Management risk (lack of management skills) | 2.96 | 7 Security risk (accidents, Incidents, etc.) | 2.87 | 8 Technology risk (adapting modern technology) | 2.59 | 9 A contrasting argument is given by an overarching thought about how people have to be threatened with dire circumstances; else, they will not behave.

And many people assume that this argument is the underpinning of this approach for framing of such laws as they've been framed over the decades. But when we look at the genesis of some of these laws, they were either pre-colonial or framed right after Independence. But condition of the country at that time was really different. At that time, the contribution of private sector and the manufacturing sector was next to nothing. Public sector was the largest creator of jobs, but when we look at the position now, private sector has been officially recognized, at the topmost level as an engine of growth in the economy. Some of these compliances were relevant in 1940s, but the world has changed today.

Competition for skilled workers has transformed the modern workplace. Firms now use pay, benefits and working conditions to attract talent in a global market. Business regulation must evolve with that economy; obsolete and punitive requirements should not survive merely because they are old.

India's economy and business environment have changed dramatically since the late 1940s, but many regulatory structures have never been comprehensively reviewed. That failure helps explain why entrepreneurs continue to describe compliance in India as unusually difficult. Back then, in early period of independence, prominent business challenges stemmed from lack of infrastructure, capital and institutional support whereas today while resources have grown, a maze of regulatory compliances, global market pressures and legal risks awaits businessmen.

Disproportionately severe penalties for minor defaults can deter early-stage ventures from entering the formal economy. The threat of prosecution for technical or procedural lapses raises costs, damages reputation and can make investors or partners reluctant to engage. Proportionate enforcement would punish genuine misconduct without treating ordinary compliance errors as crimes.

There are around 63 million enterprises in this country of which only about 1 million are in the formal sector. The reason behind this is that the moment a small entrepreneur becomes big enough or decides to expand, that very moment, he or she overnight has to negotiate 400 to 600 compliances a year. There could be more, depending on the nature of the industry that entrepreneur is engaged in. Thus, according to them, it is far better for them to remain small and perhaps start another company doing the same business, but remain free from the over regulatory compliance framework, as to stay small is to stay swift- beneath the radar, beyond the red tape.

Table: India's Business Regulatory Universe

Table: Imprisonment Clauses in India's Business Regulatory Universe

Centre-State Distribution and Control

The regulatory environment in India is complex and often involves a network of multiple agencies at the central and state levels. Factories act is a union act and labour is a concurrent subject where the centre and states or the union and the states both legislative laws. The core union act provides a framework in which the states go ahead and write the rules. So it can be said that the specific compliances for a given state are actually taken from the factories rules of that state. While the union act lays the broad foundation and the outline, but still, about the specifics on the forms and the format, the registers, the implementation of the act lies with the state.

Certain industries are under the union government where the appropriate government is union and most of the other industries are where the state rules apply. Petroleum, insurance or banking, are few among the other industries where the central or the union rules apply and for all the others, the state rules apply. The Factories Act, 1948 contains blanket provisions prescribing penalties for violations of any provision of the Act or related rules drafted by state governments.

A Step Towards Decriminalization- Paving the Way Towards Reducing Regulatory Cholesterol

On 1 February 2023, the Finance Minister Nirmala Sitharaman, in her budget speech stated that "[f]or enhancing ease of doing business, more than 39,000 compliances have been reduced and more than 3,400 legal provisions have been decriminalized. For furthering the trust-based governance, we have introduced the Jan Vishwas Bill to amend 42 Central Acts. This Budget proposes a series of measures to unleash the potential of our economy." Furthermore, the Finance Bill aimed to decriminalize various other provisions such as those under the Central Goods and Service Tax Act, 2017 and Income Tax Act, 1961.

The reform reflected India's broader ease-of-doing-business agenda and a shift from criminal prosecution towards civil adjudication for regulatory defaults. Its purpose was to reduce avoidable litigation, improve company administration and allow courts and tribunals to concentrate on disputes that genuinely require judicial attention.

Thus, the Companies (Amendment) Act, 2019 and Companies (Amendment) Act, 2020 were passed after taking into account the issues raised in the Report of Company Law Committee ("CLC") headed by Mr. Injeti Srinivas which observed that serious violations of law, especially wrongful conduct involving fraudulent elements, should be dealt with under criminal law while minor, technical and procedural non-compliances, may be dealt with through civil jurisdiction instead of criminal. Furthermore, a trust-based approach towards compliance builds faith of entrepreneurs in corporate institutions and motivates them to adopt fairer and more transparent business practices.

Over the years, for violations under the Companies Act, 2013 the government had been filing criminal cases as per the provisions of the Act. Out of more than 40,000 cases filed under the Companies Act, 1956 and Companies Act, 2013, almost 39,000 cases (more than 97 per cent) did not involve lapses of serious nature. This meant that criminal courts were being needlessly burdened with minor cases on account of procedural defaults. Consequently, the courts were not able to pay adequate attention to serious cases of fraud, deceit or injury to public interest. The fear of criminal penalty for minor defaults deterred many entrepreneurs. This also impacted the ease of doing business environment in country.

Therefore, the government decided to undertake a comprehensive review of all the penal provisions under the Companies Act, 2013 so as to identify the nature of each and every default, and ensure that the penal consequences of any lapse are proportionate to the magnitude of that lapse. The Companies Act, as it originally stood, was premised on the deterrence doctrine wherein failure to comply with provisions of the Companies Act, would entail penal consequences under criminal law. It consisted of 134 penal provisions, of which only 18 non-compliances fell under the purview of in-house adjudication mechanism and the remaining 116 non-compliances would entail initiation of criminal proceedings.

It focused on changing the nature of certain criminal offences into civil wrongs omitting certain other redundant offences altogether.

The Companies Act now consists of 124 penal provisions, of which 58 non-compliances fall under the purview of in-house adjudication mechanism and the remaining 66 non-compliances would entail initiation of criminal proceedings. Furthermore, the Amendment Act, 2020, in case of certain offences, has eliminated imprisonment and restricted the punishment to fine only and/or reduced the fine and/ or penalty so imposed. In addition, alternative means, including through the use of Data Analytics and Artificial Intelligence (AI), were to be leveraged to reduce the very likelihood of the occurrence of defaults.

The outcome and major changes brought by the amendment acts were- (1) Imposition of penalty in lieu of fine/ imprisonment which included conversion of criminal offences to civil wrongs wherein the penalties will be adjudicated by in-house adjudication mechanism and not by criminal courts. It has reduced the burden on courts, by virtue of increase in prosecutions being handled by in-house adjudication mechanism and omission of offences.

(2) Reduction of punishment, primarily, imposition of fine in lieu of imprisonment; and (3) Omission of certain offences which otherwise be dealt under other laws or alternate mechanisms or have been rendered redundant, which would ensure that there is no duplicity of proceedings.

Due to decriminalization of minor procedural and technical defaults, the numbers of prosecutions being filed in the special courts have already started reducing significantly as evidenced by the growing number of defaults being handled through the In-House Adjudication Mechanism (IAM). Companies Fresh Start Scheme (CFSS), 2020 was simultaneously rolled out that allowed companies to correct any old defaults related to filing of documents without levy of any additional fees. As a result of these complementary initiatives by the Government of India, the criminal courts can focus on more serious offences.

Decriminalization has also simultaneously de burdened the various benches of the National Company Law Tribunal (NCLT), as upon decriminalization, the companies and its officers would not be required to file applications of compounding before NCLT/Regional Director, so as to escape criminal prosecution. The benefits from this reform are many and far reaching. These measures would further incentivize.

Decriminalisation also accelerated the disposal of company-law defaults and reduced the need for compounding applications before the NCLT or Regional Director. That experience supports a wider review of obsolete offences across business legislation.

Recommendations and Conclusion

"In life, change is inevitable. In business, change is vital." said Warren G. Bennis. The business and commerce in India is governed by the laws, rules and regulations which date back to the period around independence, many of which hold less importance or have become irrelevant in the current scenario, such as in the early days in the colonial era, cholera was really rampant in the British India. Colonial-era laws required businesses to maintain limewash registers, and similar requirements later appeared in the Factories Act. Outdated provisions of this kind should be reviewed, amended or repealed where they no longer serve a modern regulatory purpose.

Removing obsolete compliance burdens would make it easier for legitimate businesses to operate and grow.

Indian legal system is complex and fragmented, with multiple laws and regulatory frameworks governing different aspects of business operations. This can create confusion and uncertainty for startups, as they may not be aware of all the applicable laws and requirements. To address this challenge, the government can consolidate and simplify the legal and regulatory frameworks to make them more accessible and user-friendly for startups. This can involve the integration of multiple laws into a single framework, the elimination of redundant laws, and the streamlining of procedures. The success rate of startups in India is relatively low, with many startups failing to scale up and generate sustainable revenue.

This can be attributed to various factors, such as lack of access to capital, talent, and technology, as well as regulatory and legal barriers. To address this challenge, the government and private organizations can provide startups with access to capital, talent, and technology through various initiatives, such as incubation programs, accelerators, and angel networks. These initiatives can also provide startups with mentorship, coaching, and networking opportunities to help them navigate the legal and regulatory landscape and overcome the challenges they face.

To improve the legal and regulatory frameworks for startups in India, the government and private organizations can focus on increasing awareness, consolidating laws, and providing startups with the resources and support they need to succeed. By addressing these challenges, India can create a more conducive environment for startups to thrive and contribute to the country's economic growth. Taken together in the long run, these efforts would encourage budding entrepreneurs to incorporate more companies. Such formal schemes will enable better access to finance & other resources, to build identity & productivity for their business and to grow in a sustainable manner.

Decriminalisation is not deregulation. Criminal liability remains justified where conduct is fraudulent, intentional or seriously harmful. The case for reform is narrower: penalties should reflect culpability and harm, so that technical defaults do not create needless fear or suppress legitimate growth.

Primary materials

Key primary materials: Bharatiya Nyaya Sanhita, 2023; Supreme Court of India judgments.