The Financial Anatomy of Revenue Leakage and Business Bottlenecks

The phenomenon of revenue leakage usually happens unintentionally and is also usually unseen by the leaders of an organisation until a formal audit of the company takes place. There are many reasons that cause revenue leakage, including (but not limited to) mistakes made during manual data entry, having different systems that do not integrate with each other, and not knowing who is responsible for governing the contracts between the organisation and its customers.

With increasing levels of competition and shrinking profit margins in the Indian market, understanding how to find these leaks is critical to continue growing successfully. Some of the primary ways that businesses lose revenue are making mistakes when determining pricing or discounts, failing to bill for events that occurred, and not enforcing escalations or indexations that are specified in the contract. The result is more than the agreed-upon value of how much was recorded. All these small failures in execution over time become substantially bigger and create large amounts of erosion in the business unit’s margins.

Pricing misalignment is one-way financial losses are incurred, with estimates indicating that pricing misalignments will cost up to 5%-8% of the contract value at the end of the contract. Unauthorised discounts that continue after the expiration date are another example of financial loss from contracts costing between 8%-12% of the contract value. Unbilled scope creep (where features and/or services are provided by teams outside the original agreement without invoicing for those additional features and/or services) is expected to cost an additional 3%-5% of total project revenue.

By establishing an in-house legal department, project teams can gain the necessary oversight to eliminate this ongoing financial obligation. In addition, moving to a centralized, technology-based Contract Lifecycle Management system, away from “spreadsheet sprawl”, will assist the legal department with ensuring that they are monitoring and tracking all of the obligations required under their contracts, so they can anticipate when they will need to renew those contracts, and bill out all of the revenue they have earned from these contracts.

Legal Frameworks of Delay: The Indian Contract Act, 1872

In India, the basis for the regulation of contracts regarding the performance period is the Indian Contracts Act, 1872 (ICA). Any company doing business in India will need to know about the legal consequences associated with the failure to meet a timeframe for performance of its obligations. Section 55 of the ICA describes the effect of a party failing to fulfil its obligations under an agreement by the time specified in the contract. The contract is voidable at the option of the promisee if the parties agreed that “time was to be of the essence” in respect to the contract.

However, the Indian courts have repeatedly held that the time for performance is not always necessary to be treated as being of the essence merely because there is a stated due date for such performance in the contract. Rather, whether the parties intended for time to be of the essence of the contract will depend upon the evaluation of the overall intentions of the parties, the subject matter of the contract and the behaviour of the parties after the making of the contract.

The commercial consequences are determined by the timing provisions within the agreement. If the timing is of the essence to the contract, the contract may be void if the parties do not perform within the time limit established in the agreement (Section 55). If the timing is not of the essence, the promisee may be entitled to recover any damages they incurred because of the breach. The third paragraph of Section 55 presents a significant operational risk because if a promisee accepts the promised work after a delay and does not provide written notice indicating that they intend to seek compensation for the delay at the time they accept the delayed performance, they will have waived their right to recover on the basis of such delay.

In addition, Section 73 provides for the recovery of both natural and foreseeable loss arising from breaches of contract, while Section 74 provides the parties with the ability to recover the amount of liquidated damages if it was a genuine estimate of the damages that will occur as a result of the breach and not a punitive measure. In-house counsel develops the procedures to provide the necessary reservations of rights notices in such a way as to ensure that no inadvertent waiver of the reservation occurs.

The Specific Relief (Amendment) Act 2018: A Shift Toward Performance

The Specific Relief Act, 1963 (SRA), underwent a major overhaul in terms of Indian contract law through the 2018 amendment. Specific performance was previously a discretionary remedy with damages being the norm before this was changed by the legislature when amending SRA to encourage timely performance by making specific performance mandatory under Section 10 which now gives businesses a much greater tool to compel a defaulting counterpart to comply with their obligations immediately rather than having to wait for the length of time of litigation to resolve in monetary judgment. In addition, the amendment established an explicit power for the courts through the addition of Section 14A to allow experts to be engaged by the court to help determine the nature of the contract or breach of the contract.

The most pressing business bottleneck is solved by “Substituted Performance” under Section 20, also known as the “right to cover”. When a wronged party has a right to cover, they can arrange to have a contract performed by a third party or themselves using the defaulting party’s funds and at the defaulting party’s risk. To invoke this right, at least 30 days’ written notice must be given to the defaulting party to provide an opportunity to cure their default.

After obtaining performance through substitute performance, the wronged party cannot seek an order for specific performance but can instead recover any costs incurred in reasonably obtaining the substitute performance. The establishment of an in-house legal department is critical to enforcing compliance with these very rigid notice timelines and ensuring that the right to cover is appropriately exercised to minimise interruptions to the projects.

Institutionalising Efficiency: The Strategic Role of In-House Counsel

The evolution of the Indian economy has created a new corporate legal function. In-house attorneys were historically classified as very much an administrative function with a focus on routine compliance; however, that has changed, and in-house counsel have become a strategic business partner and the front line of the corporation’s defence. The primary benefit of having a dedicated in-house legal function is that they have a significant amount of institutional knowledge.

External law firms are generally retained for “extraordinary” matters or specialised litigation, while in-house counsel understands the corporation as a whole and its daily operations, culture, and longer-term objectives, enabling them to provide advice that is both legally appropriate and commercially appropriate, and specific to the legal and commercial needs of the organisation.

Many companies choose to set up a legal team due to the importance of accurate budgeting and fast, efficient operations. An article indicated that 68% of companies’ General Counsel are trying to do more work “in-house” to minimise costs and make their operations more efficient. Although law firms can provide high-quality, specialized services, they are usually paid hourly, and availability can fail without timely notice; in-house lawyers can predict future expenses as they are receiving a regular salary, and their assistance is available at the same time the business decision is being made.

Corporate Governance, Risk Management, and Internal Controls

The Companies Act, 2013, imposes a legal obligation to manage risks. Section 134(3)(n) requires Board reports to include a statement regarding the creation and execution of a risk policy. The Boards of Directors for listed entities are accountable for establishing and maintaining appropriate and effective internal financial controls.

The in-house legal department is responsible for creating these controls by evaluating and eliminating the risks associated with a company’s financial well-being. Their responsibilities include documenting risks in a risk mitigation register, establishing clear lines of responsibility for risk management, and communicating any significant threats to upper management.

The governance framework laid down in India stipulates the role of Key Managerial Personnel (KMP), the role of the Company Secretary, as well as the Managing Director, who carry out the day-to-day operations of their respective organisations and those responsible for implementing strategic initiatives. The Company Secretary acts as a compliance officer under Section 205 to ensure compliance with all applicable laws and to monitor performance reporting. Furthermore, Regulation 21 of SEBI LODR requires there to be a Risk Management Committee, which does encompass cybersecurity. The legal departments and their associated procedures assist in providing adequate internal control and thus prevent fraud, improper financial reporting, and protect the value of the contract in the long run.

Resolving Commercial Disputes: The Commercial Courts Act, 2015

The Commercial Courts Act, 2015 (CCA) was created to tackle the endemic delays in resolving commercial disputes in India, historically a disincentive to foreign investors. The Commercial Courts Act was intended to effect improvements through specialist courts with defined timelines.

One of the significant features of the Act is the requirement in Section 12A for compulsory mediation and the right to access the court after an unsuccessful attempt to mediate a dispute. The proposed Commercial Courts (Amendment) Bill, 2024, seeks to establish more stringent time limits, thereby changing the nature of mediation from a formally concluded step to an active step.

The CCA offers mechanisms for case management and hearing procedures. These include fixed trial schedules and the court’s authority to grant summary judgments. Summary judgments allow the court to decide a case without trial if evidence shows no realistic chance of success for one party. The 2024 Commercial Court Bill proposes to establish dedicated commercial courts at both District and High Court levels. This will ease the general civil courts’ burden while supporting a pro-business environment for commercial entities.

For in-house legal teams, the preferred method of resolving disputes is through well-drafted Alternative Dispute Resolution (ADR) clauses, as quick and successful resolution can save businesses from incurring damages caused by the imposition of monetary judgments or expensive penalties.

Conclusion

There is a tremendous amount of evidence supporting the claim that delays in contract execution result in actual revenue losses and that the lack of an internal legal team creates a major impediment or bottleneck for the business. By establishing an internal legal team with the necessary expertise, Indian businesses can recover lost revenues, increase the speed of operations, and improve the governance of the company overall.

When combined with an AI-enabled technology platform, the establishment of a fully functional internal legal unit allows businesses to shift from a reactive “firefighting” approach to a proactive “creating value” perspective on the organisation. Legal team members will play an integral role in every aspect of the business, ensuring that the business’s obligations under contracts are not just legal documents, but rather enforceable assets that provide actual cash flow to the business.

As India continues to mature as an economy structurally, the companies that succeed in leading the next wave of growth will be those that view their legal department as a strategic partner rather than as a cost centre in the pursuit of sustainable profitability.