Once a promising electric mobility startup, the sudden downfall of BluSmart, has shaken investor confidence in India's booming startup ecosystem. Despite raising nearly $180 million from venture capital firms, strategic investors, and family offices, the company is now reportedly unable to pay salaries or meet basic operational expenses. Worse still, multiple reports allege that the promoters used investor funds for personal luxuries, vacations, high-end shopping, and entertainment. While a forensic audit is ongoing and legal responsibility is yet to be fully established, this case has raised an important question, whether BluSmart's investors were legally equipped to prevent this?
In many venture deals involving Indian parties, investment contracts tend to focus heavily on valuation and equity percentages, with insufficient attention to how the investment is actually utilised after the deal closes. Investors often rely on having a board seat or post-facto legal rights under the Companies Act. But as the BluSmart crisis shows, once funds are in the promoters' control, legal recourse can be limited unless adequate protections are built in right from the start.
In most early-stage investments, the principal documents are the Share Subscription Agreement ("SSA") and the Shareholders' Agreement ("SHA"). The SSA, which includes provisions governing the actual inflow of funds in exchange for securities, also has warranties regarding the manner in which business and operations were conducted in the past and indemnities to the investors. The SHA, which lays down the long-term relationship between the founders and the investors, is the bible for future business operations.
The SHA is an ideal document to define how investment proceeds should be used. A well-drafted clause can mandate that the funds be utilised strictly as per a pre-approved business plan or budget. Any deviation beyond an agreed upon percentage, say, 10 to 15%, can be made conditional on prior consent of the investor.
Depending on the size of the investment, an investor may have the right to nominate director(s) on the board with access to information and say in the decision making. An important right is the 'Reserved Matters' list which lists down specific decisions that the investee entity cannot take without prior investor approval. This can include budget changes, new loans, remuneration to key personnel, bank withdrawal limits, capex above a certain limit, and even hiring employees.
Another important tool is to treat fund misuse as a clear 'event of default' under the agreement. Once triggered, this default can give investors a right to demand a buyback of shares, freeze further disbursements, or even enforce exit rights at a pre-agreed return. While such clauses may appear harsh, they act as a deterrent and are especially important when large investment sums are provided upfront.
In certain deals, if the investors are of the opinion that there is a higher risk that funds may be misused, investors can consider asking for limited personal undertakings from the promoters. While such undertakings do not have to be full-fledged guarantees, they can be specific assurances not to divert funds or misuse company accounts. In case of fraud, this opens the door to equitable remedies and potentially even piercing the corporate veil, thereby making promoters personally liable for the activities of the investee company.
Access to financial information is another area where investors can strengthen their position. Merely having a board seat is not enough. The agreement should grant investors with information rights that entitle them to receive monthly, quarterly, bi-annual or annual audited and unaudited financial statements, internal audit reports, and even real-time access to bank accounts in some cases. In high-risk deals, investors may even consider linking fund disbursement to completion of milestones, with the money parked in escrow until certain targets are met.
Some institutional investors are now also exploring the appointment of independent directors or third-party auditors specifically to oversee fund utilisation. While this adds to operational overheads, it helps ensure promoters do not have unchecked control over the investee entity's finances. Even a quarterly report from an independent auditor can provide an indication at an early stage that things are amiss.
The Companies Act, 2013, does provide certain remedies to investors. Sections 166, 447, and 452 deal with breaches of fiduciary duty by a director, fraud, and wrongful possession of funds. But these remedies are slow, reactive, and often depend on proving intent. By the time an investor may have a favourable order from a court, the funds would have been long utilised and burnt. This is why preventive clauses in contracts, that provide investors with oversight on the manner that the funds are utilised, may be far more effective than post-facto litigation.
Interestingly, in the wake of BluSmart's troubles, investors have begun amending their standard investment templates to include stricter fund monitoring clauses, mandatory escrows, and even promoter indemnities. If this trend continues, we may see a gradual shift in how venture deals are structured in India.
Investment agreements must go beyond boilerplate terms and reflect the real concerns that investors face in the startup space today. Legal safeguards must be seen not as a sign of distrust, but as a tool to build better, more accountable businesses.
The BluSmart episode should not be remembered merely as a startup failure. It should prompt founders, lawyers, and investors alike to re-evaluate what accountability means in the world of private capital investments. Contracts may not guarantee integrity, but they can raise the cost of misconduct, make lapses easier to catch, and ensure that any wrongdoing has adequate consequences. In a startup ecosystem that moves fast and burns capital even faster, this kind of legal discipline is not just advantageous, it is indispensable.
About the authors: Ashima Obhan is a Senior Partner, and Arnav Joshi is an Associate at Obhan & Associates.
Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.
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