Introduction

Due diligence is the investigation or exercise of care that a reasonable business or person is normally expected to take before entering into an agreement or contract with another party or an act with a certain standard of care. It is a one of the key exercise in corporate mergers and acquisitions. Due diligence can be of Financial, Legal, Secretarial, Asset, Human Resource, Environmental, Intellectual Property etc.

Due diligence can be carried out during the following corporate events:

> Mergers and acquisitions;

> Corporate Restructuring;

> Joint Venture, Partnerships, Collaborations etc.

> Investment rounds by PE, VC, HNIs etc.

> Initial Public Offering (IPO) and Further Public Offering; (FPO)

> Leveraged Buy-outs.

Due diligence can be a one-time exercise during above mentioned events or it can be a yearly exercise by investors choose professionals. Private equity or Venture Capital funds usually undertake Due Diligence exercise yearly in order to evaluate the Investee Company and its performance. Based on due diligence report, they take informed decisions about further rounds of investment, Enterprise value, price of securities, and/or exit from the investment.

What is Legal Due diligence?

A legal due diligence is a comprehensive assessment of the possible legal risks related to the corporate status, assets, contracts, securities, intellectual property etc. of the Target Company. It works as a precautionary exercise through which one can know the strengths and weaknesses of the Target Company and helps to identify the red flags or any legal hazards before entering into the transaction.

Objectives of Legal Due diligence

The objectives of a legal due diligence exercise may vary from case to case. However, some of the common objectives in most of the due diligence would be as follows:

  • To take an informed decision on the proposed transaction;
  • To assess the risk and liability;
  • To uncover threats and weaknesses;
  • To remove and work upon any non-compliance aspect of the Target Company;
  • To arrive at proper valuation for the proposed transaction;
  • To improve the bargaining position.

Importance of Due diligence

Due diligence in legal matters is crucial for many reasons, but it’s most crucial for making wise business judgments. The reasons for this include:

> The counterparties to the proposed transaction are required to abide by all applicable laws and statutes and other legal obligations. Respect for the laws of the land is must.

> Nearly every industry is experiencing a rise in fraud. Scams involving impersonation and fraud involving forged documents/title deeds are common in real estate transactions. Precautions can be taken in this situation to prevent loss.

> Litigation is very time consuming and costly exercise for anyone. So, before any transaction, one must carry out legal due diligence so that future litigation can be avoided.

Scope of Legal Due diligence

The scope of legal due diligence depends upon the proposed transaction, parties of the transactions, nature of the business of the Target Company, size of the Target Company etc. The Major Scope of the Legal Due Diligence includes the following:

> Vetting of Constitutional documents like Registration Certificates, Statutory Documents like MOA, AOA, Corporate Policies, Code of Conduct etc.

> Oversee regulatory compliance under Companies Act, FEMA, SEBI, Labour laws, Industry specific laws etc.

> Vetting of major agreements like Shareholders Agreement, Service Agreements, Commercial Agreements, Credit Facilities Agreement etc.

> Vetting of Property related documents and title including intellectual property related registration and agreements.

> Vetting of Secretarial records like Minutes, Registers, Boards Report, Annual Report etc.

> Oversee the litigation status, cases, notices etc. and possible legal costs associated with the same.

Checklist of Legal Due diligence

Legal due diligence is a complex process that can be lengthy depending on the size and nature of the Target Company. However, in most cases, checklist for Corporate Lawyers includes, but not limited to, the following:

Corporate Registration

> Examination of status of the Target Company like verification of corporate registration documents like Certificate of Incorporation, Memorandum of Association, and Articles of Association.

> Examination of other statutory documents like PAN, TAN, GST Certificate etc.

> Business specific registration documents like if entity is NBFC then NBFC registration certificate, if Target is capital market entity then SEBI registration certificate so on and so forth.

> Labour Law Registration Certificate like Provident Fund, Employee State Insurance, Professional Tax etc.

Corporate Structure

> List of Holding, Subsidiaries and Associates Companies.

> List of Promoters, Directors and Shareholders of the Target Company.

> List of Beneficial owners of Target Company in case there is body corporate shareholders.

Financial Matters

> Details of Short term and long term debt of the Target Company.

> Various legal documents like Sanction Letters, Loan Agreement, Mortgage deed, Hypothecation deed, Pledge Agreement etc. executed by the Target Company for effecting credit transactions.

> Stamp duty receipts of the above mentioned legal documents.

> ROC charge creation forms and challans on the property mortgaged or pledged of the Target Company.

Material Agreements

> All material agreements that Target Company has executed with the Customers, Clients, Holding Company, Subsidiary Company, Joint Venture Agreements etc.

> All material agreements that Target Company has executed with the Investors and/or Shareholders like Founder’s Agreement, Share Transfer Agreement, Share Subscription Agreement, Investment Agreement etc.

> All material agreements that Target Company has executed with the Directors, Key Managerial Personnel, Holding-Subsidiary Company, Employees etc.

> Copies of any agreement pertaining to provisioning of commission, revenue share, brokerage, finders’ fee, or any other arrangement relating to capital issuance and raising of investments.

> Copies of technical collaboration agreements, technology license agreements, IT agreements, data processing agreements, intellectual property development, assignment, ownership and/or licensing agreement, website design, development, trademark license agreements, technical assistance agreements or other co-operation and any arrangements with individuals or government.

Property

> Details of list of immovable property owned by the Target Company.

> Details of Sale deed, Occupation Certificate and other legal documents verifying the ownership of the Property.

> Details of Plant and Machinery, Office equipment, Computers, Furniture and Fixtures etc.

> Details of Property taken on lease by the Target Company and Lease Agreement executed for the same.

Intellectual Property

> Details of all IP or similar rights and registration thereof.

> Details of software related rights and licensed by the Target Company.

> Details of all registered, unregistered and applied Patent, Trademark, Copyright, service marks, industrial designs, domain names, mobile applications, website etc.

> Details of any intellectual property rights licensed to and/or from third parties or any franchisee arrangements with third parties along with copies of relevant documents, including copies of all written technology licenses (including sublicenses), software licences, software license agreements, software development agreements, compulsory licenses, security agreements, royalty agreements, etc.

Corporate Secretarial

> Compliance with the provisions of the Companies Act, FEMA and SEBI rules and regulations.

> ROC Annual Compliances and Event based compliances.

> SEBI quarterly, half-yearly and yearly compliances.

> Vetting of corporate meeting minutes of the Target Company.

> Vetting of statutory registers of the Target Company.

> Vetting of various important resolutions and e-forms filled with the ROC.

> Vetting of share issuance and transfer records like form PAS-3, SH-4, Stamp duty etc.

> Vetting of various policies of the Target Company.

Litigation

> Details of all pending, threatened litigation, inquiry, investigation against the Target Company and/or its Directors and Promoters.

> Details of show cause notice, demand notice or any correspondence received from government bodies having significant effect on the Target Company.

> Any judgments, decrees, settlements, consent decrees, orders or decisions rendered by courts, authorities and/or arbitration tribunals in relation to, or having implications on the Company.

> Details of any criminal proceedings initiated by / pending against Company and / or its promoters, directors and key managerial personnel, or other employees or officers.

> List of any prior, pending or threatened action against the Company related to unfair labour practice, wrongful dismissal or termination of any employee, violation of any human rights, etc.

Insurance

> All current insurances, detailing the name of the insurance company, annual premium, the subject matter covered, the amount of cover, the nature of the cover, the date of the last renewal, the next renewal date, presence of bank clauses, and restrictions on assignment of insurance policies, if any, for the Company.

Human Resource

> Organisation structure along with names, designations, functions and responsibility, division-wise.

> List of all employees from the date of incorporation till date in excel sheet with following details:

  • Name of Employee
  • Personal Details like Address, Date of birth, Age, Gender, Marital status
  • Employment Records: Date of joining along with completed years in employment of the Company; Cost to the Company (CTC); Date of resignation / termination along with reason for the same.
  • Categories and work place: Present places of work; categorize them as permanent employees / contract labours / probationers / casual employees / apprentice.

> Copies of all human resources policies and manuals such as code of conduct policy, ethics policy, policy for prevention of sexual harassment, leave policy, asset usage policy, data security policy, grievance redressal policy, severance policy, etc. (if any).

> Information on any managing director or whole-time director of the Company being a director in or performing business activities on behalf of any other company undertaking business similar to the Company.

Procedure for exercising Legal Due diligence 

First of all, Target Company, Investor/Acquirer and Corporate Lawyers enters into Non-Disclosure Agreement before kick starting with the legal DD. After that professionals associated with the legal DD share their checklist or requisition list to the Target Company. To affect the smooth exchange of information and documents, a ‘Virtual data room’ is created which is secure, consolidated and remote way to gather, share, and review key documentation during the due diligence process in short period of time. Once, DD exercise is over, professional share their preliminary observation report to the Investor/Acquirer and the Target Company. Thereafter, all the parties seat together and discuss on the findings of the professional. This is the stage where further negotiation and bargaining can be done by the investor/acquirer. Once discussions are done and parties arrive at the final decisions, a final due diligence report is prepared and shared by the professional to the Target Company and Investor/acquirer.

Conclusion

Having seen the importance and broad scope of legal due diligence, it can be said that Legal Due diligence is must exercise before any M&A deal. If Legal DD is undertaken by the seasoned and experienced professionals, it can unearth the possible legal ramification and safeguard the interest of the acquirer/investor. It also helps in arriving at the right value of the securities and enterprise as a whole.

Author Bio

Qualification: CS
Company: DVG & Associates
Location: Mumbai, Maharashtra, India
Member Since: 02 Feb 2018 | Total Posts: 85
CS Dhaval Gusani is a founder of DVG & Associates, Company Secretaries and Corporate Law Professionals. He is a Commerce and Law Graduate and an Associate Member of the Institute of Company Secretaries of India (ICSI). He has cumulative experience of more than 8 years with Listed Company, Charte View Full Profile

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