Due diligence is the duty of care and investigation imposed on any person or company to do a standard level of inquiry into the company or business with which they are coming in contract with. This will help the party who are willing to come into contract with any business or company to know about every detail of that company, the benefits and risks they are likely to encounter with. With these formal formalities before coming into the contract will give an idea of the type of company they are contracting with and whether it suits with their portfolio or not, after that they plan accordingly. Due diligence is one of the essential steps that must be needed to be carried out during mergers and acquisitions. It is also advisable by the SEBI to exercise due diligence to exempt from any liabilities arising from any kind of offense. In this blog, we will try to discuss due diligence, its significant role in mergers & acquisitions, and its scope.
WHAT IS DUE DILIGENCE?
Due diligence is the audit or scrutiny of the material facts for future investment in any business or company. What are the material facts for any future transaction is based on that deal. It is a course of action performed to avoid any future failure, loss or tussle. By performing an extensive due diligence before entering into any business deal, will provide you the knowledge for the type of company or business organization we will dealing with, whether they are legally liable to perform such task, what are the benefits we will enjoy in coming into business with them, what are the risk factor associated with that deal or the overall portfolios of that company or deal. This led to any company or business to avoid any future litigation for any grievances that occurred with that deal. Also, they can make their decision according with the result of that due diligence.1
Due diligence is based on the concept of 'caveat emperor' which means 'buyer beware'. It imposes responsibility on the party to get a thorough analysis of the company with which they are coming into contract with. Even the SEBI regulation provides for any company to perform due diligence when entering into business transaction for getting exemption from any legal consequences.
There is currently no statutory provision in India providing for compulsory performance of due diligence before entering into any business transaction or lawful business. Also, there is no punishment provided for non compliance with the prerequisite of due diligence. It is generally advisable to perform due diligence to avoid any consequences arising from such a contract or agreement.
ROLE OF DUE DILIGENCE IN MERGER & ACQUISITION:
Merger & Acquisition (M&A) is a deal entered into by any company to extend their business operation, increase market share, diversify any business, reduce operational cost, or many more reasons. Basically, M&A is a master plan for any business organization to expand or grow their business in the current financial economy. Section 232 of the Companies Act, 2013 provides for the M&A. A merger is a long chain of complex activity whose success and failure depends upon many factors; it can be any internal or external factor. If the precise steps are not taken, the whole deal will become a failure.
M&A of any company is a lengthy and time-consuming process and often involves a large sum of money, so to avoid any damage or loss it is crucial to perform the due diligence in any transaction of M&A.
SCOPE OF DUE DILIGENCE:
The extent or subject matter of due diligence depends upon vast subjects. Here are some of the subjects listed below:
- Vetting of the documents like MOA, AOA of the company which can be easily found by the registrar of the company of that region where the company is situated.
- Supervise regulatory compliances under the Companies Act, 2013, SEBI regulations, 1997, IBC code, 2016, etc.
- Evaluating documents related to the transaction of the deal2.
- Inquiring whether the company is ongoing with any kind of prosecution for any charges.
- The object for incorporation of the company is whether legal or not or whether they disburse lawful conduct of their activities.
It is only a few of the subjects listed, but the list is vast. It is only provided for getting idea of the subject matter or scope of the due diligence. Due diligence is a must exercisable act, a prerequisite for any M&A deal helping in avoiding any major ramification or safeguard the stake or interest of any company coming into transaction.
Due diligence is the formal prerequisite process to conduct an overall inquiry into the affairs of any company before coming into a transaction or contract with that company or business. Suppose you came into a contract with a company and after signing the deal you get to know about their illegal business consequently running with their ordinary course of business or they have not complied with the necessary requirements of companies act; to avoid such a situation coming, it is necessary to perform due diligence beforehand. In today`s economy, several mergers & acquisitions take place as a strategy to expand their business operation. Still, many deals did not make it due to the non-conducting of due diligence. A study by the Harvard reveals that 50% of the M&A fails due to non- compliance with the provision of prerequisite due diligence. It is a crucial step for exempting from any legal consequences, damage, or loss.
In the field of M&A, due diligence plays a very important role, a determining factor for the successful or failed M&A deal. The due diligence unveils the risk factors associating with the particular M&A deal. It provides that the party to deal are well versed with every detail of the transaction. Therefore, the party can plan accordingly ensuring they won`t have to suffer with the deal arrangement afterward.
Footnotes
2 Corporate legal Due Diligence – Approach and Checklist
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
