DOCTORINE OF DUE DILIGENCE
Introduction of Due Diligence:
Due Diligence is a process of thorough and objective examination that is undertaken before corporate entities enter into major transactions such as mergers and acquisitions, issuing new stocks and other securities, project finance, securitization, etc. One of the key objectives of due diligence is to minimize, to the maximum extent practicable, the possibility of there being unknown liabilities or risks. The exercise is the multi-dimensional and involves investigation into the business, tax, financial, accounting and legal aspects of an issuer.

Definition of Due Diligence:
"Due diligence" is a term used for a number of concepts involving either an investigation of a business or person prior to signing a contract, or an act with a certain standard of care. It can be a legal obligation, but the term will more commonly apply to voluntary investigations. A common example of due diligence in various industries is the process through which a potential acquirer evaluates a target company or its assets for acquisition. * Due diligence can be defined as: 1. The examination of a potential target for merger, acquisition, privatization, or similar corporate finance transaction normally by a buyer. 2. A reasonable investigation focusing on material future matters. 3. An examination being achieved by asking certain key questions, including, how do we buy, how do we structure the acquisition, and how much do we pay? 4. An investigation on the current practices of process and policies. 5. An examination aiming to make an acquisition decision via the principles of valuation and shareholder value analysis. * DUE DILIGENCE IN INDIA:
The practice of undertaking a formal due diligence investigation is of comparative recent origin in India and was mainly imported as a process by foreign investors/their legal and financial advisors after the econ nomic liberalization reforms of 1991.
No statute defines the term ‘due diligence’. However, the SEBI mandates certain parties to undertake a due diligence, in the context of issuance of securities by a company. For instance: * Regulation 64 of Chapter VI of the ICDR Regulations, requires the BRLMs to exercise due diligence and satisfy themselves about all the aspects of the issue. The BRLM is also required to call upon the issuer, its promoters or in case of an offer for sale, the selling shareholders, to fulfill their obligations as disclosed by them in the offer document. * Regulation 65 requires the BRLM to submit post-issue reports to the SEBI. The BRLM is also required to submit a due diligence certificate as per the format specified in Form G of Schedule VI, along with thefinal post-issue report.(Regulation 65 (3)) * Under Regulation 83, a qualified institutions placement shall be managed by BRLM(s) registered with the SEBI who shall exercise due diligence. The BRLM, while seeking in principle approval for listing of the eligible securities issued under the qualified institutions placement, is required to furnish to each stock exchange on which the same class of equity shares of the issuer are listed, a due diligence certificate stating that the eligible securities are being issued under qualified issuers placement. * Before the opening of the issue, the BRLM is required to submit a Due diligence certificate along with the draft offer document to the SEBI. * Under Regulation 8(2)(b), the lead banker is required to submit, after the issuance of observations by the SEBI or after the expiry of the stipulated period, if the SEBI has not issued observations, a due diligence certificate at the time of registering the prospectus with the Registrar of Companies. * Under Regulation 10(3)(a), the BRLM is required to submit to the SEBI, along with the offer document, a due diligence certificate including additional confirmations.

* TYPES OF DUE DILIGENCE:
The approach to due diligence depends on the type of transaction and what is intended to be achieved.
Due diligence may be of various types: * Commercial Due Diligence: Commercial due diligence looks to understand the market the target business is operating in. The due diligence will look at the forecast level of future market growth and the target’s competitive position within that market. Part of commercial due diligence often involves phoning customers of the target business to assess their opinion of the business. This can provide extremely valuable insights into how the target business is perceived.

Commercial due diligence can be extremely valuable when an acquirer is using an acquisition to expand into a new market though may be of limited value where the target is in the acquirer’s existing market.

* Legal Due Diligence: Legal due diligence aims to ensure that there are no legal impediments to buying a business. Solicitors will typically review all the key legal documents of the target business such as employment contracts, board minutes, confidentiality agreements, articles and memorandum of association and any patents, copyrights or other intellectual property-related documents. It is likely that the same legal team that perform the legal due diligence will help with drafting the Share Purchase Agreement (SPA). * Financial Due Diligence: Financial due diligence aims to verify the factual accuracy of claims made by the sellers. This is different to an audit, financial due diligence is not so much about are the accounts correct but what the accounts tell the buyer. What are the trends of the business is it growing or declining? Are profits being supported by one-off events or the result of accounting trickery? Is there any evidence to support the sales forecasts?

On the balance sheet side financial due diligence should aim to identify any previously unknown liabilities and advise on the level of working capital the business requires. The due diligence findings should then feed into warranties and indemnities within the SPA, to mitigate any risks identified.

* Tax Due Diligence: Tax due diligence is often performed at the same time as the financial due diligence. Tax due diligence aims to ensure that there are no historical tax liabilities that have materialised due to mistakes or deception that the acquirer will become liable for. The tax due diligence team should also be able to help with acquisition structuring to minimise the future tax bill of the enlarged group.

* IT Due Diligence: IT due diligence aims to identify any IT issues in the target business. It will look at matters such as the scalability of systems, the robustness of processes (eg backups), the level of documentation of processes and code, compliance with legislation and the ability to integrate various systems.

* Why is Due Diligence Conducted?
There are many reasons for conducting due diligence, including the following: * Confirmation that the business is what it appears to be; * Identify potential "deal killer" defects in the target and avoid a bad business transaction; * Gain information that will be useful for valuing assets, defining representations and warranties, and/or negotiating price concessions; and * Verification that the transaction complies with investment or acquisition criteria. * Who Conducts Due Diligence? * Lead and co-investors, corporate development staff, attorneys, accountants, investment bankers, loan officers and other professionals involved in a transaction may have a need or an obligation to conduct independent due diligence. Target management typically assists these parties in obtaining due diligence information but because it is unwise to totally rely on management third party consultants such as Astute Diligence are often brought in to conduct due diligence

* When is Due Diligence Conducted? * Initial data collection and evaluation commences when a business opportunity first arises and continues throughout the talks. Thorough detailed due diligence is typically conducted after the parties involved in a proposed transaction have agreed in principle that a deal should be pursued and after a preliminary understanding has been reached, but prior to the signing of a binding contract. * How is Due Diligence Conducted? * The parties conducting due diligence generally create a checklist of needed information. Management of the target company prepares some of the information. Financial statements, business plans and other documents are reviewed. In addition, interviews and site visits are conducted. Finally, thorough research is conducted with external sources -- including customers, suppliers, industry experts, trade organizations, market research firms, and others. * SCOPE OF DUE DILIGENCE:
The scope of due diligence typicallydepends on the nature of transaction proposed to be undertaken. In asecurities transaction, the broadobjectives are as follows: * To obtain all material information in relation to the issuer for making disclosures in an offer document or subscription agreement, to enable investors to make an informed decision and tomeet regulatory requirements. * · To assess the nature and extent ofthe risks and highlight them. Additionally, the scope of a duediligence also depends on the mandate - whether complete review of the issuer or restricted to matters like litigation, employment, etc.

* END USE OF DILIGENCE:

* Identification and mitigation of risks in light of market practice and legal requirements. * Changes in structure of the transaction. * Price adjustment. * Conditions precedent. * Representations and warranties. * Verification of disclosures. * Retention of purchase price. * Indemnity. * Conditions subsequent to closing the transaction.