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Corporate Law Project Submitted in the Partial Fulfillment of B.A. LLB (Hons.) VI Semester, May 2010 DUE DILIGENCE

SUBMITTED TO: Ms. Srishty Neelkanth (Asst. Prof. in Law)

SUBMITTED BY: Kratika Shekhawat (264) Rasleen Kaur Dua (274) Khushboo Jain (266) Utkarsh Chaudhary (276)


This is to certify that this submitted work, is original and has not been published before neither has it been plagiarized.

Kratika SHekhawat(264)

Rasleen Kaur Dua(274)

Khushboo Jain(266)

Utkarsh Chaudhary(276)



AKNOWLEGMENTS This project would not have been possible without the help and guidance of our faculty, namely Ms. Srishty Neelkanth We are extremely indebted to her for guiding us throughout the project, assigned to us, without consideration of her own work schedule. We also express our sincere gratitude to the non-teaching staff namely, Mrs. Updesh Kaur, librarian.


TABLE OF CONTENTS ACKNOWLEGMENTS 1. CHAPTER I- INTRODUCTION 1-3 1.1.Meaning of Due Diligence...1 1.2.Need of Due Diligence....2 1.3.Significance of Legal Due Diligence...3 2. CHAPTER II TYPES OF DUE DILIGENCE..6-13 2.1.Background Due Diligence.6 2.2.Business Due Diligence7 2.3.Financial Due Diligence...8 2.4.Accounting Due Diligence.10 2.5.Legal Due Diligence...11 2.5.1. Key Areas of Legal due Diligence12 2.6. Corporate Governance13 3. CHAPTER III- LEGAL DUE DILIGENCE A PRACTICAL GUIDE...15-20 3.1.Due Diligence: Buyer & Seller Perspective.15 3.2. Know the Process..15 3.3.Managing the Due Diligence Process...17 3.4.Role of Legal consultants .18 3.5.Legal Due Diligence Process.18 3.6. Due Diligence Checklist19 3.7.Due Diligence Report- Key Findings20 4. CHAPTER IV- CASE STUDY.23 5. CHAPTER V CONCLUSION.26 BIBLIOGRAPHY27 ANNEXURE28 Sample Checklist



Chapter 1 - INTRODUCTION 1.1.Meaning of Due Diligence Due Diligence can be widely defined as a broad spectrum of investigative procedures in relation to an acquisition of a company's shares or of assets in a commercial context, a joint venture project, a financing transaction, the issue of securities and other general pre-contractual inquiries. Due Diligence has become a sophisticated and intricate process requiring very special skills on which the most delicate business decisions are founded. As defined above due diligence requires a whole lot of investigation into affairs and health of a company. In India there is as such no law or case law on due diligence. Jurisprudence of Due Diligence is closely associated with concept of Notice. A notice can be actual, constructive or imputed. Due diligence is a process of investigation to: 1. understand the structural and operational features of the target (assets, liabilities, strengths and weaknesses); 2. support transaction value; determine whether adjustments to price or an earn out are warranted; 3. identify any potential deal breakers early on; 4. assist with structuring the transaction (e.g. merger versus asset purchase); 5. assist in drafting the acquisition agreement (e.g. drafting representations and warranties, identifying important closing conditions and required third party consents, reviewing disclosure schedules); and 6. identify post acquisition steps/integration/issues.1

The due diligence process helps in investigating the affairs of the Company and to know the risks associated with the transaction. A thorough investigation is made of the financial, legal and business affairs of the company by the experts.

Sarah Jones, Due Diligence, Practising Law Institute, Corporate Law and Practice Course Handbook Series, 1726 PLI/Corp 165, 2009

Due diligence is a crucial pre-signing bargaining tool 2. If the buyer has the information of the state of the Company, he will be in a better position to assess the risk and awards of the transaction. Contractual protections (representations, warranties, conditions and indemnities) are also likely to offer limited protection when something unexpected arises. The 360 3D3 process is a comprehensive approach that engages all the relevant disciplines in order to address all the key issues that are embedded in the target to be acquired. These disciplines include actuarial, legal, tax, accounting, underwriting, claims, investment banking, general management, information technology (IT) and human resources (HR). The 360 3D process can help assess occasionally ignored aspects of the target that may have a significant impact on the value of a deal and might lead to embarrassing situations in the future

1.2.Need of Due Diligence Due diligence is the process of obtaining sufficient reliable information about the business entity to help to uncover any fact, circumstances or set of conditions that would have a reasonable likelihood of influencing a business decision or the valuable making of an offer, of a consideration and of a price to complete the transaction. There are various kind of due diligence conducted with respect to a business transaction. It may relate to business, finance, accounting or legal aspect of the company. This paper throws a light on all kinds of due diligence with special reference to legal due diligence. In a given business transaction, a law firm or legal counsel generally assists in four phases before the completion of the intended transaction. 1. The preliminary negotiations, which culminate mostly in the execution of a letter of intent or a memorandum of understanding. 2.
2 3

The legal due diligence (LDD).

Supra 1 John O. Nigh and Marco Boschetti, M&A Due Diligence: The 360-Degree View, Available at http://www.towersperrin.com/tp/getwebcachedoc?webc=TILL/USA/2006/200602/MA.pdf (visited on 3 My 2010 at 7 p.m.)

3. 4. The negotiation and signing of the definitive or final transactional document. The closing.

This memorandum discusses issues relating only to due diligence, its concept, need and format relevant to business transactions by companies within the legal and regulatory framework in India. Business transaction herein covers a wide ambit and includes: Takeovers, Mergers, Acquisitions Divestment or off-loading of assets / divisions Public or private equity or debt offering Strategic alliances and corporate investments Financial Transactions, including loans and credit facilities and guarantees Venture capital investments Evaluating investments

The foregoing items are merely representative / illustrative. A proper legal due diligence is a must as a means for determining the efficacy and even transition of business transactions. 1.3.Significance of Legal Due Diligence There are various merits of conducting Legal due Diligence. 1. Better Understand Your Business: Legal due diligence is necessary to give the buyer the information that it needs to learn about your target company and to structure its purchase of your company.4. 2. Help to Value the Target Company. The buyer will use the information learned in the legal due diligence process to determine how much to pay for your company. In addition to carefully examining obvious indicators of value such as your companys cash flows and balance sheet, the buyer and its counsel will search for more subtle indicators of value or potential liabilities in things.5 3. Help in Drafting the Relevant Documentation. The information learned in the legal due diligence process will be helpful for both the buyers counsel and targets companys counsel in drafting and negotiating the merger or acquisition agreement
4 5

Available at, http://www.stoel.com/showarticle.aspx?Show=2925 (visited on 6 May 2010, at 10 p.m.) Ibid

and related ancillary agreements. This information will be particularly helpful in allocating risk when drafting your companys representations and warranties, your companys pre-closing promises and the post-closing indemnification rights of the buyer. Further, your company will likely need to prepare a disclosure schedule, to be delivered at the time the primary transaction agreement is executed, that discloses exceptions to the representations and warranties made by your company in the agreement. The information gathered in the legal due diligence process will be helpful for your company and your counsel in preparing the disclosure schedules. In addition, if the transaction includes a securities component, this information will be very helpful in crafting a disclosure document that may need to be delivered to the buyer.6 4. Identify Impediments to Closing. In the legal due diligence process the parties will attempt to identify everything that must happen before the transaction can close. if the transaction is structured as a sale of your companys assets, it is likely that you will need to seek consent from the other parties to many of your contracts before assigning the contracts to the buyer. If the transaction is structured as a sale of your companys stock, consent will only be required if assignment is defined broadly to include a change of control transaction (common in real estate leases). If the transaction is structured as a merger, depending on the applicable state statute, whether consent is required may depend on whether it is a forward merger (in which case the legal existence of your company ceases and seeking consents may be advisable) or a reverse merger (in which case the legal existence of your company continues and it is less likely that seeking consents is required).7 Due Diligence forms the base upon which virtually all key decisions, both strategic and operational, are made. HR professionals bear a significant responsibility for a host of employees issues ranging from the integration of benefits and compensation programs to workforce restructurings, employment contract and their administration and management of

6 7

Supra 4 Ibid

issues, such as organizational culture and employment practices.8 While a smooth transition alone is an important goal, it also is the means to an even more important end. Robert Bundy says that there are three key factors to help an organization achieve merger success and people issues play an important part in each:

Business logic: why are we doing this transaction and what needs to occur for it to be

considered a success? Price Paid: What is the economic baseline and what improvements in post-merger performance do we need to see in order to pay any premium in price? Integration: How do we translate the strategy to merge or acquire into real value?

Due diligence is intented to uncover answers to thesethree questions. It prevents organization from overlooking key issues and can significantly improve the chances of the deals success.


Chapter 2 - TYPES OF DUE DILIGENCE .It is difficult to establish a uniform set of due diligence procedures for all transactions. The determination of how much diligence is necessary or appropriate or what constitutes a reasonable investigation generally will vary depending on the specific facts and circumstances. Steps that are appropriate for one offering may not be appropriate for another. This set of guidelines is intended to provide a general introduction to the due diligence process. In any particular situation though, the due diligence investigation must be designed to accomplish the identified objectives while taking into account the specifics of the proposed transaction. For any given transaction, certain areas may expand in importance while others become of lesser concern. The due diligence process will generally include the following elements: background due diligence, business due diligence, financial due diligence, accounting due diligence, legal due diligence, and corporate governance

2.1. Background Due Diligence

Before starting any due diligence investigation, it is important to be well informed about both the transaction and the issuer that is being reviewed. A good starting point for conducting due diligence is to tap into public sources of information. Internet searches of newspaper and magazine articles and other information sources about the company, its management and its industry, should be done as early as possible in the timeframe for an offering for general background purposes. Underwriters can review public sources of information about a company and its industry10:

Valerie Ford Jacob, The Due diligence Process From the Underwriters Perspective, Practising Law Institute, Corporate Law and Practice Course Handbook Series, 1746 PLI/Corp 135, June 2009

Lexis/Nexis searches of newspaper and magazine articles about the company, its directors and officers and its industry, as well as Google searches (should be done as early as possible in the deal) Analyst or rating agency reports on the company or industry sector Industry-specific magazines (such as Automotive Rental News or Chemical Report) The company's web site (which may include archived press releases and investor presentations The company's SEC, statutory/regulatory or stock exchange filings Prospectuses or SEC filings of companies in the same industry Press releases or articles regarding the company or the industry Third party chat rooms devoted to the company Public information about the country in which the company conducts most of its business

2.2. Business Due Diligence

The underwriters will also engage in a formal business due diligence process. In general, the underwriters and their counsel should regularly communicate with each other about issues they each uncover during the due diligence process. Business due diligence may include some or all of the following elements: interviews with senior management of the company (and former officers, if applicable) background checks of management interviews with the company's middle management, such as officers in charge of marketing, sales, human resources, production, manufacturing or other core areas site tours of the company's principal facilities or retail locations interviews with the company's principal customers, suppliers, lenders or other business partners11

A very important part of business due diligence is that it gives the opportunity to ask specific questions from the Companys Management. The questions can be related to anything related to

John J. Clarke, Jr, How To Prepare An Initial Public Offering: Due Diligence And Potential Liabilities, Practicing Law Institute, Corporate Law and Practice Course Handbook Series, 1798 PLI/Corp 85, March ,2010

the affairs of the company: its business, its management, history, products nd services, the market of the company, research and development etc. these wide variety of questions helps in extracting the true and current status of the company. By asking these questions to different persons, different answers may be received and thus, the real status of the company can up.

In some transactions the underwriters may request that the company retain specialized consultants to assist with the investigation of particularly specialized matters. For example, it may be prudent to retain retail consultants to tour and evaluate a new distribution center, information systems consultants to evaluate the company's systems or environmental consultants to evaluate potential clean-up sites. The underwriters and their counsel should follow up with the company or other appropriate persons on issues raised by outside consultants.

Another important part of the due diligence process is making sure that the underwriters and underwriters' counsel have received adequate backup for industry statistics, market share and similar data included in the prospectus. The underwriters' counsel should distribute a backup request to the issuer and issuer's counsel asking for backup for particular numbers and qualitative phrases such as statements regarding the company's market share or leading position in a particular area12.

2.3. Financial Due Diligence

Financial due diligence is often conducted by investment bankers and the in-house financial staff. It is important for lawyers to participate in this process to understand the financial status of the company and the major issues presented by the company's financial statements. This is particularly true in the context of a securities offering, where lawyers often become involved in drafting the management's discussion and analysis section of the offering document in which the company explains its financial results for the periods presented and discusses items that have had or could have a material impact on results.


Supra 11

Financial due diligence typically includes: a review of the company's historical and pro forma financial statements (including all footnotes), including any material changes in the reporting periods presented (including any changes in accounting principles) and the reasons for these changes significant items on the financial statements any actual or anticipated restatements, impairments or other charges unusual or non-recurring items acquisitions and divestitures and any related goodwill amortization contingencies / contractual obligations litigation / legal matters credit and foreign exchange derivatives and other hedging instruments reserves and significant estimates potential accounting charges as a result of stock and other compensation issues reversals of accrued liabilities. off-balance sheet or under-recorded liabilities and contingencies, including in particular potential employee benefit plan liabilities (unfunded pension plans) and worker's compensation liabilities. Management's Discussion & Analysis (MD&A) known trends and projections critical accounting policies results of operations and period to period comparisons related party transactions capital expenditures and contractual obligations a review of the company's short and long-term projections, including current and past internal budgets a review of credit facilities and liquidity needs (and associated costs) as well as the ability of the Company to refinance current debt facilities any unresolved comments from the SEC in connection with any filing and any non-GAAP financial information in the Company's reports or press releases.


As part of the financial due diligence process, particularly in the case of an initial public offering, bankers will review in detail the company's projections and business model with the company's CFO and financial management. Underwriters' counsel also should be involved in the process given the importance of these data points to understanding the future growth and strategic direction of the company. Bankers should analyze the reasonableness of the assumptions underlying the projections in order to determine whether the business model is realistic.

As part of this process, bankers will often review a base case model, a best case

model and a worst case model. Review of projections will frequently result in modifications or enhancements to the description of the company's business strategy and MD&A in the prospectus.

Bankers should also review the company's operating plans and capital expenditure plans (for maintenance and for growth) and consider the timing and financing of these plans, particularly in light of today's tight credit environment. Both bankers and lawyers should verify whether the company's credit facilities need to be amended or extended in order to allow the company to achieve its business plan. Debt financing for any particular company might no longer be available on terms as favorable as those granted in the past. In addition, existing capital expenditure covenants could limit the company's future growth plans. Bankers should also calculate whether the offering will cause the company to violate any financial covenants in the company's financing documents and thereby require amendment as a condition to closing.14

2.4. Accounting Due Diligence The bankers and lawyers should interview the company's independent auditors and, where material, auditors of acquired entities. Principal topics of discussion may include: 1. the independence of the company's auditing firm 2. the company's accounting policies generally 3. the company's revenue recognition and capital expenditures policies 4. actual and potential disagreements with the company, management or audit committee

13 14

Supra 10 Supra 11


5. consistency of the company's accounting policies over time and as compared to industry norms 6. issues regarding any material weaknesses or significant deficiencies 7. off-balance sheet liabilities, if any 8. the company's liquidity position 9. significant write-offs or changes in reserves or estimates, if any, and 10. proposed changes in the accounting rules or principles which could impact the company's financial statements.

There is a concept of comfort letter which is provided by the auditors to the underwriters and this is to provide assurance that the financial information in an offering document is accurate and has been independently verified. Further it gives the balance sheet and income statement of the Company of the recent months and thus, evaluates the Companys performance in the recent months.

There should also be a discussion between underwriters and the chairman of the audit committee to know the structure of the audit committee, the audit committees meeting process, review of financial data and line of communication with the company. Underwriters should also consider having a discussion with the chairman of the audit committee or other members of the committee, the Companys critical accounting policies, the matters discussed at the recent meetings. All this will bring out the true accounting picture of the Company. .

2.5. Legal Due Diligence

Legal due diligence generally is led by the underwriters' counsel and is closely monitored by the banking team. It is a document intensive process that is framed by a legal due diligence request list that is normally generated by underwriters' counsel. The due diligence request list may include and require review of: minutes of board of directors (and any subcommittees) of the company and principal subsidiaries

lawyers' letters to accountants any reports to management or the audit committee from accountants charters and bylaws stockholders agreements, registration rights agreements, warrants, preferred stock and other documents relating to the company's outstanding securities indentures, loan agreements, credit facilities and any material correspondence with lenders other material business contracts employment agreements, stock option plans and stock purchase plans

Attorneys also typically review the company's outstanding litigation and, where necessary, will interview outside counsel handling any principal litigation. Other areas where attorneys may provide close review in due diligence include: tax diligence, particularly involving IRS investigations intellectual property and a review of the company's licensing agreements employee benefit plans and stock option plans special regulatory issues, involving telecommunications, environmental or other areas, government, antitrust, or other investigations of the company's business.

Underwriters' and company counsel are usually responsible for negotiating the representations and warranties in the underwriting agreement. These negotiations will often raise due diligence issues and lead to further discussions if the company is unable to make standard representations.. 2.5.1. Key Areas15 of Legal Due Diligence Generally, a legal due diligence exercise will focus on the following areas:

Corporate structure Assets Liabilities Contracts

Supra 1


Licenses and permits

2.6. Corporate Governance

It is to be checked by the legal consultants that the proper corporate governance rules are followed by the Company.

Corporate governance has emerged as an important both in India and globally. Expectations of stakeholders are extremely high and the scrutiny by regulators and investors incredibly stringent. As a consequence, Indian companies are proactively implementing measures for the same. Going forward, one of the most important challenges for Board members is to build a foundation of trust with management, the investment community, regulatory agencies and the public. The stakes are high and the margin for error is low and while new standards are emerging, one thing remains clear: the responsibility to adopt sound governance practices has been placed squarely on corporate Directors and officers.

So when legal due diligence is conducted corporate governance aspects of the Company are to be taken into consideration. Section 149 of the Listing Agreement of SEBI requires that there should be two independent directors on the Board so it has to be checked that there are in reality two independent directors on Board. Besides this other Indispensable Principles16 of Corporate Governance which should be considered are as follows. Discipline in operations Transparency in dealings and disclosures Accountability to shareholders Responsibility of company's action Corporate Social Responsibility Improving group dynamics and harnessing individual talents


K.R. Singh, Corporate Governance and Compliance-India, Available at http://ezinearticles.com/?CorporateGovernance-and-Compliance---India&id=2102829 (visited on 3 May 2010, at 10p.m.)


Enhancing early-warning mechanisms for critical risks Mitigating exposure to liability Building credibility and trust with stakeholders Embedding sustainability as a corporate value


3. Chapter III - LEGAL DUE DILIGENCE- A PRACTICAL GUIDE 3.1. Due Diligence: Buyer & Seller Perspective 1. Buyers Due Diligence :Due diligence for a buyer is: (i) an investigation into the

target's business generally, including its past and current financial and legal condition, (ii) an evaluation of factors that may have a future impact on the target's business and (iii) confirmation of information provided by the target's management and others. In resultsoriented due diligence, the buyer and its advisors undertake this review so that the buyer can make an informed investment decision and identify and address problems and obstacles to effecting the transaction or realizing its investment objectives.17 2. Sellers Due Diligence:- Due diligence for a seller includes gathering, evaluating and organizing information about the target so that it can be presented to potential buyers in a manner that will, to the extent practicable, allow buyers to determine risk parameters and thereby hopefully lead to a higher purchase price. To do this, the seller needs to

anticipate the issues that the potential buyers are likely to focus on and their possible solutions or mitigating circumstances. In addition, information obtained during a seller due diligence process is also used to prepare the disclosure schedules to the purchase agreement18 3.2. Know the Process It is very important before conducting the due diligence that the Company conducting it through its consultants should know about the transaction. The various things that should be taken care of are :1. Industry Risks Different kinds of risks are inherent in different types of industries (e.g., financial products, banking). If, for example, intellectual property is a key component of the

Molly F. Stockley, Managing A Results-Oriented Due Diligence Process On Behalf Of A Buyer Or Seller, Practising Law Institute Corporate Law and Practice Course Handbook Series c at 1678 PLI/Corp 319, June 2010 18 Ibid


target's business, diligence will likely focus on the strength of the IP portfolio and the target's protection of that IP. Knowing that a license to use a key patent is exclusive versus non-exclusive could be a real value issue for the client.If the target is heavily regulated, diligence will likely focus on the target's regulatory compliance and any regulatory consents required to undertake the transaction.19 2. Private or Public Deal Another important thing to be noted is that representations and warranties of the closing should be known. Further, the entire information available in the public domain about the target Company should be known to the acquirer. Publicly-available documents include SEC filings and analyst and rating agency reports concerning the target. Rating agency reports can be particularly helpful for an explanation of the target's debt.

Copies of all offering memoranda, management presentations or other marketing materials that have been received from the seller. In addition, press releases and other information from the target's website are useful. the circumstances of the transaction, it may be necessary to prepare a defensive profile of the target. 20

3. Foreign Jurisdiction The issues related to the jurisdiction in caseof foreign target Company should be clearly known to the acquirer. Availability of Foreign documents in foreign language or translated language should be checked along with provision for the coordination ofthe local counsels in this process.21 3.3. Managing the Due Diligence Process To manage the Due diligence Process following aspects have to be taken into consideration.

19 20

Supra 1 Supra 17 21 Ibid


1. Initial parameters Management requires a preliminary evaluation of the areas of key importance for the success of the transaction. This can be continuity of the targets, key personnel, suppliers and customers after the acquisition. 2. Selecting due diligence teams The core team for the conduct of the due diligence should consist of:

management representatives of the acquirer; legal counsel; valuation adviser; chartered accountants (CPA)/merchant bankers; technical consultants.

This stage will also involve the coordination plan among the team members, and allocating responsibilities and functions. Usually, all external counsels are required to execute confidentiality agreements before commencement of the assignment. 3. Preparing and executive preliminary investigation - The objective of the preliminary survey is to identify deal-breaking issues upfront before money and other valuable resources are committed to a detailed investigations. Some of the critical issues that may emerge during this exercise are:

concealment of facts and figures; insufficient internal controls; non-compliance of or adventurous interpretations of contracts, legal provisions, accounting principles, policies or standards;

employee retention and core management succession; contingent liabilities; statutory non-compliance; industrial sickness (erosion of net worth); and legal proceedings.


3.4. Role of Legal Consultants Legal Firms and Lawyers play very important role in conducting Due Diligence. They are ones on chose shoulders the entire responsibility to Conduct due Diligence is levied. They form a Due diligence team which prepares the Checklist, interviews the other party and then, prepares a due diligence Report. The Findings in the Reports influence the fate of transaction i.e. whether it should be completed or not. There many national and international Law firms that provide the Due Diligence Service. It is an exhaustive process and requires expertise skills and knowledge. 3.5. Legal Due Diligence Process There is no definitive form of a legal due diligence. The investigative aspects as well as form of the LDD process varies depending upon the scope of work dictated by the client, the focus, special areas of weakness, the type of business, et al. However, the basic philosophy of a LDD is common to most processes followed in a LDD. The LDD follows a certain life cycle. The LDD covers two aspects intra-corporate

transactions and inter-corporate transactions. The various chronological stages of the LDD are22: 1. A memorandum of understanding between the transacting parties for disclosure23 2. Establishment of time-lines 3. Commencement with pre-arranged check-list(s) where the target company provides information and documents to the best of its ability and knowledge. 4. Interview with the relevant personnel of the target company 5. Independent checks with the statutory and regulatory authorities, libraries, corporate documents, banks and third parties that do business with the target company


Yang Lawyers, Legal Memorandum & Legal Due Diligence, Available at www.yangworld.com/LDDR-Y.doc (visited on 5 May 2010 at 7p.m.)


6. Transactional and corporate documentation, financial statements, tax, litigation, environment and safety issues, HR and property 7. Collation with financial due diligence for confirmation of representations, warranties and liabilities 8. Investigation of issues that would materially impact the business transaction 9. Analysis by the law firm of the foregoing 10. Drawing of the draft or preliminary report 11. Discussions with the acquirer on findings and discoveries 12. Finalisation of the LDD Report (LDDR) 13. Analysis and Strategy Detailed due diligence The success of the investigation to make a well-informed decision would lie in a well-planned, integrated and coordinated detailed enquiry procedures. Certification of completeness of disclosures The due diligence team should obtain a declaration or certificate from the target company confirming the completeness of the disclosed information and documents, and that no material data has been withheld by the target. 3.6. Due Diligence Checklist The first step in conducting legal due diligence is to search for as much publicly available information as you can access regarding the business proposed to be acquired. This generally will involve internet searches, review of all public filings with the Ministry of Corporate Affairs, a review of press release The second step generally is to prepare a due diligence request to be served upon opposing counsel and the target company. An example of a due diligence request checklist is attached as Annexure to this outline. This particular model could be used as a starting place.

It was prepared for an acquisition of a technology company. In other industry sectors, you would want to emphasize and request in greater detail other materials (and perhaps exclude some of the items requested in this model). Requests should be customized for the particular target company and may be revised as you discover more about the company. The request is not limited to

documents and other written materials. In many cases, particularly when a target company has been shopping itself for a sale, the target company will already have prepared a document room or virtual document room containing most of the requested items. In other cases, the target merely will collect the requested materials, indicate where it believes either the request is inappropriate or there are no such materials, and either send copies of those materials to the buyer's counsel or otherwise permit access to them. In the case of competitively sensitive materials and a buyer who is a competitor, some materials may not be available until just before signing definitive agreements or may be available but with restrictions on who may see them within the buyer's transaction team.

The key to successful legal due diligence is keeping an up to date checklist, conducting a careful review of the materials by lawyers who understand the deal structure, the target's business and the interaction between the due diligence review and the negotiation of representations, warranties, covenants and closing conditions in the definitive transaction documents, as well as the disclosure schedules, and full and regular communication with the client and the rest of the deal team.24 3.7. Due Diligence Report It is one of the most important part of this process. A report is prepared by the experts which contain the following contents:


company information; corporate capacity; directors, their interests and conflicts, if any; accounts; statutory compliance with the applicable regulations;

Eric Simonson, Specialized Areas Of Concern In Acquisition Transactions, Practising Law Institute Corporate Law and Practice Course Handbook Series, 1781 PLI/Corp 261, January 2010



personnel; compliance with the Industrial Disputes Act 1947, the Payment of Bonus Act 1965, the Payment of Wages Act 1936, the Payment of Gratuity Act 1972, the Employees Provident Funds and Miscellaneous Provisions Act 1952, the Employees State Insurance Act 1948, and the Local Shops and Establishments Act; as well as with any industrial settlement, award, judgment or order in any labour dispute or litigation; recognized trade unions; retrenchments, lay-off and voluntary retirement schemes; and share options, share incentive, profit sharing or other incentive schemes for employees; pension, retirement, provident fund, superannuation and gratuity schemes;

share capital; shareholders; licenses, permits, approvals and specific statutory compliance; intellectual property rights identifications of all patents, trade marks, copyrights, industrial designs, all other forms of registered and unregistered intellectual proprietary rights or other form of monopoly or property rights used or owned by the target company and rights granted to third parties;

industrial property know-how, trade secrets; infringement of third-party rights; assets immovable and movable property; exports and imports, compliance with laws; litigation judicial, quasi-judicial, arbitral and other administrative proceedings; taxation issues income tax, customs, excise and sales tax; insurance quality of insurance cover; contractual liabilities and commitments; and Environment-related issues compliance with law, social issues, and the rehabilitation of people likely to be ousted by large natural resources projects, e.g. a reservoir for a hydroelectric project.

Thus a due diligence report is a detailed one, elaborating on various aspects of company right from its corporation to its labour problem, its history at share markets, to environmental issues to taxation. It is indeed a grilling task for any lawyer of any stature


4. CHAPTER IV-CASE STUDY Legal due diligence is a very important process to be conducted to have a healthy business transaction. For better understanding of the procedure a hypothetical case study is given below:Transaction:- Company A is dealing in business of Dyes and Chemicals and is located in Karnataka. This company is planning to be acquire by Company B which is dealing in Dyes and Chemical and is Company based in China. Before proceeding with the transaction, Company A plans to conduct legal due diligence on company B through its legal consultants. The legal due diligence team will prepare the checklist as mentioned above and will investigate all the aspects related to the business of company B. These aspects will include 1. Business status 2. Corporate Records 3. Interview with Management 4. Pending Litigations 5. Intellectual Property rights Acquired by Company B 6. Financial Status of Company B. 7. Scope of Dyes and Chemicals Business in China 8. Compliance with the Corporate Governance rules etc, Thus, after examining and investigating the status of company B , a report will be prepared by the Legal consultants addressing all the issues and containing all the contents as mentioned above. A very important section of this report is Key Findings Section, that highlights the important findings of the Legal due Diligence process and thus, either approves or disapprove the transaction for Company A. There are various firms at national as well international levels that conduct legal due diligence process.

Such was the case when one of BT Telconsults 25existing clients wished to acquire a fixed and mobile incumbent company. They required a due diligence assessment of the networks, systems, IT, HR and processes. The target company had been privatised some 3 years previously and was being sold on by the current owners BT Telconsult assembled an experienced due diligence team, many of whom had worked in BTs own joint ventures and acquisition projects. A comprehensive set of due diligence reports was produced, which identified the major factors that would impact the value of the bid. This included projected Capex and Opex for use in the Business Plan, as well as high risk areas in the company strategy.26 Relying on BTs expert consultative practitioners the client was able to gain crucial insights into the commercial, organisational, technical and operational risks associated with the investment decision and build sufficient confidence in order to submit a realistic bid. The bidder was also able to benefit from BTs brand and reputation in the submission document. The BT team worked closely with the other experts involved in the due diligence, providing vital input to areas such as insurance, contracts, legal and business modeling In a recent project, a U.S. insurer determined that the present and future book of business of the target company a European multi-business financial institution was $5 billion. Taking into account related synergies both expected to derive from the deal, the U.S. company was initially prepared to pay $5.5 billion.27

However, a closer look at the people issues revealed that one-off golden parachutes to senior management in the event of a change in control amounted to $100 million. Unbudgeted pension costs, governed in part by local laws, amounted to another $30 million a year for 10 years for a total of $300 million ($220 million on a presentvalue basis using the buyers earned rate). Rationalizing the compensation plans the two companies amounted to a one-time cost of $10 million. And the complex regulations governing workforce streamlining would have created

25 26

Available at http://www.bt-telconsult.com/case_study_3-16.html (visited on 3 May 2010. At 7p.m) Ibid 27 Supra 3


additional costs of $10 million. Taken together, these people related costs amounted to $340 million the amount by which the acquirer would have overpaid in the deal had it not taken the 360-degree approach to due diligence.28


Supra 3


CHAPTER IV- CONCLUSION A carefully-managed due diligence process, whether on behalf of a buyer or a seller, is critical for results-oriented due diligence. A strong due diligence manager directs and channels the valuable time and efforts of all members of the due diligence team toward a common goal, which may be an informed investment decision (in the case of the buyer) or a higher purchase price (in the case of the seller). By following the best practices outlined above, the manager of the due diligence process should be able to add real and determinable value to an acquisition transaction.

The purposes of legal due diligence in an acquisition transaction are numerous. The various purposes of this process as mentioned is to understand the target company and its business. It helps in determining the assets and liabilities of Company and thus, puts a light on whether the transaction is beneficial for the company or not.

This is a very important process and should be conducted by the experts. It involves many facets to it i.e. financial, business, accounting, legal, etc. This project discusses all facets of due diligence with special reference to legal due diligence. Legal due Diligence process have become very popular with many mergers and acquisitions transactions being taken place.

Due Diligence has become a sophisticated and intricate process requiring very special skills on which the most delicate business decisions are founded. As defined above due diligence require a whole lot of investigation into affairs and health of a company. In India there is as such no law or case law on due diligence

The legal consultants are in a fiduciary relationship with their clients. So they should conduct this process diligently and efficiently otherwise the purpose of this concept is defeated. Due Diligence helps in making healthy transaction. If Due Diligence is conducted inefficiently, the result and the transaction will be adversely affected. Thus, due diligence is an important process which should be conducted in an efficient manner.



Journals Clarke John J. How To Prepare An Initial Public Offering: Due Diligence And Potential Liabilities, Practicing Law Institute, Corporate Law and Practice Course Handbook Series, 1798 PLI/Corp 85, March ,2010 Jacob Valerie Ford, The Due diligence Process From the Underwriters Perspective, Practising Law Institute, Corporate Law and Practice Course Handbook Series, 1746 PLI/Corp 135, June 2009 Jones Sarah, Due Diligence, Practising Law Institute, corporate Law and Practice Course Handbook Series, 1726 PLI/Corp 165, 2009 Simonson Eric, Specialized Areas Of Concern In Acquisition Transactions, Practising Law Institute Corporate Law and Practice Course Handbook Series, 1781 PLI/Corp 261, January 2010 Stockley Molly F., Managing A Results-Oriented Due Diligence Process On Behalf Of A Buyer Or Seller, Practising Law Institute Corporate Law and Practice Course Handbook Seriest, 1678 PLI/Corp 319, June 2008 Web Sources http://ezinearticles.com/?Corporate-Governance-and-Compliance---India&id=2102829 http://www.bt-telconsult.com/case_study_3-16.html http://www.stoel.com/showarticle.aspx?Show=2925 http://www.towersperrin.com/tp/getwebcachedoc?webc=TILL/USA/2006/200602/MA.pdf www.yangworld.com/LDDR-Y.doc



ANNEXURE 1. Sample Due Diligence Checklist

I. Financial Information A. Annual and quarterly financial information for the past three years 1. Income statements, balance sheets, cash flows, and footnotes 2. Planned versus actual results 3. Management financial reports 4. Breakdown of sales and gross profits by: a. Product Type b. Channel c. Geography 5. Current backlog by customer (if any) 6. Accounts receivable aging schedule B. Financial Projections 1.Quarterly financial projections for the next three fiscal years a. Revenue by product type, customers, and channel b. Full income statements, balance sheets, cash 2. Major growth drivers and prospects 3. Predictability of business 4. Risks attendant to foreign operations (e.g., exchange rate fluctuation, government instability) 5. Industry and company pricing policies 6. Economic assumptions underlying projections (different scenarios based on price and market fluctuations) 7. Explanation of projected capital expenditures, depreciation, and working capital arrangements 8. External financing arrangement assumption C. Capital Structure 1. Current shares outstanding 2. List of all stockholders with shareholdings, options, warrants, or notes 3. Schedule of all options, warrants, rights, and any other potentially dilutive securities with exercise prices and vesting provisions. 4. Summary of all debt instruments/bank lines with key terms and conditions 5. Off balance sheet liabilities D. Other financial information 1. Summary of current federal, state and foreign tax positions, including net operating loss carryforwards 2. Discuss general accounting policies (revenue recognition, etc.) 3. Schedule of financing history for equity, warrants, and debt (date, investors, dollar investment, percentage ownership, implied valuation and current basis for each round) II. Products A. Description of each product 1. Major customers and applications 2. Historical and projected growth rates 3. Market share 4. Speed and nature of technological change 5. Timing of new products, product enhancements 6. Cost structure and profitability III. Customer Information A. List of top 15 customers for the past two fiscal years and current year-to-date by application (name, contact name, address, phone number, product(s) owned, and timing of purchase(s)) B. List of strategic relationships (name, contact name, phone number, revenue contribution, marketing agreements)


C. Revenue by customer (name, contact name, phone number for any accounting for 5 percent or more of revenue) D. Brief description of any significant relationships severed within the last two years. (name, contact name, phone number) E. List of top 10 suppliers for the past two fiscal years and current year-to-date with contact information (name, contact name, phone number, purchase amounts, supplier agreements) IV. Competition A. Description of the competitive landscape within each market segment including: 1. Market position and related strengths and weaknesses as perceived in the market place 2. Basis of competition (e.g., price, service, technology, distribution) V. Marketing, Sales, and Distribution A. Strategy and implementation 1. Discussion of domestic and international distribution channels 2. Positioning of the Company and its products 3. Marketing opportunities/marketing risks 4. Description of marketing programs and examples of recent marketing/product/public relations/media information on the Company B. Major Customers 1. Status and trends of relationships 2. Prospects for future growth and development 3. Pipeline analysis C. Principal avenues for generating new business D. Sales force productivity model 1. Compensation 2. Quota Average 3. Sales Cycle 4. Plan for New Hires E. Ability to implement marketing plan with current and projected budgets VI. Research and Development A. Description of R&D organization 1. Strategy 2. Key Personnel 3. Major Activities B. New Product Pipeline 1. Status and Timing 2. Cost of Development 3. Critical Technology Necessary for Implementation 4. Risks VII. Management and Personnel A. Organization Chart B. Historical and projected headcount by function and location C. Summary biographies of senior management, including employment history, age, service with the Company, years in current position D. Compensation arrangements 1. Copies (or summaries) of key employment agreements 2. Benefit plans E. Discussion of incentive stock plans F. Significant employee relations problems, past or present G. Personnel Turnover 1. Data for the last two years 2. Benefit plans VIII. Legal and Related Matters A. Pending lawsuits against the Company (detail on claimant, claimed damages, brief history, status, anticipated outcome, and name of the Companys counsel)


B. Pending lawsuits initiated by Company (detail on defendant, claimed damages, brief history, status, anticipated outcome, and name of Companys counsel) C. Description of environmental and employee safety issues and liabilities 1. Safety precautions 2. New regulations and their consequences D. List of material patents, copyrights, licenses, and trademarks (issued and pending) E. Summary of insurance coverage/any material exposures F. Summary of material contacts G. History of SEC or other regulatory agency problem, if any