Part I : Introduction to Due Diligence  
by Anshul Ramesh and Avesh Harshan
Due diligence is one of those terms that you may understand superficially but not much in practice. Ordinarily, due diligence refers to the care that a reasonable person exercises to avoid harm to himself, other persons or their property. Due diligence allows a person to make informed decisions as it enhances the information available to decision-makers.

The phrase due diligence is not constrained to only the commercial or legal sphere. It is required in almost every sphere, in some way or the other. It is always better to be safe than sorry. Due diligence is like doing your homework. If you do it, you are prepared for the worst. Due diligence makes you understand your current circumstances, the advantages and disadvantages of your alternatives, therefore putting you in a better position for making informed decisions[1].

While most of us may not think about it, we exercise due diligence quite frequently in different aspects of our lives. Most people would be doing some internet-based research before making any major purchase, such as a car or any electronic device. We browse the internet to get an idea of the fair price, the technical details, low-interest finance offers, customer reviews, etc. just to be certain that we do not end up paying a price higher than was required.

Similarly, before entering into any real estate / property transaction, we perform due diligence by investigating the title documents, encumbrance certificate, insurance policies and government authorisations, to ensure they are in accordance with the statutory requirements[2]. Thus due diligence is the homework done by an individual, before finalizing any deal or transaction, whether on a business level or a personal level.

Let us assume that you have an apartment, which you intend on leasing out. As a landlord, you would not simply lease your apartment to the person willing to pay the most. You may check several other things, such as whether such person intends on using it for accommodation or for renting it to a third party for non-accommodation purposes or if he is a bachelor, which could be against the relevant housing society rules (right or wrong, irrespective) etc. and.

Another example would be that lawyers need to do their due diligence before filing a case or appearing before a judge. In order to obtain relief in a court of law, it is imperative that the necessary care and due diligence is exercised by the person seeking such relief. In J. Samuel v Gattu Mahesh[3], the Supreme Court held that:

19. Due Diligence is the idea that reasonable investigation is necessary before certain kinds of reliefs are requested. Duly diligent efforts are a requirement for a party seeking to use the adjudicatory mechanism to attain an anticipated relief. An advocate representing someone must engage in due diligence to determine that the representations made are factually accurate and sufficient. The term ‘due diligence’ is specifically used in the Code so as to provide a test for determining whether to exercise the discretion in situations of requested amendment after the commencement of trial.
20. A party requesting a relief stemming out of a claim is required to exercise due diligence and it is a requirement which cannot be dispensed with. The term ‘due diligence’ determines the scope of a party’s constructive knowledge, claim and is very critical to the outcome of the suit.

Due diligence is also essential for transactions involving loans. Let us assume that you are approach a bank for a car loan. It would be rather foolish of you and the bank to merely negotiate an agreement for giving the loan at a certain rate of interest. So much can go wrong in the future, therefore making it necessary for the parties to conduct due diligence. You, the party accepting the loan, have to conduct due diligence with respect to other sources of a probable loan, prevailing rates of interest, which asset would serve as security/bond for the transaction, among other things. The onus of determining whether lending to you is a profitable transaction, is on a designated employee / agent of the bank, and he has to conduct due diligence on you, your past loan history, past criminal records, income records, property owned, probability of default, among other things. Only after he is satisfied, will the bank sanction the loan. Since both parties have come to a better and more informed consensus, after conducting due diligence, the chances of the transaction ending in a loss, are significantly reduced.

Again, while investing financially, say in stocks and bonds, there is a need to conduct the needed due diligence before investing. Due diligence involving comparison of stocks, market economy, past stock market behavior, previous history of that company’s stocks, knowing the company’s business, government policies, like those concerning taxation and dividends, among other things, is required to be done, before one knows where and why to invest. All this information is to be analyzed in the midst of personal expectations such as desired rate of interest, period of investment, willingness of taking risk, etc.

An important legal principle is that of “caveat emptor” and “caveat vendor”. This legal parlance translates to “let the buyer and seller beware”. This means that you as a buyer or seller should know what any other reasonable man knows. For example, if you are buying a horse, and the seller sells you a blind one, you cannot later complain or go to a court of law for damages. The reason here is that the principle of “caveat emptor” would apply i.e. you should have known that the horse was blind while purchasing and despite that you went ahead with the purchase. Therefore, now you cannot sue the seller.

A vendor is under no duty to communicate the existence, even of latent defects, in his wares, unless by act or implication he represents such defects not to exist[4]. Obviously in a scenario wherein a buyer could not have known of its defect, the principle does not apply. For example, if you bought a pair of bluetooth earphones which do not work and it could not be reasonably known at the time of purchase, such a transaction can be voided[5].

Similarly, if a seller sells to the buyer a M.F. Hussain painting, and it later turns out to be a replica/fake, the seller cannot claim that he was unaware. The principle of “caveat vendor” would apply. The purpose of the above discussion is to emphasize that these principles stem out of having done the requisite due diligence before making a purchase or a sale. Clearly, due diligence is needed even in the smallest of transactions, such as buying and selling of commodities.

The term due diligence has been extended to a large number of transactions, mainly related to the business and corporate world. Due Diligence is one of the most common terms one can come across during a discussion over a corporate deal. The purpose of due diligence is to verify the legitimacy of the claims provided by the seller and to determine their worth. When a buyer purchases a company, whether they purchase assets or liabilities or shares, they need to know what they buy. Generally, these things are done by the process of due diligence. This is the reason why in every corporate deal which takes place, due diligence is one of the most important processes involved in that deal[6].

In the corporate world today, there are many transactions taking place on a day-to-day basis and sometimes the degree of uncertainty and the risks involved in the process of those transactions is catastrophic. No one knows exactly how the market situation would affect the company or if the company loses its investors or any other situation which would make it difficult to manage the affairs of the deal which took place. This is where due diligence comes to the rescue. Before entering into any Mergers & Acquisition (M&A) deal or say any corporate transaction, due diligence is conducted so that the parties are prepared beforehand, for any unpleasant surprise.

The main aim of due diligence is to recognize and diverge the risks, to nullify them and to maximize the shareholder value. By the means of due diligence, the risk factor which is related to the key issues of the deal, which would otherwise be discovered only at a later stage, can be reduced to a certain level. A thorough analysis of the company is carried out, providing a better idea to determine the fair purchase price and also educating the parties to the transaction of the advantages and disadvantages of the deal, therefore, saving money as well as the time involved in the deal process.

Now coming to Mergers and Acquisitions (M&A), the large interest area this research project primarily focuses on. Conducting due diligence, in these cases, is much more complicated than some of the transactions mentioned above. In this sense, it is a practice through which the parties to a merger spend time checking the balance sheets and legal histories of their potential partners before closing the deal[7].

Conducting effective due diligence is both a science and an art, requiring careful comprehension and concentration. It involves a detailed analysis of various aspects such as company information, accounts, share capital, industrial property, statutory compliance with applicable regulations, personnel, pending legal disputes, intellectual property rights, licenses, permits, approvals, insurance, taxation issues and environmental related issues, among many others. There is no definite non-exhaustive list. What needs to be covered in the due diligence report will vary from deal to deal and business to business. There is no fixed procedure or method of performing due diligence. Thus a due diligence report is a detailed one, elaborating on various aspects of a company, right from its incorporation to its labour problems and from its history at share markets to environmental issues to taxation[8].

From the perspective of a buyer the process of conducting due diligence, aims to identify the company’s data and potential liabilities under consideration and thus to save them from uncertainty and also from surprise risks and dangers.

Due diligence is an exhaustive exercise that involves processes such as business due diligence, legal due diligence, accounting due diligence, etc. Being a dynamic process, due diligence incorporates within the process itself almost all the essential aspects of a company’s activities, such as finance, accounting, tax, audit, etc.

Mr. Anshul Ramesh (4th Year Law student, Jindal Global Law School) and Avesh Harshan (3rd year Law student, National Law University and Judicial Academy, Assam) are interns at Corp Comm Legal under Mr. Bhumesh Verma.

[1] Spedding, Linda S. 2008. Due Diligence Handbook- Corporate Governance, Risk Management And Business Planning. CIMA Publishing.
[2] Singhania, Ravi, and Aditya Mehrotra. 2016. "LEGAL DUE DILIGENCE IN REAL ESTATE TRANSACTIONS - Singhania And Partners". Singhania And Partners.
[3] J Samuel v Gattu Mahesh (2012) 2 SCC 300 (SC).
[4] Commr. Of Customs (Preventive) v Aafloat Textiles (I) (P) Ltd. (2009) 11 SCC 18 (SC) 
[5] Sales of Goods Act 1930, s 16
[6] Spedding, Linda S. 2008. Due Diligence Handbook- Corporate Governance, Risk Management And Business Planning. CIMA Publishing
[7] Maurer, Bill. 2005. "Due Diligence And "Reasonable Man," Offshore". Cultural Anthropology 20 (4): 474-505.
[8] Mathur, Charu. 2002. "India: Legal Due Diligence". Mondaq.