For us, the buck started moving with title searches in the sub-registrar’s office – and anybody who’s been there, feels he’s seen it all, till you discover the world outside your toadpool. The inspection of municipal and ROC records is a move up the rung. For a generation of Indian lawyers, conducting the 360
Degree Due Diligence (‘DD’) exercise, in the changing scenario of cross border M & A, was a quantum leap from the toadpool to the Atlantic Ocean.
The term Due Diligence (“DD”) came into common use as a percolation from the US Securities Act, 1933, in relation to a defence taken by stock brokers, when accu-sed of inadequate disclosure to investors. A similar principle is recognised under Section 13 of the (Indian) Sale of Goods Act 1930, being the Latin maxim, Caveat Emptor. Over the years, this approach has been adapted with variations, for business transactions, particularly M & A.
The conduct of a DD proceeds on the premise that honesty and transparency are items one cannot take for granted – especially when it involves a large pay out. Anyone who is in the market is bound to sex up their image and hike the price. The intent of DD is to check out on the commodity and price, and ensure that there are no black holes ahead, rather than rely on warranties and indemnities.
DD is not purely a legal exercise – it involves financial, tax, commercial, technical, regulatory and compliance recognition and risk identification. In cross-border transactions with changing risk sensitivities and emerging issues, the traditional due diligence methodology sometimes may not work, and certain critical information may actually slip through the cracks.
What is required is flexibility – in the checklist – the investigation process, the data analysis – all of which have to be specific to the structure and purpose of the deal – the reasons why the acquirer is contemplating the acquisition — is it to set up a footprint in a new jurisdiction, is it part of a multiple jurisdictional global expansion strategy, is it purely an investment, or a short term trading decision — or to achieve a win-win synergy, involving backward and forward integration with the acquirer’s existing businesses and leveraging the same.
The historical approach has been to organise DD locationally, with the functions allocated on a compartmentalised basis. The financial and legal teams work in segregation, not only resulting in duplication, sometimes inconsistent assessments and even taking contrary positions.
The lawyer’s role was initially envisaged as historical, but lawyers’ involvement in business due diligence has become increasingly important with the lawyer emerging as the key person in advise, negotiations, and overall deal structuring in coordination with the acquirer’s in-house team.
The lawyer’s participation in formulating the DD strategy is therefore critical, and has to be attuned to the acquirer’s aspirations, as also the target’s profile, its corporate culture, existing leadership, liabilities, all of which have to be considered in order to decide whether to take over or partner with the organisation.
In any emerging market, particularly in India where cross-border deals were revived after a long hiatus, the initial reaction was a mixture of hesitation and hostility. It took acquirers some time to come to terms with the gaps in business practices and ethics, the vulnerable internal controls, inaccessibility to public information and the dilatory systems.
These shortcomings may have initially prolonged the DD exercise, but Indian lawyers were quick to adapt to the evolution in DD approach. Take for example, the conduct of an operational due diligence (ODD) in which the review is focused more on the future of the target rather than its history, and which is being adopted increasnin M & A. The assessment is based on the functional operations of the target, interconnectedness of these operations, and how the acq-uirer and targets’ combi-nation will impact future earnings.
Or the approach to human capital DD, which has been realigned keeping in mind, that an acquisition may flop if the key people are not retained. The historical approach, was to make a headcount and analyse benefits and compensation.
The current approach is to identify qualified, experienced key personnel as a value addition, factor this in the acquisition price or otherwise, and advise on appropriate continuation incentives, as Indian law does not prevent an employee from terminating his employment, notwithstanding contractual terms to the contrary.
Environmental DD has emerged as a determining deal factor representing the changing face of DD.
But that’s a story for another day.
Kumkum Sen is a Partner at Rajinder Narain & Co., and can be reached at kumkumsen@rnclegal.com
