due diligence project

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DUE DILIGENCE

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RAJIV GANDHI NATIONAL UNIVERSITY OF LAW, PATIALA, PUNJAB

Corporate Law Project

Submitted in the Partial Fulfillment of B.A. LLB (Hons.) VI Semester, May 2010

DUE DILIGENCE

SUBMITTED TO: SUBMITTED BY:

Ms. Srishty Neelkanth Kratika Shekhawat (264)

(Asst. Prof. in Law) Rasleen Kaur Dua (274)

Khushboo Jain (266)

Utkarsh Chaudhary (276)


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CERTIFICATE

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)


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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.


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TABLE OF CONTENTS

ACKNOWLEGMENTS

1. CHAPTER I- INTRODUCTION 1-31.1.Meaning of Due Diligence...1

1.2.Need of Due Diligence....2

1.3.Significance of Legal Due Diligence...3

2. CHAPTER IITYPES OF DUE DILIGENCE..6-132.1.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 Diligence122.6. Corporate Governance13

3. CHAPTER III- LEGAL DUE DILIGENCEA PRACTICAL GUIDE...15-203.1.Due Diligence: Buyer & Seller Perspective.15

3.2. Know the Process..15

3.3.Managing the Due Diligence Process...173.4.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 VCONCLUSION.26

BIBLIOGRAPHY27

ANNEXURE28

Sample Checklist


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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 arewarranted;

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.

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


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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 letterof intent or a memorandum of understanding.

2. The legal due diligence (LDD).2Supra 13John O. Nigh and Marco Boschetti, M&A Due Diligence: The 360-Degree View, Available athttp://www.towersperrin.com/tp/getwebcachedoc?webc=TILL/USA/2006/200602/MA.pdf (visited on 3 My 2010 at7 p.m.)
http://www.towersperrin.com/tp/getwebcachedoc?webc=TILL/USA/2006/200602/MA.pdfhttp://www.towersperrin.com/tp/getwebcachedoc?webc=TILL/USA/2006/200602/MA.pdf


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3. The negotiation and signing of the definitive or final transactional document.4. 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 buyerthe 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 thelegal 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 legaldue diligence process will be helpful for both the buyers counsel and targets

companys counsel in drafting and negotiating the merger or acquisition agreement

4 Available at, http://www.stoel.com/showarticle.aspx?Show=2925 (visited on 6 May 2010, at 10 p.m.)5Ibid


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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 willattempt 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 isrequired 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

6Supra 47Ibid


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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:

9Business logic: why are we doing this transaction and what needs to occur for it to beconsidered a success?

Price Paid: What is the economic baseline and what improvements in post-mergerperformance 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.

8J.C. Verma, BHARATS CORPORATE MERGERS AMALGAMATION & TAKEOVERS, BHARAT LAWHOUSE, New Delhi, Ed. 5th 2008, p. 3259Ibid, p. 326


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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

reasonableinvestigation 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,

legalduediligence, 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:

10 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


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Lexis/Nexis searches of newspaper and magazine articles about the company, itsdirectors 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 asAutomotive Rental News or Chemical Report) The company's web site (which may include archived press releases and investorpresentations

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

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


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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.

12 Supra 11


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Financial due diligence typically includes:

a review of the company's historical and pro forma financial statements (including allfootnotes), including

any material changes in the reporting periods presented (including any changes inaccounting 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 theability 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.


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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. 13As 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 alsocalculate 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 firm2. the company's accounting policies generally3. the company's revenue recognition and capital expenditures policies4. actual and potential disagreements with the company, management or audit committee

13Supra 1014Supra 11


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5. consistency of the company's accounting policies over time and as compared to industrynorms

6. issues regarding any material weaknesses or significant deficiencies7. off-balance sheet liabilities, if any8. the company's liquidity position9. significant write-offs or changes in reserves or estimates, if any, and10. 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 thecommittee, 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

Legalduediligence 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 legalduediligence

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 principalsubsidiaries


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Licenses and permits2.6. 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

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


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


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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 thetarget'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 results-

oriented 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 andorganizing 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

agreement

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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 RisksDifferent 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

17 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 at1678 PLI/Corp 319, June 201018Ibid


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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 DealAnother 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 JurisdictionThe 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.

19Supra 120Supra 1721Ibid


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1. Initial parameters Management requires a preliminary evaluation of the areas of keyimportance 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 diligenceshould 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.


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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 disclosure232. Establishment of time-lines3. 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 company5. Independent checks with the statutory and regulatory authorities, libraries, corporate

documents, banks and third parties that do business with the target company

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


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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 andliabilities

8. Investigation of issues that would materially impact the business transaction9. Analysis by the law firm of the foregoing10.Drawing of the draft or preliminary report11.Discussions with the acquirer on findings and discoveries12.Finalisation of the LDD Report (LDDR)13.Analysis and Strategy

Detailed due diligence The success of the investigation to make a well-informed decisionwould 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


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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 legalduediligence 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;

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


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4. CHAPTER IV-CASE STUDYLegal 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 status2. Corporate Records3. Interview with Management4. Pending Litigations5. Intellectual Property rights Acquired by Company B6. Financial Status of Company B.7. Scope of Dyes and Chemicals Business in China8. 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 importantfindings 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.


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Such was the case when one ofBT 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 companya European multi-business financial institutionwas $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 $10million. And the complex regulations governing workforce streamlining would have created

25 Available at http://www.bt-telconsult.com/case_study_3-16.html (visited on 3 May 2010. At 7p.m)26Ibid27Supra 3
http://www.bt-telconsult.com/case_study_3-16.htmlhttp://www.bt-telconsult.com/case_study_3-16.html


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additional costs of $10 million. Taken together, these people related costs amounted to $340

millionthe amount by which the acquirer would have overpaid in the deal had it not taken

the 360-degree approach to due diligence.28

28Supra 3


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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, theresult and the transaction will be adversely affected. Thus, due diligence is an important process

which should be conducted in an efficient manner.


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BIBLIOGRAPHY

Books

VermaJ.C., BHARATS CORPORATE MERGERS AMALGAMATION & TAKEOVERS, BHARAT

LAW HOUSE, New Delhi, Ed. 5th 2008

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 LawInstitute Corporate Law and Practice Course Handbook Series, 1781 PLI/Corp 261, January2010

Stockley Molly F.,Managing A Results-Oriented Due Diligence Process On Behalf Of A BuyerOr 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
http://ezinearticles.com/?Corporate-Governance-and-Compliance---India&id=2102829http://www.bt-telconsult.com/case_study_3-16.htmlhttp://www.stoel.com/showarticle.aspx?Show=2925http://www.towersperrin.com/tp/getwebcachedoc?webc=TILL/USA/2006/200602/MA.pdfhttp://www.yangworld.com/LDDR-Y.dochttp://www.yangworld.com/LDDR-Y.dochttp://www.towersperrin.com/tp/getwebcachedoc?webc=TILL/USA/2006/200602/MA.pdfhttp://www.stoel.com/showarticle.aspx?Show=2925http://www.bt-telconsult.com/case_study_3-16.htmlhttp://ezinearticles.com/?Corporate-Governance-and-Compliance---India&id=2102829


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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 footnotes2. Planned versus actual results3. Management financial reports4. Breakdown of sales and gross profits by:a. Product Typeb. Channelc. Geography5. Current backlog by customer (if any)6. Accounts receivable aging scheduleB. Financial Projections

1.Quarterly financial projections for the next three fiscal yearsa. Revenue by product type, customers, and channelb. Full income statements, balance sheets, cash2. Major growth drivers and prospects3. Predictability of business4. Risks attendant to foreign operations (e.g., exchange rate fluctuation, government instability)5. Industry and company pricing policies6. Economic assumptions underlying projections (different scenarios based on price and marketfluctuations)7. Explanation of projected capital expenditures, depreciation, and working capital arrangements8. External financing arrangement assumptionC. Capital Structure

1. Current shares outstanding

2. List of all stockholders with shareholdings, options, warrants, or notes3. Schedule of all options, warrants, rights, and any other potentially dilutive securities with exerciseprices and vesting provisions.4. Summary of all debt instruments/bank lines with key terms and conditions5. Off balance sheet liabilitiesD. Other financial information

1. Summary of current federal, state and foreign tax positions, including net operating loss carryforwards2. 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 rates3. Market share4. Speed and nature of technological change5. Timing of new products, product enhancements6. Cost structure and profitabilityIII. 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)


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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. CompetitionA. Description of the competitive landscape within each market segment including:

1. Market position and related strengths and weaknesses as perceived in the market place2. 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 channels2. Positioning of the Company and its products3. Marketing opportunities/marketing risks4. Description of marketing programs and examples of recent marketing/product/publicrelations/media information on the CompanyB. Major Customers

1. Status and trends of relationships2. Prospects for future growth and development3. Pipeline analysisC. Principal avenues for generating new business

D. Sales force productivity model

1. Compensation2. Quota Average3. Sales Cycle4. Plan for New HiresE. Ability to implement marketing plan with current and projected budgets

VI. Research and Development

A. Description of R&D organization

1. Strategy2. Key Personnel

3. Major ActivitiesB. New Product Pipeline

1. Status and Timing2. Cost of Development3. Critical Technology Necessary for Implementation4. RisksVII. 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 plansE. Discussion of incentive stock plans

F. Significant employee relations problems, past or present

G. Personnel Turnover

1. Data for the last two years2. Benefit plansVIII. Legal and Related Matters

A. Pending lawsuits against the Company

(detail on claimant, claimed damages, brief history, status, anticipated outcome, and name of theCompanys counsel)


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B. Pending lawsuits initiated by Company

(detail on defendant, claimed damages, brief history, status, anticipated outcome, and name ofCompanys counsel)C. Description of environmental and employee safety issues and liabilities1. Safety precautions2. 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

due diligence project

Documents