Diploma in Advanced Entrepreneurship Management & Corporate Law

Module : 11

3. Legal Importance of Due Diligence Report

Introduction

Due diligence is an investigation of a business or person prior to signing a contract, or an

act with a certain standard of care.

It can be a legal obligation, but the term will more commonly apply to voluntary investigations.
A common example of due diligence in various industries is the process through which a potential
acquirer evaluates a target company or its assets for an acquisition. The theory behind due
diligence holds that performing this type of investigation contributes significantly to informed
decision making by enhancing the amount and quality of information available to decision makers
and by ensuring that this information is systematically used to deliberate in a reflexive manner
on the decision at hand and all its costs, benefits, and risks.

The term “due diligence” means "required carefulness" or "reasonable care" in general usage
and became a specialized legal term and later a common business term, where the process is
called "reasonable investigation". This Act included a defense, referred to later in legal usage as
the “due diligence” defense, which could be used by broker-dealers when accused of inadequate
disclosure to investors of material information with respect to the purchase of securities. In legal
and business use, the term was soon used for the process itself instead of how it was to be
performed, so that the original expressions such as "exercise due diligence in investigating" and
"investigation carried out with due diligence" were soon shortened to "due diligence
investigation" and finally "due diligence".

As long as broker-dealers exercised “due diligence” (required carefulness) in their investigation

into the company whose equity they were selling and as long as they disclosed to the investor
what they found, they would not be held liable for non-disclosure of information that was not
discovered in the process of that investigation.
The broker-dealer community quickly institutionalized, as a standard practice, the conducting of
due diligence investigations of any stock offerings in which they involved themselves. Originally
the term was limited to public offerings of equity investments, but over time it has come to be
associated with investigations of private mergers and acquisitions as well.

Business transactions and corporate finance

Due diligence takes different forms depending on its purpose:

1. The examination of a potential target for merger, acquisition, privatization, or similar

corporate finance transaction normally by a buyer. (This can include self due diligence or
“reverse due diligence”, i.e. an assessment of a company, usually by a third party on
behalf of the company, prior to taking the company to market.)
2. A reasonable investigation focusing on material future matters.
3. An examination being achieved by asking certain key questions, including, how do we buy,
how do we structure an acquisition, and how much do we pay?
4. An investigation of current practices of process and policies.
5. An examination aiming to make an acquisition decision via the principles of valuation and
shareholder value analysis.

The due diligence process (framework) can be divided into nine distinct areas:

1. Compatibility audit.
2. Financial audit
3. Macro-environment audit.
4. Legal/environmental audit.
5. Marketing audit.
6. Production audit.
7. Management audit.
8. Information systems audit.
9. Reconciliation audit.
It is essential that the concepts of valuations (shareholder value analysis) be linked into a due
diligence process. This is in order to reduce the number of failed mergers and acquisitions.

In this regard, two new audit areas have been incorporated into the Due Diligence framework:

 the Compatibility Audit which deals with the strategic components of the transaction and in
particular the need to add shareholder value and
 the Reconciliation audit, which links/consolidates other audit areas together via a formal
valuation in order to test whether shareholder value will be added.

Types of due diligence

 CDD, commercial due diligence, where a target company's commercial status – the market
position of its products and/or services – is reviewed,
 FDD, financial due diligence, where the target company's financial status is reviewed,
 IDD, integrity due diligence, where a company's exposure to legal, corruption and regulatory
risks is analyzed and assessed,
 ODD, operational due diligence, where the operational aspects of a target company are
reviewed
 DILIGENCE REPORT

To,

The Manager,

[Name of the Bank]

[Address of the Branch Office]

I/We have examined the registers, records, books and papers of [Name of the Company] (the
Company) as required to be maintained under the Companies Act, 1956 (the Act) and the rules
made thereunder, the provisions of various statutes, wherever applicable, the provisions
contained in the Memorandum and Articles of Association of the Company. In my/our opinion
and to the best of my/our information and according to the examination carried out by me/us
and explanations furnished to me/us by the Company, its officers and agents. I/We report that
in respect of the period from [period]:

1. the management of the Company is carried out by the Board of Directors comprising the
following persons as provided in Annexure I :

2. During the period under review no changes took place relating to the shareholding pattern of
the company.

3. During the period under review the Company has not made any alteration in the provisions of
the Memorandum of Association and Article of Associations of the Company.

4. The company has during the period under review, entered into the transactions with business
entities in which directors are interested. (Attached and marked as Annexure II)

5. The company has during the period under review, advanced loans, given guarantees and
provided securities amounting to Rs._________ to its subsidiary company and no advanced
loans, given guarantees and securities provided to the directors.

6. The Company has during the period under review, has not made any loans and investments;
or given guarantees or provided securities to other business entities.
7. The amount borrowed by the Company from directors, members, public, financial institutions,
banks and others during the period under review are within the borrowing limits of the Company.
The break up of the company's borrowings are being attached herewith and marked as Annexure
III.

8. The Company has during the period under review, not defaulted in the repayment of any public
deposits or unsecured loans and the Company or its Directors are not under the Defaulter's list
of Reserve Bank of India or in the Specific Approval List of ECGC.

9. The Company has during the period under review, created, modified or satisfied charges on
the assets of the company, the details of the same is being attached herewith and marked as
Annexure IV.

10. The Company has no Forex exposure and Overseas Borrowings during the period under
review.

11. The Company has not issued, offered and allotted any securities to the persons entitled
thereto and has also issued letters, coupons, warrants and certificates thereof to the concerned
persons and also the Company never redeemed any of its preference shares/debentures and
bought back its shares, during the period under review.

12. The Company has insured all its secured assets.

13. The Company has complied with the terms and conditions, set forth by the lending institution
at the time of availing the facility and also during the currency of the loan and has utilized the
funds for the purposes for which these were borrowed.

14. The Company has not declared any dividends to its shareholders.

15. The Company has insured fully all its assets.

16. The Company / Directors are not in the willful defaulters' list of RBI.

17. The Company / Directors are not in the Specific Approval List of ECGC.

18. The Company has paid all its statutory dues and that there are no arrears.
19. The Company being the private limited Company and as such the provisions stipulated in
Section 372 A of the Companies Act in respect of its Inter Corporate loans and Investments are
not applicable to the Company.

20. The Company has complied with the applicable and mandatory Accounting Standards issued
by the Institute of Chartered Accountants of India.

21. There is no amount lying with the Company which required be crediting or paying to the
Investor Education and Protection Fund.

22. A list of prosecutions initiated against or show cause notices received by the Company for
alleged offences under the Act and also the fines and penalties or any other punishment imposed
on the Company in such cases is attached and marked as Annexure V and Annexure VI.

23. As the Company is an unlisted private limited Company, the various clauses of the Listing
Agreement, is not applicable to the Company.

24. The Company has deposited both Employees' and Employer's contribution to Provident Fund
with the prescribed authorities.

Note : The qualification, reservation or adverse remarks, if any, may be stated at the relevant
place(s).

Date : FOR ____________________

Place : COMPANY SECRETARIES

[Name of the PCS]

C.P.No. _________