Due diligence and disclosure

Scope of due diligence

What is the typical scope of due diligence in your jurisdiction? Do sellers usually provide due diligence reports to prospective buyers? Can buyers usually rely on due diligence reports produced for the seller?

Typically, the scope of due diligence in India extends to a review of:

  • the corporate records and filings maintained or made with the registrar of companies to ensure compliance with the provisions of the Companies Act;
  • foreign exchange filings (if applicable) made with the RBI to ensure that any prior investment was in compliance with the applicable laws;
  • material contracts with customers, suppliers, lenders, etc, or in relation to real property, to understand the key terms, and any restrictions, requirements of consent, intimation or otherwise that are relevant for the proposed transaction;
  • licences, registrations and permits obtained for the conduct of operations to ensure their validity and sufficiency, and to evaluate their compliance with the requirements under the applicable laws;
  • pending or threatened litigations involving the company, including proceedings or investigations by regulators;
  • labour and employment-related documents, including agreements with employees, and policies adopted to evaluate compliance with the requirements under the applicable labour laws;
  • IP, to ensure that the IP critical to the business is duly registered;
  • related-party transactions, which form a key aspect of the legal, financial and tax due diligence process in India; and
  • ancillary documents, including those pertaining to information technology, and insurance policies obtained in connection with the business, etc.

However, the scope of due diligence depends on the sector in which the company operates. For instance, if a company is engaged in the manufacturing sector, the licences and approvals obtained by the company, along with their operational and environmental (if applicable) compliances, are key to the due diligence. On the other hand, if the company is engaged in the services sector, the material agreements entered into by it, would be important. Further, many investors also engage advisers to conduct anti-money laundering, bribery and corrupt practices-related due diligence.

Sellers do not usually provide due diligence reports to prospective buyers. However, in the case of an acquisition through an auction or bid process that involves multiple bidders, the seller may provide a vendor due diligence report to the bidders. Even in such cases, reliance by the bidders on the due diligence report provided by the seller is highly negotiated. However, with respect to key issues identified in the report, areas in which the information is inadequate or areas that are important to the bidder, the bidder may conduct a confirmatory due diligence exercise of its own, or may request further information from the seller.

In addition, to obtain significant advantage in a competitive bid scenario, many buyers are now evaluating the benefits of relying upon representations and warranties insurance on a regular basis. However, it should be noted that such insurance products are fairly expensive and do not provide blanket protection.

Liability for statements

Can a seller be liable for pre-contractual or misleading statements? Can any such liability be excluded by agreement between the parties?

As part of the agreements executed by the parties, sellers typically provide representations and warranties with respect to the company as on the date of the transaction and for the conduct of business by the company before such date. Such representations and warranties are typically backed by an indemnity from the sellers. Thus, for a breach of such representations and warranties, or to the extent that such representations and warranties are found to be misleading, a seller may be liable for an indemnity claim by the buyer. Separately, the seller may also be liable for damages in a court of law for a breach of a representation or warranty.

It is not uncommon for parties to exclude or limit the liability of the seller (both in terms of time and amount) for a breach of such representations and warranties. However, such limitation is the subject of extensive negotiations between the parties.

Publicly available information

What information is publicly available on private companies and their assets? What searches of such information might a buyer customarily carry out before entering into an agreement?

The following information relating to private companies may be publicly available:

  • the details of incorporation of the company;
  • the management of the company;
  • corporate filings made by the company;
  • encumbrances on the assets of the company;
  • indebtedness of the company;
  • IP that is owned by the company;
  • land records for the real estate that the company owns or possesses; and
  • litigation (ongoing as well as concluded) pertaining to the company.

Typically, a buyer carries out searches relating to corporate compliance of the company, its indebtedness, financial position, litigation to which it is a party, its business organisation and corporate structure, or other particular areas material to the buyer.

Impact of deemed or actual knowledge

What impact might a buyer’s actual or deemed knowledge have on claims it may seek to bring against a seller relating to a transaction?

Claims against sellers under Indian contract law can be under two categories, as set out below.

Damages

The concept of damages under Indian contract law is based on the principle of foreseeability, that is, only such loss is recoverable as was reasonably foreseeable to result from the breach at the time of the contract. Accordingly, foreseeability depends upon the knowledge then possessed by the parties. It is well established that damages flowing naturally from the breach, whether under ordinary circumstances or from special circumstances, owing to the knowledge either in the possession of, or communicated to, the parties, are recoverable. Therefore, knowledge of circumstances that could be the subject matter of a damages claim against a seller is at times helpful in the Indian context. At the same time, Indian courts would be wary of awarding damages with respect to a claim made by a buyer who, despite having knowledge of such irregularity based on its due diligence process, chose to enter into such transaction.

Indemnity

In relation to the provisions governing indemnity under the transaction documents, the definition of knowledge, the independent investigation clause, and the sandbagging or anti-sandbagging provisions are extensively negotiated between the parties. The buyer generally tries to ensure that his or her knowledge (whether actual or constructive) does not preclude him or her from bringing an indemnity claim under the transaction documents. The seller, however, will typically argue that all knowledge (actual or constructive) acquired by the buyer (and its representatives) based on the disclosure letter and all the other documents disclosed or provided by the seller should restrict the buyer from bringing any indemnity claims against the seller or its affiliates after the consummation of the transaction.