2 What is ‘due diligence’ ? Due diligence is the process whereby an investing party investigates, analyses, and evaluates an intended major investment, transaction, takeover, or business partnership prior to committing capital to it. Due diligence can be termed as a risk aversion strategy aimed at checking if the information about the investment that is available is correct and complete.There are several forms of due diligence – business due diligence, technical due diligence, financial due diligence, intellectual property due diligence and legal due diligence. This presentation discusses only aspects relating to legal due diligence.
3 “Due diligence” defined The term “due diligence” as relevant in this context is defined in the Merriam Webster’s Dictionary of Law as:The process of investigation carried on by a disinterested third party (such as a law firm or an accounting firm) on behalf of a party contemplating a business transaction (as a corporate acquisition or merger, a loan of finances, or especially purchase of securities) for the purpose of providing information with which to evaluate the advantages and risks involved.
4 Essential aspects of due diligence Due diligence is understood by the legal, financial and business communities to mean the disclosure and assimilation of public and proprietary information related to the assets and liabilities of the business being purchased. This information includes financial, human resources, tax, environmental and legal matters.Due diligence would include full understanding all of the obligations of the target company: debts, rights and obligations, pending and potential lawsuits, leases, warranties, all high and impact laden contracts – both inter-corporate and intra-corporate.
5 Meaning of 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.The preliminary negotiations, which culminate mostly in the execution of a letter of intent or a memorandum of understanding.The legal due diligence (‘LDD’).The negotiation and signing of the definitive or final transactional document.The closing.
6 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 are:A memorandum of understanding between the transacting parties for disclosureEstablishment of time-linesCommencement with pre-arranged check-list(s) where the target company provides information and documents to the best of its ability and knowledge.Interview with the relevant personnel of the target company
7 The legal due diligence process Independent checks with the statutory and regulatory authorities, libraries, corporate documents, banks and third parties that do business with the target companyTransactional and corporate documentation, financial statements, tax, litigation, environment and safety issues, HR and propertyCollation with financial due diligence for confirmation of representations, warranties and liabilitiesInvestigation of issues that would materially impact the business transactionAnalysis by the law firm of the foregoingDrawing of the draft or preliminary reportDiscussions with the acquirer on findings and discoveriesFinalisation of the LDD Report (‘LDDR’)Analysis and Strategy
8 Additional information from reports 1. Copies of any studies, appraisals, reports, analyses or memoranda within the last three years relating to the Company (i.e., competition, products, pricing, technological developments, software developments, etc.).2. Current descriptions of the Company that may have been prepared for any purpose, including any brochures used in soliciting or advertising.3. Descriptions of any customer quality awards, plant qualification/certification distinctions, ISO certifications or other awards or certificates viewed by the Company as significant or reflective of superior performance.4. Copies of any analyst or other market reports concerning the Company known to have been issued within the last three years.5. Copies of any studies prepared by the Company regarding the Company's insurance currently in effect and self-insurance program (if any), together with information on the claim and loss experience thereunder.6. Any of the following documents filed by the Company or affiliates of the Company and which contain information concerning the Company: annual reports
9 Objectives of legal due diligence Identify the correct value of a business transactionVerifying the size of known liabilitiesChecking any unforeseen liabilitiesUnderstand the financial and accounting position of the target companyIntellectual property rights of target company need to be identified, ownership needs verification, and validity has to be established.Ownership of domain name is to be checkedto check the person from whom shares are to be bought is the rightful owner of sharesInspecting documents relating to allotment and issue and transfer of shares, the approval of transfers at board meetings and registration of various transfer documents.Former shareholders have returned certificates and new shareholders have valid certificates.Verifying shares that are to be sold are not subject to any charges or encumbrances.
10 Objectives of legal due diligence Verify title to any freehold or lease hold property of target company and any other major assetsWhether there are charges or any other encumbrances over property or assetsCheck if consents and releases are requiredAny licence, permission ,regulatory approval is required to lawfully conduct business of target companyDisclosure letter can be a source of information , word with other advisers such as financial advisersPublic information –general public records, internet due diligence, search of land registry , registry of trademarks , designs, patents, Registry records of ROC, etc
11 Objectives of legal due diligence Check List of any export, import or customs permits or authorizations, certificates, registrations, concessions, exemptions, etc., that are required in order for the Company to conduct its business and copies of all approvals, etc. granted to the Company that are currently in effect or pending renewal.Check any correspondence with or complaints from third parties relating to the marketing, sales or promotion practices of the Company.
12 How legal due diligence may help? Compliance with local lawsSecurities or other regulatory violations or disciplinary actionsExtensive litigation and/or bankruptcies – assessment of feasibility of pursuing litigationFinancial statementsUnpaid tax liens and/or judgementsPast business failures and related debtFraudulent or exaggerated credentialsMisrepresentations or character issuesDiscoveries and disclosures
13 Importance of legal due diligence Assets – real and intellectual property, brand valueReputation and goodwillCross-border issues – double taxation, foreign exchange fluctuation, sovereign risk, investment climate, cultural impact on HRCultural Due Diligence: An important aspect of LDDs in cross-border transactions is cross-cultural study, which is not typically covered, especially in India. The compatibility and adaptability of corporate cultures and ethics between the acquirer and the target company must be analysed.
14 Legal risk managementsome aspects enabling effective legal risk management arising out of the LDD are:Information procured from target company’s personnelRepresentations and warranties – also covering conditions precedent and conditions subsequentA merge of financial analysis of target company with legal risk analysis
15 LDD and legal documentation One of the most important aspects in the LDD is the transactional documentation under inter-corporate transactions, in other words, contracts.Contract value and impact – lock-in periods and other restrictive clausesStatutory and regulatory compliances and consentsRestrictions of any formNon-compete, non-solicitation and confidentialityIntellectual propertyHuman resourceThe cut off date and closure date
16 Environmental legal due diligence A list of facilities or other properties currently or formerly owned, leased, or operated by the Company and its predecessors, if any.Reports of environmental audits or site assessments in the possession of the Company, including any Phase I or Phase II assessments or asbestos surveys, relating to any such facilities or properties.Copies of any inspection reports prepared by any governmental agency or insurance carrier in connection with environmental or workplace safety and health regulations relating to any such facilities or properties.Copies of all environmental and workplace safety and health notices of violations, complaints, consent decrees, and other documents indicating noncompliance with environmental or workplace safety and health laws or regulations, received by the Company from local, state, or federal governmental authorities. If available, include documentation indicating how such situations were resolved.Copies of any private party complaints, claims, lawsuits or other documents relating to potential environmental liability of the Company to private parties.Listing of underground storage tanks currently or previously present at the properties and facilities listed in response to Item 1 above, copies of permits, licenses or registrations relating to such tanks, and documentation of underground storage tank removals and any associated remediation work.
17 Patent due diligenceList of Indian and foreign patents, including, for each patent: a. country b. grant number c. grant date d. expiration date e. publication number f. publication date g. inventors h. title i. number and date of Indian patent to which the foreign patent is a counterpart j. dates on which annuities were paid, identity of parties paying annuities k. name and address of foreign agent responsible for maintenance of the patent.
18 Patent due diligence2. List of foreign patent applications, including for each application: a. national patent office in which pending b. filing date in that office c. priority date d. application number e. number of European Patent Office application or Patent Cooperation Treaty application giving rise to the application inventors f. title Patent Rights As Between the Company and Its Employees1. List of agreements between the Company and any of its employees conveying patent rights to the Company.2. Invention development memoranda (which recites details about patentable inventory for review by the Company's patent lawyer and which could tell about areas the Company has chosen not to patent).3. The Company's written policy on patenting inventions, if any.4. List of key employees/inventors and employment and other agreements with same.
19 Trademark due diligence Company's Files1. Review of trademark/service mark/domain name files: a. Indian and foreign registration, application and assignment files, including prosecution histories b. Licenses and Registered User Agreements and license files, including quality control files c. Rejected applications d. Protest letters (sent and received) e. Litigation files (e.g., past infringements, disputes, demands or language in court orders may impact future litigation) f. Settlement agreements, administrative or judicial decisions affecting ownership or validity of the marks (e.g., may restrict expansion of mark geographically or to other goods) g. Trademark search report files on current marks h. Concurrent use agreements.
20 Trademark due diligence 2. Computer printout of trademark record maintenance of the Company, including maintenance and status report on all registrations, pending applications, licenses Registered User Agreements, assignments, etc.3. Advertising, brochures, packaging and other materials which may disclose, inter alia: a. Style and secondary marks that are protectable or which may infringe third party uses b. Slogans that are protectable or which may infringe third party uses c. Misuse of marks (e.g., use as generic terms; misuse of ® or failure to use ®) d. Protectable or infringing trade dress.4. Sample products a. For proper trademark markings b. To consider possible protection of configuration.5. List of trade/domain name registrations
21 Copyright due diligence Registrations and Ownership1. List of all Indian Copyright Registrations owned by the Company for relevant subject matter, including: a. Registration Number b. Registration Date c. Title as listed in Registration d. Publication Date e. Creation Date f. Author (if anonymous work, list each employee who prepared any portion of the work) g. Subject matter covered h. Description of deposit filed in support of the registration i. Name and current address of each person who participated in creation of the subject matter from whom a written assignment has been obtained j. Name and current address of each person who participated in creation of the subject matter from whom a written assignment has not been obtained k. Identification of circumstances which would support the subject matter, or any particle thereof, being considered a work made for hire.
22 Copyright due diligence Copyright registrations and files listed above for each registration.3. List of all relevant non-Registered works (which are nevertheless protected via copyright) which have ever been offered for license, use or sale by the Company, including: a. Name and version of work b. Release date c. List of previous versions and their release dates d. Creation Date e. Name and current address of each person who participated in creation of the work from whom a written assignment has been obtained. f. Name and current address of each person who participated in creation of the work from whom a written assignment has not been obtained.Licenses1. For each work owned or used by the Company, a list of all underlying licenses which convey rights in copyright to the Company, including: a. name and address of licensor b. date c. work licensed2. For each work owned by the Company, a list of licenses conveying rights in copyright to a third party, including: a. name and address of licensee b. date c. work licensed3. Each license listed in items numbered 1 and 2 above.
23 IP -legal due diligence Infringement Claims1. Demand letters that the Company has sent regarding third party infringement of the Company's trademarks, patent rights or copyrights.2. Demand letters that the Company has received regarding infringement of third party rights or copyrights.3. Files for any litigation that has occurred involving the trademarks, patent rights and copyrights.4. Consent orders regarding infringement litigation.5. List of all patent clearance searches that have been conducted relating to the technology.
24 Meaning of ‘Acquisition’ An acquisition may be defined as an act of acquiring effective control by one company over assets or management of another company through purchase of shares without any combination of companies. Thus, in an acquisition two or more companies may remain independent, separate legal entities, but there may be a change in control of the companies
25 Acquisition vs Takeover When an acquisition is 'forced' or 'unwilling', it is called a takeover. In an unwilling acquisition, the management of 'target' company would oppose a move of being taken over. But, when managements of acquiring and target companies mutually and willingly agree for the takeover, it is called acquisition or friendly takeover.Takeover-A person or group of persons ( acquirer ) acquiring shares or acquiring voting rights or both of a company ( target company) from its shareholders, either through private negotiations with shareholders or through public offer in the open market with the object of gaining control over its managementWhile in the Companies Act (Section 372), a company's investment in the shares of another company in excess of 10 percent of the subscribed capital can result in takeovers. An acquisition or takeover does not necessarily entail full legal control.
26 Laws governing acquisition of a company An acquisition of shares of a listed target company is governed interalia, by Companies Act , by SEBI, and Takeover codeFor acquisition of shares of unlisted or private company , the governing law is contained in Section 108 of the Companies Act, 1956 –transfer of shares takes place on mutual agreement of parties.
27 Laws governing acquisition of a company If acquisition results in a combination , then provisions of Competition Act 2002 are also applicable and approval of CCI is required. ,if acquisition requires inflow or outflow of money to ore from India FEMA is also, RBI permission may be required.Listing agreement- Section40 A and 40 B-Disclosure for particulars by shareholder to the target company once threshold limit 5% is crossed and mandatory public offer for acquisition of minimum percentage when threshold limit of ten percent was crossed.-SEBI Regulations 1994Takeover code-automatic /specific exemptions
28 Negotiation between parties and drafting an MOU for acquisition Set up a foundational understanding-binding/non-bindingRepresentations and warranties-ownership of assets-tangible and non tangible-IP assets includedFinancial status of the company –liabilities/debts-both accrued/continentRegulatory approvals for conduct of business by target company to be in placestaff/employees retained
29 Negotiation between parties and drafting an MOU for acquisition Undertaking to sell agreed percentage of shares –free and clear of encumbrancesAmount of considerationDirector is to continue to be part of management of target company –lockin minimum term, salary,etcFirst right to purchase remaining sharesSteps to be taken after execution of this agreementCosts for drafting formal agreementsNon compete clause-territory ,time, activityConfidential and proprietary rights-in perpetuityNon solicitation
30 Negotiation between parties and drafting an MOU for acquisition Incase of breach of provisions- reserve right to equitable remedies-specific performance or injunctive reliefSeverability clauseAssignment clauseShareholder approvals and other corporate approvalsAgreement binding subject to bonafide due diligence by both partiesAmendmentsWaiverSupersedes previous understanding with target companyBest efforts clause
31 Negotiation between parties and drafting an MOU for acquisition Governing law of agreementForum for dispute resolutionConstruction and interpretationHeadingsService of Notices-mode of service, address for service.Signature by authorized representatives and witnessesSchedules to MOU-IP rights and assetsVerified financial documents of the company certified by auditorsLiabilities of the companyStaff ParticularsTransitional services by directorsFinancial and other limits of authority of director ( transitional services)
32 Thank You! SETH ASSOCIATES New Delhi Law Office: ADVOCATES AND LEGAL CONSULTANTSNew Delhi Law Office:C-1/16, Daryaganj, New Delhi , IndiaTel:+91 (11) ,Corporate Law Office:B-10, Sector 40, NOIDA , N.C.R ,IndiaTel: +91 (120) ,Fax: +91 (120)