Module 8
8. Due-Diligence
Understanding the importance of due-
diligence for M&A
transaction especially legal due-
diligence
Typical Deal Process in M&A (For details see “Mergers
and Acquisitions – A Primer” by Arjya B. Majumdar
• 1. Term Sheet / Heads of Terms
• Outlines key commercial terms — price, share type, governance, etc.
• Partially binding: confidentiality, exclusivity, dispute resolution.
• Sets the framework for due diligence and definitive agreements.
• 2. Due Diligence
• Investigation of financial, operational, and legal risks in the target.
• Legal basis: Buyer beware (Sale of Goods Act, 1930 – no implied warranties).
• Identifies risks → affects valuation & contract clauses.
• Leads to inclusion of conditions, representations, warranties, and indemnities to mitigate risks.
• 3. Definitive Documents
• Main transaction contracts:
• Investment: Share Subscription Agreement (SSA) + Shareholders Agreement (SHA)
• Acquisition: Share Purchase Agreement (SPA) (+ SHA)
• Merger: Scheme of Arrangement
• Capture commercial terms, risk allocation, post-deal obligations, and dispute resolution.
• 4. Completion / Closing
• Execution of the transaction: transfer of shares, payment, board changes, filings.
• Marks fulfilment of conditions precedent and finalization of legal obligations.
• Oxford Learner’s dictionary: a careful investigation of the state of a
business by a person or organization that is thinking of buying it or
investing in it.
• Corporate Finance Institute: Due diligence is a process of verification,
investigation, or audit of a potential deal or investment opportunity to
confirm all relevant facts and financial information and to verify
anything else that was brought up during an M&A deal or investment
process. Due diligence is completed before a deal closes to provide
the buyer with an assurance of what they’re getting.
Rationale
• Due diligence helps investors and companies understand the nature of a deal, the risks
involved, and whether the deal fits with their portfolio. Essentially, undergoing due
diligence is like doing “homework” on a potential deal and is essential to informed
investment decisions.
• There are several reasons why due diligence is conducted:
• To confirm and verify information that was brought up during the deal or investment
process
• To identify potential defects in the deal or investment opportunity and thus avoid a bad
business transaction
• To obtain information that would be useful in valuing the deal
• To make sure that the deal or investment opportunity complies with the investment or
deal criteria
• Due diligence is the backbone of M&A under Indian law. It protects
acquirers from future liabilities, supports negotiation fairness, and
ensures regulatory compliance. For international investors, Indian due
diligence bridges legal and commercial expectations.
• Diligence refers to prudence, vigilant activity, attentiveness, or care —
qualities that vary in degree from a momentary thought to the most
vigilant anxiety. As defined in People v. Hewitt, 78 Cal. App. 426, 248
P. 1021, 1024, it embodies the concept of acting with careful and
persistent effort.
• Due Diligence, on the other hand, represents such a measure of
prudence, activity, or assiduity as may reasonably be expected from,
and ordinarily exercised by, a prudent and reasonable person under
specific circumstances. It is not governed by an absolute standard but
depends upon the facts and context of each case (Perry v. Cedar Falls,
87 Iowa 315, 54 N.W. 225).
Legal Foundation of Due Diligence in
India
• Section 16, Sale of Goods Act, 1930 – No implied warranties of quality or
fitness.
• Shares are ‘goods’ under Section 2(7), so buyer assumes risk unless expressly
warranted.
• Since shares are considered “goods”, buyers assume inherent risks unless
protections (conditions, warranties, indemnities) are inserted into contracts
like the Share Subscription Agreement (SSA) or Share Purchase Agreement
(SPA)
• Legal due diligence thus identifies risks and forms the basis for warranties
and indemnities.
• Reflects the 'buyer beware' doctrine ensuring informed decision-making.
• The Companies Act, 2013 and SEBI have certain provisions in case of merger and acquisition transactions.
• Importantly, directors duties require that it shall be the duty of the director to prioritize the needs and goals
of the company.
• The US Supreme Court held the director in a case of Smith v. Van Gorkom, (2) legally liable to the
stakeholders for assuring premium of 39-62% for the proposal of merger which exceeds market price limit.
The court opined that the director should be cautious while conducting Board meetings for a prominent
corporate transaction, i.e., the sale of the company.
• Recently, in Nirma Industries and Anr. v. Securities and Exchange Board of India 6, the
Supreme Court, applying the aforementioned principle to investment acquisitions,
strictly interpreted Regulation 27 (d) of the SEBI (Substantial Acquisition of Shares and
Takeovers Regulations) 1997 and held that that due care and caution must be
exercised by the investor company in ensuring appropriate due diligence in respect of
the target company before investing. While doing so, the Court indicated that Nirma
Industries were aware of various litigations and therefore, could not plead ignorance of
the litigation and the dangers of the investment.
Background
• Due diligence is the process by which acquirers, investors, or merging entities
identify and assess risks in a target company before a transaction.
• Accounting perspective: Detects financial irregularities or inconsistent
transactions.
• Operational perspective: Examines inefficiencies or risks in processes and
systems.
• Legal perspective: Reviews compliance, statutory obligations, and contractual
liabilities.
• A risk is any factor that may cause a material adverse effect on the target
company—whether civil, criminal, regulatory, or contractual. Such risks can
lower valuation and must be mitigated or contractually addressed.
• Legal Due Diligence: Legal Due Diligence is used to ensure that there are no legal issues in buying a business or investing in
it. In this, the potential purchaser will review the important legal documents of the target firm such as employment
contracts, board meeting minutes, articles and memorandum of association and patents and copyrights or any other
property related documents compliance status of the applicable laws etc.
• Tax Due Diligence: This is aimed at ensuring that there are no past tax liabilities in the seller firm that might have
materialized due to mistakes or deception and could hold the acquirer liable for it.
• IP Due Diligence: IP due diligence is focused on establishing what rights the company may have in various intellectual
property and where it might rely on the intellectual property of another entity. Typical areas of interest are patent,
copyright and trademark filings; descriptions of the company’s IP protection processes; licensing agreements, IP
Assignment document, etc.
• Operational Due Diligence: Operational due diligence (ODD) is the process by which a potential purchaser reviews the
operational aspects of a target company during mergers and acquisitions. The ODD review looks at the main operations of
the target company and attempts to confirm (or not) that the business plan that has been provided is achievable with the
existing operational facilities plus the capital expenditure that is outlined in the business plan.
• Commercial Due Diligence: This aims at understanding the market the target business is operating in. This looks the
current market status and the forecast of the market growth in future and the target’s position in the market with relation
to its competitors. This also involves interaction with the significant customers of the business to understand their opinion
about the business.
• Information Technology (IT) Due Diligence: This aims at identifying if there are any IT issues in the target business. This
involves into matters such as scalability of systems, robustness of the processes, IT base and infrastructure, capacity of
server, the level of documentation of processes, compliance with the legislation and ability to integrate various systems.
• HR Due Diligence: This aims at understanding the impact of human capital on the proposed deal. This involves review of
number and type of manpower, skills, employment records, compensation schemes, HR processes, ongoing HR litigations,
effectiveness of the sales force and cultural factors.
Risk Identification & Categorization
• • Deal-breakers – critical risks that may abort the deal.
• • Mitigable risks – addressed via contractual mechanisms:
• - Conditions Precedent / Subsequent
• - Representations & Warranties
• - Indemnities
• - Escrow or Holdback structures
Practical Significance
• • Influences valuation and negotiation strategy.
• • Provides legal justification for post-deal claims.
• • Strengthens governance and transparency in transactions.
• • Essential for cross-border and high-value Indian M&A deals.
Broad Scope of Legal Due Diligence
• Covers a review of:
• Incorporation and governance documents
• Statutory and regulatory compliance
• Property titles and licenses
• Contracts and key agreements
• Ongoing or potential litigation
• Employment and HR records
• Corporate structure and statutory compliance (Companies Act, 2013)
• Contracts and material agreements
• Employment and labor issues
• Intellectual property rights
• Litigation and regulatory matters
• Environmental and property ownership aspects
Process of Conducting Due Diligence
in Mergers and Acquisitions
• Due diligence is a comprehensive exercise that requires specialized knowledge, expertise, and experience to be completed in a time-bound and
effective manner. It involves a detailed investigation and evaluation of all aspects of the target company to identify potential risks, liabilities,
and opportunities before finalizing a merger or acquisition. The process typically involves the following key steps:
• Constitution of the Due Diligence Team:
A multidisciplinary team is formed comprising experts from various domains such as legal, financial, taxation, technical, and operational fields.
The coordination among team members should be supervised by a senior-level officer to ensure smooth execution and integration of findings.
• Assignment of Responsibilities:
Each member of the due diligence team is assigned specific tasks based on their area of expertise. Clear allocation of roles helps in efficient
data collection, analysis, and reporting.
• Collection of Data and Information:
The due diligence process involves obtaining comprehensive information about the target company, including but not limited to:
• Corporate records – Incorporation documents, board resolutions, and company filings.
• Promoters’ and shareholders’ details – Ownership structure and shareholding patterns.
• Key contracts and agreements – Intellectual property, sales, purchase, and IT contracts.
• Compliance records – Statutory and regulatory compliance under applicable laws.
• Human resource (HR) records – Employee details, compensation structure, and benefits.
• Financial records – Audited financial statements, ERP data, and accounting policies.
• Litigation history – Ongoing and past legal cases or disputes.
• Insurance information – Coverage, claims, and liabilities.
• Analysis and Evaluation:
The collected information is carefully analyzed to assess the target
company’s financial health, operational efficiency, compliance status, and
market position. The acquirer evaluates the potential benefits of the
transaction in terms of market expansion, cost efficiencies, and competitive
advantage.
• Feasibility and Regulatory Compliance:
If the due diligence findings indicate that the proposal is viable and
beneficial, the acquiring entity proceeds with the necessary regulatory
approvals. This includes compliance with the Companies Act, 2013, SEBI
Regulations, RBI guidelines, FDI policies, and Competition laws, as
applicable.
Due diligence report
• The contents of a due diligence report should more or less include certain points which would draw the attention
• of the intending buyer, viz:
• Comments on the management and organisation,
• Details of key managerial/ technical personnel,
• Details of marketing efforts undertaken,
• Details of financial liabilities and commitments that the intending buyer would have to meet after deal and which
are not disclosed in the audited accounts,
• Deviations from the generally accepted accounting policies/ practices,
• Analysis of major expenditure/costs, details of major/critical customers and suppliers,
• Compliance of taxation and other statutory laws as well as status and impact of all litigation in this respect,
• Benefits enjoyed by the intending seller which the intending buyer may lose on takeover and vice versa,
• List of adjustments to the latest financial statements compiled on the basis of all findings, which have an impact
on the “price” of the target acquisition to be considered by the intending buyer.
• Number and type of litigations,
• Details of key assets and customers takeaways
Challenges in Conducting Due
Diligence
• 1. Limited Availability of Information:
One of the key challenges in due diligence is the lack of complete or reliable information. The acquiring party often depends on data
provided by the target company’s management, which may be selective, outdated, or incomplete. This lack of transparency can lead to
inconsistencies in assessment and may later result in disputes or financial losses once the transaction is completed.
• 2. Restricted Access to Information:
Even when information exists, gaining access to it can be difficult. The target company’s management may hesitate to share sensitive or
proprietary data before a deal is finalized, especially if confidentiality concerns or competitive risks are involved. This restricted access
limits the acquirer’s ability to fully evaluate the target’s operations, finances, and legal standing.
• 3. Time Constraints:
Due diligence is often conducted under tight deadlines, particularly when both parties are eager to close the deal quickly. Limited time
can prevent thorough examination of key aspects such as compliance, contracts, or potential liabilities. Additionally, obtaining
necessary consents or approvals from third parties—such as regulators, suppliers, or partners—can cause further delays and
uncertainty.
• 4. Contingent and Historical Liabilities:
Identifying and evaluating contingent or historical liabilities can be complex. Issues such as pending litigation, tax disputes, or
unrecorded debts may not be fully disclosed or easy to quantify. This uncertainty can hinder the ability of legal and financial advisors to
make accurate assessments and recommendations.
• 5. High Cost of Due Diligence:
Comprehensive due diligence requires the involvement of various experts—legal, financial, technical, and operational—whose
professional fees can accumulate quickly. These costs can become substantial, particularly in large or cross-border transactions. If the
