Due Diligence in Merger and Acquisition

Jyotsna Chaturvedi Senior Associate

MAHESHWARI & CO. Advocates & Legal ConsultantsTelephone: 91-11-2610 1906Fax: 91-11-2617 1201E-mail: jyotsna@maheshwariandco.com

Due Diligence in context of M & ADue Diligence can be defined as the examination of a potential target focusing on material future matters for aiming to make an acquisition decision via the principles of valuation and shareholder value analysis and getting answers to key questions, including:

Do we buy ?

How much do we pay?

How do we structure the acquisition

Need for Due DiligenceThe standard puts the onus on the buyer to conduct a thorough investigation to ensure he is receiving the benefit of the bargain. due diligence satisfies the officers' and directors' fiduciary duty to make sure any decision made will maximize value for existing shareholders.

A due diligence audit is the equivalent of checking references before hiring. In general, a due diligence audit focuses on information outside of what is freely presented.

Advantages of Due DiligenceImprove/validate valuation processMaximise SynergyDevelop Additional Negotiating LeverageIdentify, Access and reduces risk

Diligence is about

Reasons of Failures

Contd. All these could be avoided by conducting proper due diligence what we also call 360-Degree Due Diligence (360 3D).

It is a process with 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.

360 3D

Steps of Due DiligenceCompiling of Due Diligence Checklist

Procuring Detailed Information/Documents as per the checklist

Analyzing of Information/Documents

Critically evaluating the analyzed information Preparing of a Report with suggestive actions

Compiling of Due Diligence ChecklistCompiling a due diligence checklist is a resourceful tool when undergoing a merger and acquisition. The checklist assists in covering all business components to ensure that a proper investigation is performed in order to prevent any delays or complications for the involved parties.

Categories

Corporate CompliancesComplete Group Structure and inter group transactions

Nature of Business of all with their status i.e. dormant or active

Last three years financials of all as submitted to ROC, SEBI and SE

Statutory Registers and Minutes Books

List of all loans (inter-corporate or otherwise), agreed limits, current outstanding and copies of all agreements and other governing documents and Government/RBI approvals, as applicable.

Corporate Contd.Particulars of any debentures, debenture stock, term loans or other financing arrangements and copies of all agreements and other governing documents.

Copies of all outstanding mortgages, charges, liens or similar arrangements, affecting the company or any of its assets, position of registration of charges with ROC

Property/LeasesTitle verification of purchased and leased properties.

Land use/ sanctioned plan compliances.

Utilities (electricity/water) compliances.

Examination of leases to ensure Companys interests is adequately protected with no hidden potential liabilities.

Proper stamping and registration of property documents

Municipal taxes and local tax compliances

Litigation, Investigation & ClaimsReview of all investigations, legal action, disciplinary proceedings (including pending or threatened) against the Company and its Directors since its incorporation, by governmental or other bodies or individuals or organizations.

Review of any order, judgment or decree of any Court, governmental or regulatory body to which the Company is associated or by which it is bound.

Review of dispute/proceedings, if any, pending before any quasi-judicial authorities.

Litigation Contd.Review of any current litigation/arbitration or other disputes in which the Company is presently involved or may become involved or any settlements entered into with respect to any litigation.

Intellectual Property RightsReview of all copyrights, trademarks, service marks, patents and other intellectual property (including all applications thereof) owned/licensed/assigned/registered and copies of all agreements and instruments relating to/involving the acquisitions, assignment, licensing, ownership and registration thereof.

Review of all non-disclosure agreements and/or confidentiality agreements executed by the Company.

Labour/HR CompliancesBusiness activities, office locations & hours of work for each office of the Company.

Details regarding outsourcing/contract labour:

Do the contractors / outsourcing agency pay wages, control and supervise their employees, grant leave, do performance appraisal, take disciplinary action and otherwise perform all the functions of an employer qua their employees?

Whether the Company is exempted from complying with any Labour Legislations.

HR Contd. Details of registration of the Company with various statutory authorities (if applicable) for e.g. - ESI, PF, and Miscellaneous Provisions Act, Industrial Employment Standing Orders Act, Shops & Establishment Act , Factories Act .

How is Provident Fund being paid to the employees employed by the Company? Details of companys contribution to Employees Provident Fund along with the rates and proof of upto date payment.

Details of Bonus etc. if any of the Company.

Environment Licences, permissions, authorizations and consents from environmental authorities

Details of any breach of any law, code

Details of any environmental management committee reports (if any)

Hazardous materials, spills, emissions etc. of the Company

CCI in M & AAll M & A with combined turnover of Rs 4,500 crore or more will require approval of CCI from June 1, with an objective to safeguard interests of consumers and promote industrial growth

Some major Failures Survey conducted by McKinsey and company shows that many parent companies often over estimate the value of target company due to lack of due diligence.

In 1998 the German auto car maker Damlier Benz merged with Chrysler Group for a value of $36 billion. It was perceived to be a merger between equal but after a few years, the value of Chrysler fell to a mere $7.4 billion and the merger had proved to be a failure The failure was attributed to inability to conduct due diligence It over estimated the value of the target company which led to the merger being unsuccessful.

How due diligence saved a company from big fraudA small Canadian exploration firm, Bre-X Minerals Ltd., announced that it had made one of the world's largest gold discoveries containing some 3-4% of the world's reserves which soared the value of Bre-X shares giving the company a market capitalization higher than that of several major mining companies.

Eventually, Bre-X proposed to form a partnership with Freeport-McMoRan, a U.S. company. Before making a firm commitment, Freeport insisted on carrying out due diligence.

Contd.The results shook the mining industry; Bre-X contained no significant gold After the scam was uncovered, the Bre-X share price crashed, and disgruntled shareholders (who lost about $3 billion) began taking legal action against the company.

Consensus of Minds!!!

MAHESHWARI & CO.Advocates & Legal Consultants**