Due diligence report 20150414

Business Law Professor Florencio TRAVIESO

Charles GUERIN / Estelle BOISSART / Garance COUVRY

Pauine PROT / Rebeka KRSKOVA / Woojin KIM

Class 13 / Year 2014-15

Due Diligence in International Transactions

To what extent can economic crisises impact on due diligence?

Business Law Professor Florencio TRAVIESO

Charles GUERIN / Estelle BOISSART / Garance COUVRY

Pauine PROT / Rebeka KRSKOVA / Woojin KIM

Class 13 / Year 2014-15

Table of Contents

CH 1: WHAT IS DUE DILIGENCE? 1 ETYMOLOGY 1 FUNCTIONAL TYPES AND PURPOSES 2 DUE DILIGENCE FRAMEWORK 4 IMPORTANCE OF DUE DILIGENCE 6 DUE DILIGENCE CHECKLIST 8

CH 2: DUE DILIGENCE UNDER LAW 12 UNDER TAX LAW AND ACCOUNTING REGULATIONS 12 UNDER INTELLECTUAL PROPERTY LAW 12 UNDER ENVIRONMENTAL LAW 13 UNDER EMPLOYMENT LAW 15

CH 3: DUE DILIGENCE AND CURRENT EVENTS 19 DUE DILIGENCE POST 9/11 & ENRON 21

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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.1

Throughout our report, we will analyse due diligence in many aspects and will finally draw a

conclusion to our research question: “To what extent can economic crises impact on due

diligence?”

Etymology

« Due diligence » are reasonable steps taken by a person to avoid committing a tort or offence.

More this is an investigation or audit of a potential investment. It permits to confirm all the

material facts regarding an investment situation.

Before that, the first time that the combination of the two words was used, it was in a poem by

Richard Carew, called "A Herring's Tale." In this poem he said that monarchs had their commands

obeyed “with due diligence”.2

After that, the term due diligence was used in the United States of America at a time of a Great

depression. It came more precisely from the « securities act of 1933 ». The securities act of

1933 are primarily intended to restrict the sale, but they contain an act concerning the defense (at

1 http://whatis.techtarget.com/definition/due-diligence 2 http://www.evs-translations.com/blog-com/tag/due-diligence-word-etymology/

Chapter 1 What is Due Diligence?

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section 11) called "due diligence" to describe a legal defense when information is disclosed

improperly. This term is generally used by brokers-dealers when accused of inadequate disclosure

to investors. When broker-dealers used « due diligence » in their investigation into the company

which selling equities, they will not be held guilty of non-disclosure of elements in the

investigation.

This term is now introduced into the legal vocabulary of different nations, and became an

important concept to investigate in a potential investment, more precisely for the risk analysis of a

future investment.3

Functional Types and Purposes

Due diligence is about trusting and having confidence in your business partner.

Many companies undertake the due diligence process with insufficient vigor, to maximize due

diligence efficiency and reliability it is easier not to work on a global and general area.

Since it is a complex process differing from case to case we will have a look at different types of

due diligence.

In order to identify issues, to establish the true value or cost of a business, and to evaluate if

this one is beneficial or not we divide due diligence into three main categories: legal, financial,

and commercial. We will call them the three types of diligence. This division facilitates the work

on due diligence issues since each case will be about another point, meaning that each firm will

choose on which part it want to study.

The firm will prefer the legal type if it is concerning laws issues, questions about possibilities

and obligations. Whereas financial analysis is necessary while evaluating the profit or loss of the

business and more generally costs and earnings. Finally, commercial type of due diligence takes

into account the whole market and not only our business, it analyses the competition environment.

3 http://www.oxforddictionaries.com/definition/english/due-diligence

Legal Financial Commercial

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Legal

When speaking about the legal part of a due diligence we consider all the legal basis of

transactions. We take here into account the legal structure, contracts, loans, properties,

employment, pending litigations and put these elements into its legal context. Most of the time the

question is “Can the target business hold with this or can it exercise it?”. We look at the legal

environment of the firm, if it has a lot of restrictions or if it is a “free field”. Thanks to the answer

the firm can evaluate if it should or rather not enter the business.

Financial

Financial due diligence focuses more on the verification and stability of financial information. It

assesses the underlying performance of a target business. For the financial evaluation we consider

firm’s earnings, assets, liabilities, cash flows, debts and management.

The most common method is to do accounting and financial audits, to do some simulations and

see if the firm is able to handle it.

Financial audits can very easily determine whether the firm will succeed its objectives and even

more, it will show imperfections needing to be improved to do so.4

Commercial

This evaluation is a macro-environmental one. We do not evaluate a special firm or target

business but the entire market owning it.

We focus on competitors, analyze the business plan in a global context, aiming to sate

afterwards if the business matches with reality or if it is unachievable.5

Purpose

Due diligence takes different forms depending on its purpose:

4 http://www.icaew.com/en/members/business-resources/business-management-and-strategy/m-and-a/types-of-due-diligence 5 http://www.referenceforbusiness.com/small/Di-Eq/Due-Diligence.html#ixzz3XCi6EDqw

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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

Due Diligence Framework

1. Knowing what you “need” to know

First of all a company needs to be aware of the type of due diligence to a particular transaction.

Each type of transaction has a specific due diligence checklist. That’s why a company should know

what they have to do check before beginning the due diligence.

Another important factor is time: in a transaction there is always a period to provide a potential

expertise or a potential audit of the company, which is about to be sold. It may vary according to

countries.

To perform a good due diligence, the best way is to be well focused and efficiently allocated.

The work on the due diligence has to be irreproachable, so that the company that wants to invest

should take care about the checklist and to act smartly.

We should be familiar with the type of due diligence and have experience with this type in order

to understand what kind of information need a company to understand the process of the due

diligence and to know what they have to look at.

The information that a company should require is really useful to understand the goal and set

new goals for the future and to reach it.

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2. Assembling the due diligence team

The due diligence team is really important in a transaction; they have a important role because

the team have to implement a new strategy and to satisfy their bosses. They also have to analyze

what kind of target they will choose and to interact with them. This is an opportunity to create a

more positive relationship.

Industry knowledge, experience carrying out due diligence investigations, and an awareness of

roles, responsibilities and deadlines for the due diligence work are all important factors to consider

when choosing the due diligence team members.

The due diligence team has to look for information in a matter sensitive to the particular

transaction: certain employees of company may not know that assets are being sold; these

employees might react negatively to the transaction (Company A has been counting with company

B). If the employees find out in the preliminary stages of A and B’s deal, this could frustrate the

continuations of due diligence process and jeopardize the deal.

3. Preparing the “target” for the diligence event

We need to decide with the “target” what date is needed for assessment, how it will be

collected and for what purposes, who will have access to it, and where it will be stored.

Then, denoting these specifications at the outset helps the due diligence process runs smoothly.

4. Managing interactions between firms

The “Target” focused due diligence and transaction focused due diligence. Investigations occur

at very sensitive periods and often involve sensitive and confidential information.

The deal may not occur, that’s why a need to balance sharing proprietary information and the

knowledge is required in most of cases.

This is really important to clearly define of roles and responsibilities of staff, actions for each

stage of the process and information upload for a data room.

They must have clear understanding of the management process of the data room and must have

clear plan in place to manage the release of information in stages of required knowledge and

advancing stages of negotiation.

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5. Using the collected information to create value in both firms

Information gleaned from the due diligence investigation can be valuable to both parties the

information and issues found can be addressed prior to a deal, and/or included and indemnified in

the closing agreements.

Due diligence can lead to less reliance on Representations and warranties and a clearer idea of:

1) The general state of the business

2) The way the business has been run in the past

3) Whether the business has been operated according to industry standards or in a unique

fashion because of certain factors, rights or assets that the purchaser may or may not acquire.

4) Actual and contingent liabilities;

5) Third - party interests.

Sometimes due diligence searches can turn up unanticipated information which indicate that the

transaction should not go through for a balance of reasons, walking away from a bad deal before

sharing confidential information is a luxury for businesses which have created a comprehensive due

diligence framework that shares sensitive information as it is needed for the due diligence

investigation.

Importance of Due Diligence

In a globalized world, international transactions are more than ever at the forefront. This

directly impacts the due diligence process, as it can differ drastically when doing domestic business

or international business. International transactions impact due diligence in two ways: it makes it

even more important and at the same time it makes it even more complex. Due diligence is the

process by which the person who conducts it can obtain valuable information. This information is a

critical component of the transaction process.6

6 http://www.protiviti.com/en-US/Documents/POV/POV-Due-Diligence-Protiviti.pdf

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When doing business internationally, such as mergers and acquisitions or FDI, the investor needs

to gather as much pertinent information as possible about the target assets and about the

implications of doing business in the possible host country. But, due diligence in international

transactions may be a particularly difficult exercise because of the scarcity of information and

difficulty in processing it. And as the main objective of due diligence is to identify, reduce and

quantify uncertainty and risks, due diligence in an international transaction has to, no matter

what, be held thoroughly.7

This information gathered will help the investor, partner or buyer, to make a choice of entering

in the transactions or not. It will also provide the person with great insights of the target company

and the potential issues and terms that have to be negotiated before closing the deal. We may say

that conduct due diligence in the most effective and efficient way is really important in many

ways. Indeed, to put it simply, it reduces the risk of losing money, an issue stressed with the

economic crisis. Due diligence, more than avoiding to become poorer, can also makes you richer.

Due diligence permits to gain information that will be useful for valuing assets, defining

representations and warranties, and negotiating price concessions.

It also permit to limit the risk of being suited, because if the target is engaging in illegal

activities it might causes you problem when doing business with it. But thorough due diligence is

also a moral imperative that permit the investor to avoid any remorse.8

Also, it can be appealing for an investor to base its choices on personal or general perceptions

and assumptions of what is the host country. We believe that the credo ‘trust your instincts” does

not suit at all when doing international transactions. This is why we need due diligence, to confirm

that the business is really what it appears to be9 and to be aware of all the hidden aspects of the

host country.

Eventually, the best approach to international due diligence can be summed up by the sentence

“never assume anything”.

Also due diligence is undeniably necessary, it can be tricky and vicious. Effectively what is due

and what is diligent can vary amongst people. In addition, the due diligence process in contextually

7 http://www.fasken.com/en/home/ 8 http://exitpromise.com/due-diligence-process-when-acquiring-a-business/ 9 http://www.astutediligence.com/diligence_basics.htm#why

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dependent. Indeed, it differs from one situation to another, even if we can find some similitudes

between the due diligence processes, there is no formal rules or standards that can be applied to

all the situations where due diligence is needed.

To finish, we must say that due diligence is important but it is not magical. What we mean is

that even a perfectly conducted due diligence cannot guarantee that the transaction will be

successful. It only increases your chances of success and decreases your risks of failures.

Also, even if the transaction turns out to be unsuccessful or if it unfortunately results in legal

proceedings, having conducted a good due diligence upstream could represent a great help.

Effectively, a thorough due diligence, where the person took all the reasonable care in analyzing

the transaction and prevent what at the end actually occurred, is a defense argument. It shows

that the offence happened by accident and not by choice or negligence, because all the necessary

precautions were taken to avoid it.10

Due Diligence Checklist

The due diligence checklist is an efficient way for assessing the value of a business and the

potential risks in a sale or investment situation. The checklist therefore enables to thoroughly

investigate the different factors of a business. The checklist process usually takes place after the

two parties have agreed to make a deal, but before officially signing a contract. The checklist is

divided in several parts which facilitates the process of due diligence. The checklist usually

includes:

Organization and Good Standing

This section usually gathers corporate records and documents about the organization. This includes

the company’s articles of Incorporation, and all amendments thereto, the company’s bylaws, and

all amendments thereto, the company’s organizational chart and information about shareholders

and their ownership on shares. All agreements (warrants, voting trusts etc..), all the places where

10 http://www.allens.com.au/pubs/env/envmay01.htm

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the company does business or owns/leases property, a certificate of Good Standing from the

Secretary of state where the company is incorporated and copies of active status reports.

Financial Information

The financial information refers to all the financial data which is related to the company.

Usually, there is a lot of information given that not only it involves an analysis of all financial

statements (usually for three years) but also other documents such as auditor’s letters or

descriptions of the company’s internal control procedures.

Physical Assets

The physical assets include a schedule of fixed assets and the locations thereof. and a schedule

of sales and purchases of major capital equipment (during last three years).

Real Estate

This part focuses on a schedule and copies of all real estate leases, deeds, mortgages, title

policies, surveys, zoning approvals, variances or use permits.

Intellectual property

To check intellectual property, it is necessary to look at patents, trademarks, copyrights,

descriptions of important technical know-how and all the agreements which are linked to them.

Employees and Employee Benefits

This section includes all information about employees to ensure that they work in an ethical,

legal and appropriate environment. For instance, descriptions of employee problems and issues,

labour disputes and health benefits are checked. Their current salaries, positions and bonuses are

also part of the section.

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Licenses and Permits

This checkpoint involves copies of any governmental licenses, permits or consents and any

documents relating to any proceedings of any regulatory agency.

Environmental Issues

To analyze the environmental status of the company, all the information about the way the

company handles environmental issues are examined as well as whether it manages such the issues

in a legal way (permits, licenses).

Taxes

The taxes are usually analyzed through income tax returns, audit and revenue agency reports,

tax settlement documents and employment tax filings (for the last three years).

Material Contracts

All the contracts which relate to subsidiary, partnership, or joint venture relationships and

obligations are focused on. These types of contracts also involve loan, security, distribution options

and stock purchase agreements as well as all the other possible material contracts.

Customer information

The customer information refers to all the data about customers, such as a schedule of the

company's twelve largest customers in terms of sales thereto and a description of sales thereto

over a period of two years. This section also collects information about purchasing and credit

policies as well as materials in the marketing department.

Litigation

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Litigation includes a schedule of all pending and threatened litigation and unsatisfied judgments.

Insurance Coverage

This checkpoint takes into account a schedule and copies of the company's general liability,

personal and real property, product liability, errors and omissions, key-man, directors and officers,

worker's compensation, and other insurance.

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Under Tax Law and Accounting Regulations

A century after it gained its power to tax corporate income, Congress is still finding new ways to

do it – and affecting M&A due diligence in the process. Buyers, sellers, and their advisors invariably

consult the Internal Revenue Code (Title 26 of the U.S. Code) when structuring their transactions.

They know that it is important to ensure compliance with tax code sooner rather that later. During

the due diligence stage, buyers ad sellers an benefit from understanding the tax and accounting

aspects of transaction structure.

After all, the aim of due diligence is to reduce post-merger exposure to insolvency or liability –

an knowing tax law and accounting regulations can help in this regard.

Under Intellectual Property Law

Intellectual Property (IP) due diligence is an audit to evaluate the quantity and the quality of

intellectual property assets owned by, or licensed to, a company, business or individual. In

addition, an assessment of how IP is acquired and protected by the concerned company is also

necessary. In terms of process, it involves gathering information on the value and the risks of a

company’s intangible assets.11

There are two main ways IP due diligence can be carried out. The first one consists of a

prospective purchaser in relation to the IP assets of the target company. IP due diligence can also

be done by a company on its own IP assets in order to prepare for a transaction. The first step to

conduct IP due diligence is to identify IP assets in order to understand whether they are relevant

for the company. The second step implies verification of IP ownership: this is an assessment of the

intangible is made based on whether it is owned by the company, which enables to identify

ownership problems as well as what solutions exist. Then, the process looks at restrictions on IP

11 http://www.taylorwessing.com/synapse/ip_duediligence.html

Chapter 2 Due Diligence under Laws

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asset use, which relates to freedom to operate and how the value can be assessed. The fourth step

is to establish the validity and strength of IP rights. Finally, IP infringements in order to avoid

developing conflicts between parties.12

The main consideration while looking at due diligence in terms of IP is materiality. This concept

can be used to fasten the process of due diligence instead of making it a never-ending one. This

occurs when there is an agreement on a specific definition of the IP rights that are material to the

business. In other words, this enables to save time and costs. Materiality can be assessed through

turnover or profits relating to the IP rights.

To sum up, IP due diligence is a key process which contributes to the process of developing an IP

strategy, although it is just is a precondition for any capital investment.

Under Environmental Law

Nowadays, we witness an increased concern for the environmental issues, what might be due to

an increased awareness of the urgent need for sustainable development, even despite the

economic crisis and its consequences. This environmental concern is seen in people’s daily life with

individual actions, as well as in politics and business. Effectively, researchers and scientists are

formal: we need to change our habits, if no the impacts could be even more dramatic and will be

irreversible. What is highly recommended by the environment professional is a drastic reduction of

CO2 emissions as well as a need for clean and sustainable sources of energy (hydraulic, solar,

wind). But all of these recommendations require an international cooperation between countries,

countries and industries, and industries and individuals. That is why we assist to the emergence of

new and diverse regulations, conventions, treaties, laws concerning the environment and its

protection. These new legal tools to protect the environment can be introduced by international

authority or NGOS or can also be directly ones included in national laws. Actually, since 1972 and

the Stockholm Conference on the environment, international environment law is a separate area of

12 https://www.iprhelpdesk.eu/sites/default/files/newsdocuments/IP_due_diligence_0.pdf

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public international law. The main institutions that deal with these environmental issues are: the

United Nations Environment Program, the OECD, the European Union and the council of Europe.13

The international environment law is interdisciplinary, meaning that it is crossed with numerous

areas such as politics, research, and economics… Furthermore, the international environment law

concerns various topics: climate change, sustainable development, biodiversity, trans frontier

pollution, marine pollution, endangered species, desertification, hazardous materials and

activities, and use of the seas.14

The main international treaties, dealing with the environmental protection, are: the UN

convention on the Human environment in 1972 (note: considered for the first time environmental

protection as an international matter), the United nations conference on Environment and

Development in 1992 in Rio (note: aimed to define the means for a sustainable development), the

Kyoto protocol in 1997 (note: it commits state parties to reduce greenhouse gases emissions, based

on the facts that global warming exists and that it is due to man-made CO2 emissions), and in 2002

the World Earth Summit (note: focused on different challenge such as improving people’s life and

the protection of the natural resources, but absence of the USA)15

As for the due diligence process, it is not exempt from integrating the environmental issues.

Effectively, while conducting the due diligence, the investor should look at the environmental

concerns arising from the analysis of the transaction. The reasonable care concerning the

environment, care that is evidently present all along the process and no matter the issues, is called

the environmental due diligence (EDD). The EDD allows opportunities and constraints, linked to the

environment, to be identified.16

Also it is important to bear in mind that it is better and beneficial for companies to accept and

implement this by their own, rather than having the burden imposed externally after through fines

or even legal proceedings.17

The main focus of the EDD is to determine if the present or past operations of the target

company are responsible for pollution damages that can represent a potential economic risk (risk of

having extra costs due to the need for corrective measures, for example costs for depolluting some

13 https://www.law.georgetown.edu/library/research/guides/InternationalEnvironmentalLaw.cfm 14 http://www.asil.org/sites/default/files/ERG_ENVIROMENT.pdf 15 https://www.law.cornell.edu/wex/international_environmental_law 16 http://www.ecoagir.fr/audit-environnement/due-diligence-environnement/due-diligence-environnement.html 17 http://www.allens.com.au/pubs/env/envmay01.htm

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zones), as well as a legal risk if the damages caused are contradictory to the requirements in the

sector.18

As we saw earlier (cf: importance of due diligence), well conducted due diligence can represent

a defense argument if things don’t happen according to the plan. So, EDD is a necessary exercise

that is performed to satisfy certain liability protections that may be available under federal and

state environmental laws.19

In the USA, due to expansive liability under environmental statutes, most notably CERCLA (note:

Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA)( note:

commonly known as Superfund, was enacted by Congress on December 11, 1980), a purchaser of

contaminated property can be held liable for all cleanup costs regardless of whether the purchaser

caused the contamination or knew it was present. Therefore, taking the appropriate steps to

understand what you are buying and with whom you are transacting is critical.

What we mean by appropriate steps is that, under federal law, investors can protect themselves

from liability under CERCLA thanks to the conduct of proper due diligence, as established by EPA

regulation and guidance (Proper due diligence is referred to by EPA as “all appropriate inquiries”)

If a purchase performs due diligence in accordance with AAI, it can qualify for liability

protection known as the “bona fide prospective purchaser defense” (BFPD).20

Under Employment Law

The Employment Due Diligence clarifies whether the employment-related documents have been

concluded and it has been established in the company. Moreover it allows company to see if there

is any employment contract from a foreign country. During the Due Diligence process we are

informed of any risks and discovery make by the due diligence team. After the study of this party

the company has gathered enough data in order to improve and to set new goals.

The due diligence team checked the employers, employees, supervisors, managers and

directors. They really take care about the work condition and health. Then, they take in account

18 http://www.ecoagir.fr/audit-environnement/due-diligence-environnement/due-diligence-environnement.html 19 http://www.environmental-law.net/key-practice-areas/environmental-due-diligence/ 20 http://www.ohioenvironmentallawblog.com/2013/06/articles/brownfields/buyer-beware-five-environmental-due-diligence-tips-for-purchasers/

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all act and regulation done in the country and inside the company because it may have some

bilateral contract between the top managers and the Trade Unions.21

The due diligence team begins with the employers:

-‐ Employers must have ensured health, safety and welfare at work of their employees

(section 15 of the ACT)

-‐ They look at the ability to the employers to communicate perfectly with his teams

and to provide them the information that they need in the right time.

-‐ The team assesses the ability to the employers to pick up the best supervisors. That

means they want to know if he is able to take the persons who has qualifications required to

apply for supervisors.

-‐ They clarify potential legal risks relating to conclusion of service agreements with

natural persons (service providers). What is the level of awareness of potential hazards?

Then, the supervisors have to responds to several criteria for a due diligence under employment

law. The due diligence team assesses the supervisors in the same way as they evaluate the

employers. Supervisors are under the employer; they should be able to act as the employer when

he is not present inside the factory.

We offer due diligence of employment contracts and civil law contracts. This activity has a

simple goal, assess the risk linked to employees and to defines new goals and clear objectives:

-‐ Individual employment contracts and civil law contracts concluded by the employer;

-‐ Internal regulations and collective labor agreements, social packages and agreements

concluded with trade unions and employee councils;

-‐ Working time and remuneration policies; we also advise on simplification and

standardization of employee remuneration policies;

-‐ Collective labor law relations.

The due diligence team verify the worth of performing obligations towards employees’

representatives, trade unions and employee councils. They have to analyze employment disputes

and to find out a way solve this problem by restructure the process. Of course the employers is

informed of any obligations resulting from this act and what would be the consequences.22

21 http://exitpromise.com/due-diligence-process-when-acquiring-a-business/ 22 http://www.pwc.pl/en/doradztwo-prawne/prowadzenie-prawno-pracowniczej-analizy-prawnej-due-diligence-dla-celow-transakcji.jhtml

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The due diligence team needs to assess 6 different steps. Each step has its own importance and

it brings a huge number of data not negligible for the potential buyer.

ANALYSIS OF AGREEMENTS CONCLUDED WITH EMPLOYEES

The evaluation of the compatibility of the company’s standard employment agreement and other

agreements concluded with employees with the law. The due diligence company relate the

importance of these measures according the needs of the company. Each contract and regulations

have to go in the same way with the company otherwise it is useless and time-consuming.

ANALYSIS OF EMPLOYMENT AGREEMENTS CONCLUDED WITH KEY

PERSONNEL

The evaluation of the compatibility of employment agreements concluded with key employees

with the law and the needs of the company. Sometimes key personnel have special agreement

between them and the employer.

RULES AND POLICIES OF THE COMPANY

The due diligence team take care about the clarification of all necessary policies regarding

working environment have been adopted in the company. The rules and the policy of the company

have to be the more convenient for every worker. It should have a good working condition and a

cohesion inside the company. Thus, the study of the rules and the policy is important to evaluate

this aspect.

REPRESENTATIVES OF EMPLOYEES AND THE EMPLOYER

The Checking of whether the requirements on electing employer’s representatives as well as

employees’ representatives have been duly met. How do they organize their own representative

election inside of the company? This question can reveal more than it seems because if there are

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no employees’ representatives it could mean that this is a kind of dictatorship and this is an

unclear situation.

EMPLOYER’S OBLIGATION TO INFORM AND CONSULT EMPLOYEES

In case of medium and large companies, the due diligence team will clarify whether the

procedures of informing and consulting employees established by law are being followed and

provide relevant instructions. A leader cannot impose his own rules without talking to his

employees. The evaluation of the procedures and the legitimacy of its rules and regulations are

quite important in order to don’t spend time in solving problems before working.

COLLECTIVE EMPLOYMENT RELATIONSHIPS

The analysis of the terms of the collective agreement should meet the requirements of the new

Employment Contract Act. Every agreement has to be written in a specific way and it has to

respond to standards imposed by the law of the host country.23

23 http://borenius.ee/en/our-services/services/fixed-fee-services/employment-due-diligence/

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Due Diligence Post 9/11 & Enron

After those crises, many people realised that it is high time to raise the bar on due diligence. In

addition to being extreme examples of terrorism and fraud, the World Trade Centre catastrophe,

Enron debacle and other recent major accounting scandals have hoisted bright red flags that should

drive corporate leaders to take a hard look at who they’re really doing business with.

The spectacular failure of Enron and the still unfolding scandal spawned by its collapse are

having a profound impact on the way lawyers and other professionals conduct “due diligence”

reviews in corporate transactions. Simply put, many areas that were previously ignored or

relegated to cursory review are now the subject of intense scrutiny. Accounting practices are at

the forefront of these recent developments, thus this article examines some of the pertinent

trends in this area. First, however, a brief explanation of the due diligence process itself.

In both merger and acquisition transactions and public securities offerings, a team of lawyers,

accountants and other professionals conducts what is commonly called a “due diligence”

investigation of the affected company or companies. In M&A transactions, both buyer and seller

typically conduct due diligence investigations on one another, though the investigations are usually

much more intensive on the seller. In the case of public securities offerings, the investment

bankers who underwrite the offering conduct due diligence on the proposed issuer. The purpose of

Chapter 3 Due Diligence and Current Events

9/11 Enron

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these due diligence investigations is two-fold: first, to ensure that the target of the investigation

does not have undisclosed problems or liabilities that could make proceeding with the transaction

unwise -- either at the proposed deal price or at any price; and second, in the case of securities

offerings, to obtain the benefits of the so-called “due diligence defense” to certain types of civil

liability for false or misleading information in the prospectus.

No area of the due diligence landscape has been more transformed by Enron than the accounting

area. Enron has resulted in significantly greater scrutiny of anything and everything that touches or

involves a company’s accounting practices. Prior to Enron, it was not uncommon for both

investment bankers and acquirors to accept a target company’s “numbers” pretty much at face

value, and to not go behind those numbers in any significant detail. Simply put, those days are

over, at least for the foreseeable future. Today, prudent participants in both M&A and offering

transactions are not just looking at the numbers, they’re looking behind them and questioning the

reasoning and judgment that underlie a company’s financial statements and the transactions they

reflect. Moreover, the Securities and Exchange Commission has issued a significant number of

accounting-related pronouncements in recent months -- many of them Enron-motivated -- that are

of key importance to public companies and those that aspire to be. As part of today’s due diligence

exercise, a company’s compliance with these new requirements must be carefully assessed.

Accounting issues that are “hot buttons” in today’s environment, and thus those areas that are

most likely to attract intense scrutiny during the due diligence process, include the following:

pro forma presentation of earnings, typically in quarterly press releases

disclosure of a company’s “critical accounting policies” in that portion of a prospectus or

periodic financial report required to set forth a textual discussion of the company’s

financial statements

the use of “special purpose entities” and other structured finance vehicles through which

the financial reporting of transactions is moved “outside” a company’s financial

statements

revenue recognition practices

so-called “earnings management” and the use of non-recurring restructuring charges to

reduce ordinary operating expenses

segment-based reporting and disclosure

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In addition to assessing the overall quality of the financial statements themselves, acquirers

and underwriters now more than ever look closely at the accounting and control infrastructure that

is in place within a company. Among the questions that will be asked are the following: Is the

accounting and control infrastructure sound? Are the outside auditors truly independent? Are there

avenues for discussion and disclosure to appropriate parties should accounting irregularities

surface? Is the audit committee fully engaged and functioning as it should?

At the end of the day, all those crisises have made due diligence checklist of today much

stricter than before.