elementary meaning of due diligence is reasonable care taken by a person to avoid harm to other people and their property.
Interestingly the term, “due diligence” is not defined in any Indian law. To put it very simply, due diligence is a process of thorough and objective examination that is undertaken before any corporate entity(ies) enter into major transactions such as mergers and acquisitions, raising of money from the public and others. It is a process of “checking” and “making sure” that all compliances as regards the prevalent Indian laws and as applicable to the particular company is in place and in order. Perhaps in India the most elaborate laws as regards “due diligence” can be found in the SEBI Issue of Capital and Disclosure Requirements Regulations 2009. Also depending on the nature of the transaction and the needs of the client, due diligence can be of many types including commercial, financial, environmental and others.
Due diligence is an exercise of ascertaining the possible risks that can be associated with an entity. This exercise is undertaken by both the person interested in investing in an entity (investor due diligence) or by the target entity itself (vendor due diligence). On completion of the due diligence exercise, each party discuss the issues involved after review of the documents provided by the target entity in order and try to incoporate findings of the same in the transaction documents. A due diligence exercise is accompanied by a due diligence report, which is prepared based on the requirement of the client. This report sometimes just highlights the issues involved and sometimes also includes summary of the documents reviewed alongwith the issues arising out of such documents. Please note, all that the investor is lloking to understand is in the event he acquires any kind of interest in the target entity, what would be the risks that he would be taking and how these risks can be mitigated.
Please note, the due diligence exercise involves much more activities than what I have listed above. However, this nutshell view might be of help.
‘Due diligence’ refers to the standard of care and determination; a reasonable person will have to apply before making a decision or a judgment. This term is widely used in business transactions in which either party to the transaction investigates and enquires about the transaction so as to avoid any future risk or harm. The most common example for the application of due diligence is the investigation or an audit of the potential investment i.e. before making an investment in any company, the investor will have to ascertain the health of the target company by looking at its assets and liabilities in the short, medium and long term. This process is carried out by analyzing the financial information to spot any misappropriation or governance issues.
In fact, the concept of ‘due diligence’ is not an Indian origin and is nowhere defined in the Indian law. This term was first used in the United States’ securities Act 1933 in which due diligence is one of the defenses available to the business brokers for the non disclosure of material information related to the purchase of securities as long as exercised ‘due diligence’ in their investigation into the company by virtue of section 11 of the aforementioned Act. This concept was brought into the Indian scenario by the foreign investors during the post liberalization period 1991. Later, this term was reflected by SEBI in which SEBI mandates certain parties to undertake a due diligence in the context of issuance of securities by a company.
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