Importance of Conducting Legal Due Diligences in Business and Immovable Property Transactions

Acquisitions, purchases and investments are paths to the growth of an organization adopted in several fields. However, before an individual or a business organization considers partnering with another organization, considers buying out an organization or even considers buying immovable property, it is important that such individual or business organization carries out a due diligence of the organization or immovable property that it intends to acquire, invest in or buy.

Normally, the term “due diligence” includes both financial and legal due diligences. The buyer or investor undertakes both these due diligences through experts in the field to assess the situation, identify risks, lacunae or liabilities which the entity or property carry and analyze them, thereby helping the buyer or investor to make an informed decision and minimize their own liabilities in entering into the transaction.

We, in this article, are writing about the importance of conducting a legal due diligence in such transactions from an Indian legal perspective.

The term “legal due diligence” is not defined under Indian laws. However, the term “due diligence” generally means taking due care before undertaking any transactions. In other words it is the duty and obligation of a buyer, investor or a joint venture partner to, as a prudent person, carry out an investigation into the target entity, take due care while executing the transaction or purchase, and understand the risks and consequences of the matter before proceeding with the proposed transaction. As the cautious version of the age-old saying goes, “ignorance is no bliss” and the reader will do well to note that the buyer or investor will have to bear the risks, liabilities and consequences of the transaction. This is especially in view of the fact that the Indian courts do not take a lenient view of the woes of a buyer, investor or a joint venture partner who claims that it was not aware of certain issues or ignorant of the obligations to be performed by it in the transaction for the reason that the buyer or investor failed to carry out a basic investigation into the target entity before proceeding to transact with and who thus attempts to rely on its own omissions. .

It is therefore in the best interest of an individual or a business establishment interested in either merging, partnering with or acquiring another business entity, or in acquiring an immovable property, that it exercises due care by carrying out a detailed legal due diligence of such target company or a immovable property.

Listed below are some of the important issues that an individual or an organization would need to consider when merging, acquiring, or subscribing to the shares of a target company, or whilst acquiring an immovable property.

Important issues to be considered when an individual or a business organization is considering merging, acquiring, entering into a joint venture, or subscribing to the shares of the target organization, whether a Proprietary concern, partnership concern or a private or public limited company

A proper analysis of the target entity is of utmost importance to the investors to ensure that they are aware of the advantages and disadvantages of entering into such a transaction, the liabilities that they could be exposed to and to also evaluate the actual appropriate consideration payable for the specific transaction with the target entity.

Before undertaking a legal due diligence exercise, it is important for the investor to reflect upon what it intends to achieve with such take over, merger or joint venture with the target entity, i.e., the investor would need to be clear on the scope of the intended transaction. It is important to evaluate , for instance, whether the target entity owns any movable or immovable property and whether such property would be a part of the proposed transaction; whether the target entity owns any intellectual property rights(and if yes, whether such intellectual property rights would form a part of the proposed transaction); and whether the target entity has employees, (and if yes, whether all the employees will form a part of the proposed transaction or only a certain section of the employees involved).

Once the investor is clear on the intended final objective of such transaction and its scope, the main issues which would need to be identified and analyzed may be categorically deduced. It would then need to get into a detailed investigation of the target entity from, amongst others, the following perspectives (which would vary on a case-to-case basis):

  • Investigation into the ownership of the shared of the target entity. This includes confirming if the shareholders have brought in the shareholding contribution, whether such shares have been properly allotted, etc.;
  • Investigations into whether the target entity is in compliance with its statutory obligations under the Companies Act, 1956 of India where applicable, under the different labour laws of India with respect to its employees etc;
  • Investigations with respect to the various laws under which the target entity is registered and its compliances vis-a-vis registrations under them;
  • Investigations into the immovable property which forms a part of such transaction, if any;
  • Investigations into the number of employees employed by the target entity and whether the target entity is in compliance with its statutory obligations vis-a-vis its employees;
  • Investigations into the intellectual property rights such as trademarks, copyrights and patents owned by target entity;
  • Investigations into whether any cases have been filed by and/or against the target entity and the consequences they would have target entity;
  • Additional specific investigations as may be required on a case-specific basis with respect to the target entity.

Each of the above investigations would require the investor to look into various documents and seek clarifications from the target entity to be able to ascertain the consequences of such investigations and accordingly, the risk factors involved in proceeding with proposed transaction and would involve a detailed, technical study to reach a conclusion on each issue.

Important issues to be considered by an individual or business organization while purchasing an immovable property or entering into a transaction or investment involving immovable property

Detailed below is one of the aspects of an investigation which is very important, both for an investor transacting with a target entity which involves immovable property as well as from an independent perspective of an individual or organization intending just to purchase an immovable property.

While purchasing an immovable property, an individual or business organization would need to look into the following documents:

  • Title search of the property, right from the parent deed until the time the seller has come into possession of the property in question;
  • Confirming that the property is free from all charges and encumbrances. This has to be done by going through encumbrance certificates issued by the appropriate authority. If the immovable property is owned by a company then in addition to the above charge documents filed with the Registrar of Companies also needs to be checked;
  • Copy issued by the relevant municipal authorities showing the seller as the owner of the property. Such a document is known a Khata in Karnataka and a Patta in Tamil Nadu;
  • Confirmation on the nature of property being purchased,i.e., if the property can be used for residential or business purposes, as the case may be. If the buyer intends to purchase an agricultural property, then an investigation would need to be carried out from the perspective of the specific law applicable to the state to check whether the individual or business organization can purchase agricultural land in such state;
  • In case of the property having a building on it, the buyer would need to confirm that the building has been approved by an appropriate authority and the constructed building is as per approved plan;
  • If the seller is a company then in addition to the above documents it would be advisable in general to do a check of the following::
  • List of shareholders;
  • List of directors;
  • Bank details;
  • Three years’ balance sheet;
  • Share certificates;
  • Details of shares transfers, if any, etc.

The above list of documents to be looked into is a preliminary generic list – the documents to be seen when buying an identified property could vary depending on the facts and circumstances in each case.

In addition to the above, it is also advisable to carry out a physical inspection and investigation of the property in question to confirm the actual built up area of the building in question, the actual measurement of the land, etc.

It is very important to note that carrying out a proper title search and confirming that the property does not suffer from any inherent defects in title or is not charged to a third party is of utmost importance. Failure on the part of the buyer to conduct a proper due diligence on the property in question could have a long-lasting adverse effect in terms of the buyer’s ownership over the property in question and consequently, its right to sell the same to a third party free from charges, liens and encumbrances.

Carrying out a legal due diligence is therefore in the best interests of an investor or buyer to thoroughly acquaint itself with the ins and outs of the target entity of the property, analyze the risks and liabilities of the transaction (and thereby, the prudency of the decision to transact) and take all steps necessary to avoid such liabilities and future difficulties which may arise from not having carried out a thorough investigation.

Disclaimer: As already stated above this article is just to bring to the notice of the readers the importance of conducting legal due diligences in certain transactions and to give a brief overview of the issues to be looked into before undertaking such transaction. The above information / suggestions / guidelines / tips are generic in nature and should not be acted upon unless a professionally qualified legal consultant has examined the requirements of the transaction and has advised that some of the above terms may be made applicable to a proposed transaction.

Further we shall not be held responsible or liable for any losses or damages (direct, indirect, punitive, incidental, special, consequential damages or any damages whatsoever including, without limitation, damages for loss of use, data or profits and irrespective of whether it is based on contract, tort, negligence, strict liability or otherwise, even if we have been advised of the possibility of damages) caused to any person or entity on account of such person or entity acting upon the information provided in this article without seeking the advice of a professional legal consultant. The information provided is “as is,” and “as available”.

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