Transcript Legal Due Diligence for Acquiring Business in India – Do’s

Legal Due Diligence for Acquiring Business
in India – Do’s & Don'ts of Formulating an
MoU
1 August 2008,
PHD chambers of Commerce & Industry
, New Delhi
Karnika Seth
Managing Partner
SETH ASSOCIATES
ADVOCATES AND LEGAL CONSULTANTS
Copyright reserved © Seth Associates 2008.
What is ‘due diligence’ ?
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Due diligence is the process whereby an investing
party investigates, analyses, and evaluates an
intended major investment, transaction, takeover,
or business partnership prior to committing capital
to it. Due diligence can be termed as a risk aversion
strategy aimed at checking if the information about
the investment that is available is correct and
complete.
There are several forms of due diligence – business
due diligence, technical due diligence, financial due
diligence, intellectual property due diligence and
legal due diligence. This presentation discusses
only aspects relating to legal due diligence.
“Due diligence” defined
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The term “due diligence” as
relevant in this context is
defined in the Merriam
Webster’s Dictionary of Law
as:
The process of investigation
carried on by a disinterested
third party (such as a law firm
or an accounting firm) on
behalf of a party
contemplating a business
transaction (as a corporate
acquisition or merger, a loan of
finances, or especially
purchase of securities) for the
purpose of providing
information with which to
evaluate the advantages and
risks involved.
Essential aspects of due diligence
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Due diligence is understood by the legal, financial
and business communities to mean the disclosure
and assimilation of public and proprietary
information related to the assets and liabilities of
the business being purchased. This information
includes financial, human resources, tax,
environmental and legal matters.
Due diligence would include full understanding all
of the obligations of the target company: debts,
rights and obligations, pending and potential
lawsuits, leases, warranties, all high and impact
laden contracts – both inter-corporate and intracorporate.
Meaning of legal due diligence
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Definite agreements & closing
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LDD
MOU
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In a given business
transaction, a law firm or legal
counsel generally assists in
four phases before the
completion of the intended
transaction.
The preliminary negotiations,
which culminate mostly in the
execution of a letter of intent
or a memorandum of
understanding.
The legal due diligence
(‘LDD’).
The negotiation and signing of
the definitive or final
transactional document.
The closing.
Legal Due Diligence Process
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There is no definitive form of
a legal due diligence. The
investigative aspects as well
as form of the LDD process
varies depending upon the
scope of work dictated by the
client, the focus, special areas
of weakness, the type of
business, et al. However, the
basic philosophy of a LDD is
common to most processes
followed in a LDD.
The LDD follows a certain life
cycle. The LDD covers two
aspects – intra-corporate
transactions and intercorporate transactions.
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The various chronological stages of
the LDD are:
A memorandum of understanding
between the transacting parties for
disclosure
Establishment of time-lines
Commencement with pre-arranged
check-list(s) where the target
company provides information and
documents to the best of its ability
and knowledge.
Interview with the relevant
personnel of the target company
The legal due diligence process
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Independent checks with
the statutory and regulatory
authorities, libraries,
corporate documents, banks
and third parties that do
business with the target
company
Transactional and corporate
documentation, financial
statements, tax, litigation,
environment and safety
issues, HR and property
Collation with financial due
diligence for confirmation of
representations, warranties
and liabilities
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Investigation of issues that
would materially impact the
business transaction
Analysis by the law firm of the
foregoing
Drawing of the draft or
preliminary report
Discussions with the acquirer
on findings and discoveries
Finalisation of the LDD Report
(‘LDDR’)
Analysis and Strategy
Additional information from reports
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Reports
1. Copies of any studies, appraisals, reports, analyses or memoranda within
the last three years relating to the Company (i.e., competition, products,
pricing, technological developments, software developments, etc.).
2. Current descriptions of the Company that may have been prepared for any
purpose, including any brochures used in soliciting or advertising.
3. Descriptions of any customer quality awards, plant
qualification/certification distinctions, ISO certifications or other awards or
certificates viewed by the Company as significant or reflective of superior
performance.
4. Copies of any analyst or other market reports concerning the Company
known to have been issued within the last three years.
5. Copies of any studies prepared by the Company regarding the Company's
insurance currently in effect and self-insurance program (if any), together
with information on the claim and loss experience thereunder.
6. Any of the following documents filed by the Company or affiliates of the
Company and which contain information concerning the Company: annual
reports
Objectives of legal due diligence
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Identify the correct value of a business transaction
Verifying the size of known liabilities
Checking any unforeseen liabilities
Understand the financial and accounting position of the target company
Intellectual property rights of target company need to be identified,
ownership needs verification, and validity has to be established.
Ownership of domain name is to be checked
to check the person from whom shares are to be bought is the rightful owner
of shares
Inspecting documents relating to allotment and issue and transfer of shares,
the approval of transfers at board meetings and registration of various
transfer documents.
Former shareholders have returned certificates and new shareholders have
valid certificates.
Verifying shares that are to be sold are not subject to any charges or
encumbrances.
Objectives of legal due diligence
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Verify title to any freehold or lease hold
property of target company and any
other major assets
Whether there are charges or any other
encumbrances over property or assets
Check if consents and releases are
required
Any licence, permission ,regulatory
approval is required to lawfully conduct
business of target company
Disclosure letter can be a source of
information , word with other advisers
such as financial advisers
Public information –general public
records, internet due diligence, search
of land registry , registry of trademarks
, designs, patents, Registry records of
ROC, etc
Objectives of legal due diligence
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Check List of any export, import or customs
permits or authorizations, certificates,
registrations, concessions, exemptions, etc.,
that are required in order for the Company
to conduct its business and copies of all
approvals, etc. granted to the Company that
are currently in effect or pending renewal.
Check any correspondence with or
complaints from third parties relating to the
marketing, sales or promotion practices of
the Company.
How legal due diligence may help?
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Compliance with local laws
Securities or other regulatory violations or
disciplinary actions
Extensive litigation and/or bankruptcies –
assessment of feasibility of pursuing litigation
Financial statements
Unpaid tax liens and/or judgements
Past business failures and related debt
Fraudulent or exaggerated credentials
Misrepresentations or character issues
Discoveries and disclosures
Importance of legal due diligence
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Assets – real and intellectual property, brand value
Reputation and goodwill
Cross-border issues – double taxation, foreign
exchange fluctuation, sovereign risk, investment
climate, cultural impact on HR
Cultural Due Diligence: An important aspect of
LDDs in cross-border transactions is cross-cultural
study, which is not typically covered, especially in
India. The compatibility and adaptability of
corporate cultures and ethics between the acquirer
and the target company must be analysed.
Legal risk management
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some aspects enabling effective legal risk
management arising out of the LDD are:
– Information procured from target company’s
personnel
– Representations and warranties – also covering
conditions precedent and conditions subsequent
– A merge of financial analysis of target company
with legal risk analysis
LDD and legal documentation
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One of the most important aspects
in the LDD is the transactional
documentation under intercorporate transactions, in other
words, contracts.
Contract value and impact – lockin periods and other restrictive
clauses
Statutory and regulatory
compliances and consents
Restrictions of any form
Non-compete, non-solicitation and
confidentiality
Intellectual property
Human resource
The cut off date and closure date
Environmental legal due diligence
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A list of facilities or other properties currently or formerly owned, leased, or operated by
the Company and its predecessors, if any.
Reports of environmental audits or site assessments in the possession of the Company,
including any Phase I or Phase II assessments or asbestos surveys, relating to any such
facilities or properties.
Copies of any inspection reports prepared by any governmental agency or insurance
carrier in connection with environmental or workplace safety and health regulations
relating to any such facilities or properties.
Copies of all environmental and workplace safety and health notices of violations,
complaints, consent decrees, and other documents indicating noncompliance with
environmental or workplace safety and health laws or regulations, received by the
Company from local, state, or federal governmental authorities. If available, include
documentation indicating how such situations were resolved.
Copies of any private party complaints, claims, lawsuits or other documents relating to
potential environmental liability of the Company to private parties.
Listing of underground storage tanks currently or previously present at the properties
and facilities listed in response to Item 1 above, copies of permits, licenses or
registrations relating to such tanks, and documentation of underground storage tank
removals and any associated remediation work.
Patent due diligence
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List of Indian and foreign patents,
including, for each patent:
a. country
b. grant number
c. grant date
d. expiration date
e. publication number
f. publication date
g. inventors
h. title
i. number and date of Indian
patent to which the foreign patent
is a counterpart
j. dates on which annuities were
paid, identity of parties paying
annuities
k. name and address of foreign
agent responsible for maintenance
of the patent.
Patent due diligence
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2. List of foreign patent applications, including for each application:
a. national patent office in which pending
b. filing date in that office
c. priority date
d. application number
e. number of European Patent Office application or Patent
Cooperation Treaty application giving rise to the application inventors
f. title
Patent Rights As Between the Company and Its Employees
1. List of agreements between the Company and any of its
employees conveying patent rights to the Company.
2. Invention development memoranda (which recites details about
patentable inventory for review by the Company's patent lawyer and
which could tell about areas the Company has chosen not to patent).
3. The Company's written policy on patenting inventions, if any.
4. List of key employees/inventors and employment and other
agreements with same.
Trademark due diligence
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Company's Files
1. Review of trademark/service mark/domain name files:
a. Indian and foreign registration, application and assignment
files, including prosecution histories
b. Licenses and Registered User Agreements and license files,
including quality control files
c. Rejected applications
d. Protest letters (sent and received)
e. Litigation files (e.g., past infringements, disputes, demands
or language in court orders may impact future litigation)
f. Settlement agreements, administrative or judicial decisions
affecting ownership or validity of the marks (e.g., may restrict
expansion of mark geographically or to other goods)
g. Trademark search report files on current marks
h. Concurrent use agreements.
Trademark due diligence
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2. Computer printout of trademark record maintenance of the
Company, including maintenance and status report on all
registrations, pending applications, licenses Registered User
Agreements, assignments, etc.
3. Advertising, brochures, packaging and other materials which may
disclose, inter alia:
a. Style and secondary marks that are protectable or which may
infringe third party uses
b. Slogans that are protectable or which may infringe third party
uses
c. Misuse of marks (e.g., use as generic terms; misuse of ® or
failure to use ®)
d. Protectable or infringing trade dress.
4. Sample products
a. For proper trademark markings
b. To consider possible protection of configuration.
5. List of trade/domain name registrations
Copyright due diligence
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Registrations and Ownership
1. List of all Indian Copyright Registrations owned by the Company for
relevant subject matter, including:
a. Registration Number
b. Registration Date
c. Title as listed in Registration
d. Publication Date
e. Creation Date
f. Author (if anonymous work, list each employee who prepared any portion
of the work)
g. Subject matter covered
h. Description of deposit filed in support of the registration
i. Name and current address of each person who participated in creation of
the subject matter from whom a written assignment has been obtained
j. Name and current address of each person who participated in creation of
the subject matter from whom a written assignment has not been obtained
k. Identification of circumstances which would support the subject matter, or
any particle thereof, being considered a work made for hire.
Copyright due diligence
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Copyright registrations and files listed above for each registration.
3. List of all relevant non-Registered works (which are nevertheless protected via copyright) which have
ever been offered for license, use or sale by the Company, including:
a. Name and version of work
b. Release date
c. List of previous versions and their release dates
d. Creation Date
e. Name and current address of each person who participated in creation of the work from whom a
written assignment has been obtained.
f. Name and current address of each person who participated in creation of the work from whom a
written assignment has not been obtained.
Licenses
1. For each work owned or used by the Company, a list of all underlying licenses which convey rights in
copyright to the Company, including:
a. name and address of licensor
b. date
c. work licensed
2. For each work owned by the Company, a list of licenses conveying rights in copyright to a third party,
including:
a. name and address of licensee
b. date
c. work licensed
3. Each license listed in items numbered 1 and 2 above.
IP -legal due diligence
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Infringement Claims
1. Demand letters that the Company has sent
regarding third party infringement of the Company's
trademarks, patent rights or copyrights.
2. Demand letters that the Company has received
regarding infringement of third party rights or
copyrights.
3. Files for any litigation that has occurred involving
the trademarks, patent rights and copyrights.
4. Consent orders regarding infringement litigation.
5. List of all patent clearance searches that have
been conducted relating to the technology.
Meaning of ‘Acquisition’
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An acquisition may be defined as an act of
acquiring effective control by one company
over assets or management of another
company through purchase of shares
without any combination of companies.
Thus, in an acquisition two or more
companies may remain independent,
separate legal entities, but there may be a
change in control of the companies
Acquisition vs Takeover
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When an acquisition is 'forced' or 'unwilling', it is called a takeover. In
an unwilling acquisition, the management of 'target' company would
oppose a move of being taken over. But, when managements of
acquiring and target companies mutually and willingly agree for the
takeover, it is called acquisition or friendly takeover.
Takeover-A person or group of persons ( acquirer ) acquiring shares
or acquiring voting rights or both of a company ( target company)
from its shareholders, either through private negotiations with
shareholders or through public offer in the open market with the
object of gaining control over its management
While in the Companies Act (Section 372), a company's investment
in the shares of another company in excess of 10 percent of the
subscribed capital can result in takeovers. An acquisition or takeover
does not necessarily entail full legal control.
Laws governing acquisition of a
company
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An acquisition of shares of a listed target
company is governed interalia, by
Companies Act , by SEBI, and Takeover
code
For acquisition of shares of unlisted or
private company , the governing law is
contained in Section 108 of the Companies
Act, 1956 –transfer of shares takes place on
mutual agreement of parties.
Laws governing acquisition of a
company
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If acquisition results in a combination , then
provisions of Competition Act 2002 are also
applicable and approval of CCI is required. ,if
acquisition requires inflow or outflow of money to
ore from India FEMA is also, RBI permission may be
required.
Listing agreement- Section40 A and 40 BDisclosure for particulars by shareholder to the
target company once threshold limit 5% is crossed
and mandatory public offer for acquisition of
minimum percentage when threshold limit of ten
percent was crossed.-SEBI Regulations 1994
Takeover code-automatic /specific exemptions
Negotiation between parties and
drafting an MOU for acquisition
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Set up a foundational understandingbinding/non-binding
Representations and warranties-ownership
of assets-tangible and non tangible-IP
assets included
Financial status of the company –
liabilities/debts-both accrued/continent
Regulatory approvals for conduct of
business by target company to be in place
staff/employees retained
Negotiation between parties and
drafting an MOU for acquisition
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Undertaking to sell agreed percentage of shares –
free and clear of encumbrances
Amount of consideration
Director is to continue to be part of management of
target company –lockin minimum term, salary,etc
First right to purchase remaining shares
Steps to be taken after execution of this agreement
Costs for drafting formal agreements
Non compete clause-territory ,time, activity
Confidential and proprietary rights-in perpetuity
Non solicitation
Negotiation between parties and
drafting an MOU for acquisition
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Incase of breach of provisions- reserve right to equitable
remedies-specific performance or injunctive relief
Severability clause
Assignment clause
Shareholder approvals and other corporate approvals
Agreement binding subject to bonafide due diligence by both
parties
Amendments
Waiver
Supersedes previous understanding with target company
Best efforts clause
Negotiation between parties and
drafting an MOU for acquisition
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Governing law of agreement
Forum for dispute resolution
Construction and interpretation
Headings
Service of Notices-mode of service, address for service.
Signature by authorized representatives and witnesses
Schedules to MOUIP rights and assets
Verified financial documents of the company certified by auditors
Liabilities of the company
Staff Particulars
Transitional services by directors
Financial and other limits of authority of director ( transitional
services)
Thank You!
SETH ASSOCIATES
ADVOCATES AND LEGAL CONSULTANTS
New Delhi Law Office:
C-1/16, Daryaganj, New Delhi-110002,
India
Tel:+91 (11) 65352272, +91 9868119137
Corporate Law Office:
B-10, Sector 40, NOIDA-201301, N.C.R
,India
Tel: +91 (120) 4352846, +91 9810155766
Fax: +91 (120) 4331304
E-mail: [email protected]