What should be disclosed during due diligence

Due diligence is critical during any transaction, be it a potential merger and acquisition, investment, loan or financing. The general principle of buyer beware makes it important for any investor or purchaser to examine all material information as part of the due diligence exercise.

There have been numerous instances where mistakes in the due diligence process have proved to be costly after the completion of the transaction. It is the responsibility of the buyer to investigate and analyse the assets, liabilities, records, financials, and customers of a business to ensure that what is being acquired aligns with its expectations. It is the responsibility of the seller to correctly disclose what is necessary and material for the buyer to make an informed decision. The seller or target is asked to provide a prospective buyer with the information that the buyer needs to satisfy its own due diligence inquiries and to evaluate the target’s business.

Advisers conducting due diligence for the buyers generally commence such exercises with a broadly worded requisition list. The seller or target has to maintain a delicate balance between neither divulging more nor divulging less than what is required. It is essential for the seller or target to be mindful of their duty to disclose.

The general rule is that mere non-disclosure does not constitute misrepresentation, unless there is a duty to disclose material facts, however disreputable such non-disclosure may be in the particular circumstances. As stated in the explanation of section 17 of the Contract Act, 1872, “mere silence as to facts likely to affect the willingness of a person to enter into a contract is not fraud, unless the circumstances of the case are such that … it is the duty of the person keeping silence to speak, or unless his silence is, in itself, equivalent to speech.”

The courts have held that the duty to speak only arises where one of the parties is without the means of discovering the truth and has to depend on the good sense of the other party. Where a person is not asked for any information that he has no legal duty to disclose, he has no duty to speak of it. Obviously, a seller cannot be called on to disclose that of which he is not aware.

A seller or a target should be mindful that unless there is a duty to disclose, it can choose to remain silent about the aspects not asked for. However, where the seller or the target is entitled to remain silent, but instead chooses to speak, it has to speak truthfully and completely. The task is challenging in the initial phase when the requisition is broad; at this stage, the seller needs to be careful as to what has been asked for and what it is bound to be disclosed. Generally, in any due diligence exercise, the process is iterative and evolves in important respects over time. If the buyer asks for specifics, the seller cannot remain silent or disclose partial or misleading facts when it is aware of facts that it considers are material for the buyer to make an informed decision.

Daiichi Sankyo Company Limited v Malvinder Mohan Singh and others (2018) is a landmark case in recent corporate M&A history where the buyers, Daiichi Sankyo, alleged fraudulent misrepresentation against the sellers of Ranbaxy on the grounds of incomplete disclosure at the time of due diligence. Subsequent arbitration proceedings awarded over US$338 million in damages to the buyers. The fact that the sellers provided no representation and the warranty to the buyers under the share purchase and share subscription agreement could not protect them.

Practical suggestions for a seller or target regarding due diligence are:

• Sellers and targets should undertake advance preparation and devote substantial time and resources;
• The management of the target spearheading the due diligence exercise should have a firm grasp on the affairs of the target and should be fully involved in the due diligence exercise;
• Trusted and competent professional advisers should assess what to disclose and what not to disclose. The team of professional advisers for the seller or company should be as deeply involved in the diligence exercise as that of the buyer;
• Every disclosure should be recorded and documented with proper back up. Oral discussions during the due diligence exercise should be recorded in writing as far as possible;
• Disclosure letters that are part of the transaction documents should be carefully drafted and not exclude any key disclosure;
• A well-drafted nondisclosure agreement is essential to protect the target’s secrets and proprietary information.

GV Anand Bhushan is a partner and head of the Chennai office and Abhishek Jain is a senior associate at Shardul Amarchand Mangaldas & Co.

Shardul Amarchand Mangaldas & Co
Nariman Point
Mumbai – 400 021Executive Chairman: Shardul Shroff
Managing Partner Mumbai: Akshay Chudasama
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