M&A Due Diligence in India: How to Spot Target Company Non-Compliance
Warning Signs of Problems: IP that isn't registered, registrations that have expired, unclear ownership (e.g., if a contractor created the IP), claims that the company is copying others, or others are copying them. These issues can greatly lower the Consider that you are about to purchase a promising new company. You've discussed figures and are nearly prepared to sign the agreement. But what if there's a big problem hiding inside that company? What if a forgotten fine, a lawsuit you don't know about, or a small mistake in how they treat employees could turn your exciting new deal into a very expensive headache?
This isn't just a scary thought; it's a real risk when companies buy or merge with others (M&A) in India. That's why a careful check, called due diligence, isn't just a fancy business term. It's like having your own detective agency to find every possible risk before you put your name on anything.
Here at SKMC Global, we know that a successful M&A deal in India depends on looking very closely at the company you want to buy. So, let's learn how you can be a smart investigator, focusing on how to spot a target company's non-compliance (meaning they haven't followed the rules) and protect your money.
1. Why Checking Everything (Due Diligence in mergers and acquisitionsc) Is a Must-Do
Think of due diligence in mergers and acquisitions as the ultimate background check. When you buy a house, you look for cracks, check the pipes, and review old records, right? Buying a company is much, much bigger, with a lot more at stake.
The main purpose of due diligence is to fully reveal the true condition of the company you're looking at. It's about:
- Checking the Story: Is what the seller tells you actually true?
- Finding Surprises: "Discovering secret debts, future legal battles, or inefficient operations that could become expensive problems."
- Setting the Right Price: Changing how much you'll pay after seeing the company's full picture (its problems and chances).
- Getting a Better Deal: Giving you reasons to ask for better conditions, promises, and safety features in the final contract.
- Planning for Later: Understanding how the company works inside so that putting it together with your existing business goes smoothly after you buy it.
India has many laws and rules, both for the whole country and for individual states. In this complex environment, thorough m&a and due diligence is your best protection.
2. Your Checklist: What to Look At Very Closely
To really find problems, your due diligence needs to cover many different areas. Here are the main places you'll need to investigate like a detective:
The Company's Rulebook: Corporate & Secretarial Checks
What to check: This is where you look at the company's basic legal setup. Is it properly registered? "Are the company's main rulebooks (like its founding papers) current? Check that all official records (like who owns shares, who is on the board, and any company debts) are right and finished." Make sure meeting minutes for the board and shareholders are properly recorded and that all yearly reports and financial statements are filed on time with the Registrar of Companies (ROC), as required by the Company Law 2013.
Warning Signs of Problems: Missing or confusing records, no meeting notes, not appointing required directors (like a Resident Director or Women Director if needed), or mistakes in old share transfers. A big red flag is often not following Section 180(1)(c) of the Companies Act, 2013, which needs shareholder approval for large loans. Also, watch out for private companies (not small or government ones) that haven't converted their physical shares to digital format – this is a new rule.
The Money Story: Financial & Tax Health
What to check: Look deeply into their financial reports (balance sheets, profit & loss, cash flow), accounting rules, internal controls, audit reports, and all tax filings (Income Tax, GST, TDS – Tax Deducted at Source, customs duties). Look for any unpaid taxes. Pay extra attention to how they record money coming in, any possible future debts, money exchanged between related companies, and hidden financial commitments.
Warning Signs of Problems: Financial reports that don't make sense, hidden debts, not paying enough taxes (and don't forget stamp duty on agreements!), or clear mistakes with TDS rules. Also, remember foreign exchange rules (FEMA, RBI guidelines); mistakes here can cost a lot.
Legal Battles: Contracts & Lawsuits
What to check: Read all contracts and agreements (with customers, suppliers, employees, landlords, banks). Look for any current or threatened lawsuits, arbitration cases, government investigations, and make sure they follow laws specific to their industry.
Warning Signs of Problems: Confusing parts in contracts, not fulfilling contract promises, ongoing or possible lawsuits against the company, not following specific industry rules (like environmental permits for factories), or not telling you about official warnings from regulators. "Be very careful about any past or present actions that hint at bribery or cheating. Laws like the US FCPA, India's PCA, and the UK Bribery Act mean you could be held responsible for old mistakes."
Protecting Ideas: Intellectual Property (IP)
What to check: Make sure the company clearly owns its inventions (patents), brand names (trademarks), creative works (copyrights), and secret business details." Check that these are valid and can be enforced. Review any agreements about using IP or creating new IP, and ensure employee contracts properly give IP rights to the company.
Value of a company built on its ideas.
The People: Human Resources & Labor Laws
What to check: Look at their employee agreements and company rules for staff. See if they're paying all needed employee benefits, like PF, ESI, and gratuity. Check if they follow rules for minimum pay, factory safety, and if there are any current arguments with workers."
Warning Signs of Problems: Not paying required benefits, incorrect ways of firing employees, unresolved complaints from workers, or a history of worker strikes or unrest. For example, not paying gratuity contributions can even lead to serious trouble for directors.
Beyond Money: Environmental, Social, and Governance (ESG)
What to check: This is a growing area of due diligence. Look at environmental permits, how they control pollution, manage waste, their safety records, how they impact society, their internal company management rules, and if they have anti-bribery/anti-corruption (ABAC) programs.
Warning Signs of Problems: Expired environmental permits, past environmental violations, poor safety records, weak company management structures, or no strong anti-bribery program. Investors are increasingly penalizing companies with poor ESG records, and your new acquisition could become a target for activists or regulators if ESG risks are high.
3. Smart Tools for Modern Reviews
Checking a company used to mean piles of paper. Now, it's much more modern:
Online Rooms (VDRs): These are very safe online spaces. You share important papers there, and only allowed people can see them. They also track every change.
Smart Computer Programs (AI): Computers are now helping more and more. They quickly read huge numbers of documents, finding strange things, red flags, or mistakes. They do this much faster and better than people.
Deep Checks (Forensic Audits): If your first look shows big problems or hints of fraud (like odd money transfers or weak company rules), for compliance and non- compliance then you might need a deeper "forensic audit." This can find hidden financial tricks or secret bribery that normal checks might miss.
- Expert Advisors: This is perhaps the most important tool. Hiring experienced legal, financial, and tax experts who know a lot about Indian laws and rules for specific industries is vital. Their skill in finding small but important compliance and non-compliance issues, especially related to the Company Law 2013, FEMA, and SEBI rules, is priceless.
4. What's New: Recent Changes & Important Talks
India's rules for M&A are always changing. Staying up-to-date is key for good due diligence:
Companies Act, 2013 Updates:
Faster Mergers: New rules (Companies (Compromises, Arrangement and Amalgamations) Amendment Rules, 2023) aim to make some mergers quicker. But due diligence is still crucial to make sure your deal fits these rules and is proper.
New Data Protection Law (DPDP Act, 2023): This new law has a big effect on your checks (due diligence), especially if the company handles personal information. Buyers must now carefully see how the target company protects private data, follows this DPDP Act, and manages risks like data leaks.
This means looking closely at data agreements, how they get consent, and their cybersecurity. Not being careful here can lead to big fines.
Digital Shares Rule: A key point for private companies (not small or government ones) is the rule to convert physical shares into digital form. Not following this can be a big problem during due diligence and closing the deal, so check this early!
Auditor Reports: Proposed changes might make auditors explain why they resigned, including if they suspect fraud or major rule-breaking. This could be an early warning sign for buyers.
Competition Act, 2002 – New Rules:
Deal Value Check: The Competition Commission of India (CCI) now looks at the deal's value. If a global deal is worth more than INR 20 billion (about US$238 million) and the company being bought has "significant business in India" (based on things like user numbers or sales in India), it needs to be reported to the CCI. This means the CCI can look at more deals, especially in tech, so careful due diligence is needed to avoid issues and fines.
ESG & Anti-Corruption – Growing Importance:
Big news cases (like those involving Mondelēz-Cadbury India, Adani Green, Azure Power, Cognizant, Beam India) show that governments and the public are paying much more attention to ethical behavior and anti-bribery/anti-corruption (ABAC) rules. Due diligence now deeply checks for old bribery schemes, fake contracts with third parties, and environmental rule-breaking. The buyer can be held responsible for past bad acts.
It's becoming more important to make sure the target company has strong ABAC programs, ways for employees to report problems secretly, and regular training on rules.
5. Fixing Problems: Solutions, Not Stopping the Deal
Finding problems (non-compliance) doesn't always mean the deal is off. It's a chance to act smartly:
Fix It: For small problems, you can agree with the seller to fix them before or soon after the deal closes.
Change the Price: If the problem has a clear money cost (like a coming fine), you can lower the purchase price to cover it.
- Get Protections: Ask for special clauses in the sales agreement that make the seller financially responsible for specific problems you found, if those problems happen after you buy the company.
- Ask for Stronger Promises: Make sure the seller gives strong "representations and warranties" in the contract, promising that they followed rules in the past and told you everything.
- Walk Away: For big, unfixable problems that completely change the deal's value or create too much risk, don't be afraid to walk away. It's better to lose a deal than to buy a big problem.
Conclusion
"The world of buying and merging companies in India is exciting but can be tricky. Here, a careful check (due diligence) is your best helper. It's not just about simple tasks; it's about handling problems wisely and making your company more valuable. By knowing common issues (like following or not following rules), using new tools, and getting help from experienced experts, you can handle India's special M&A world with confidence. This makes sure your new purchase truly helps your business grow and win."
For expert help with M&A due diligence and smart advice on Indian Company Law 2013 and following all rules, visit www.skmcglobal.com. Our team is here to help you make smart choices and achieve great M&A success.