Mergers and Acquisitions (M&A) are complex transactions, often worth millions—or even billions—of dollars. While valuations, synergy estimation, and deal structure get most of the focus, perhaps the most critical phase involves any M&A deal is Due diligence. In India, there are more risks due to shifting regulatory environments and corporate practices heterogeneity. Target company non-compliance ranks among the largest red flags in an M&A deal that can kill the deal.
In this blog, we will be explaining how India M&A due diligence helps to uncover non-compliance and what acquirers should be looking out for in the way of red flags to be able to avoid risk.
What is Due Diligence in M&A?
Due diligence is simply a careful examination of a company done by a prospective buyer. The aim is to make an evaluation of the assets, liabilities, business operation, legal status, and potential risks of the company.
- Financial and tax compliance
- Legal and regulatory compliance
- Corporate governance
- Intellectual property and technology
- Human resources and labour law compliance
- Contracts and litigations
Why is Compliance So Critical in Indian M&A Deals?
India's regulatory environment is governed by a plethora of authorities—MCA, SEBI, RBI, Income Tax Department, Labour Authorities, etc. The risk of non-compliance ranges from financial penalties to criminal proceedings, loss of reputation, or even deal termination.
The investor or buyer can be required to assume liabilities in the event of non-compliance being discovered subsequent to the transaction and hence it is equivalent to extremely important that such issues are surfaced even prior to this.
How to Detect Non-Compliance During Due Diligence?
Let us now go to the meat of the issue: how can signs of non-compliance be detected while conducting M&A due diligence in India? Below are the primary areas and warning signs to monitor:
1. Review of Corporate and Statutory Records
Begin with a detailed examination of the statutory registers of the company, board resolutions, ROC filings, and memorandum and articles of association.
- Unfiled or late annual filings (e.g., AOC-4, MGT-7)
- Statutory registers missing and not maintained (not updated)
- Board meetings with no quorum or no notice
- Allotted shares or transferred shares without authorization
- These suggest violations of the Companies Act, 2013. The ramifications are significant especially where shareholder rights and management/control of the company are involved.
2. Tax and Financial compliance
Tax compliance is volatile in India and ever-evolving in relation to GST, income tax, TDS and transfer pricing. Proper examination of tax filings and audits should be completed.
Red Flags:
- Arrears of tax or tax disputes
- Discrepancies between financial accounts and GST returns
- Erroneous TDS deduction or delay in payment
- Transactions between group companies without arms-length pricing
- These issues can attract huge penalties or litigation post-acquisition.
3. Labour and Employment Law Compliance
India's labour law scenario is intricate and state-specific. Right from ESIC to PF to contract labour rules, all need to be carefully verified.
Red Flags:
- Non-enrolment or delayed payment to PF/ESIC
- Usage of unregistered or unlicensed contractees
- Inadequate employment contracts or non-standard offer letters
- Non-payment of gratuity, bonus, or statutory benefits
- Such violation-related claims by the employees might be raised post-transaction and become the liability of the acquirer.
4. Industry and Environmental Compliance
For infrastructure, manufacturing, or energy companies, sectoral norms, pollution board approvals, and environmental clearances are of the highest priority.
Red Flags:
- Old environmental licenses or approvals
- EIA (Environmental Impact Assessment) norms deficiency
- Violations of FSSAI, pharma, telecom, or other sectoral norms
- These could lead to notices for closure, fines, or disruption of business if not detected during the transaction.
5. Foreign Exchange Management Act (FEMA) Compliance
In cross-border M&A, FEMA compliance is inevitable. All foreign investments, transfer of shares, and external borrowings must comply with RBI guidelines.
Red Flags:
- Delays in reporting FDI to RBI (e.g., under Form FC-GPR/FC-TRS)
- Inappropriate valuation of share transfers involving foreign investors
- Unauthorised ECBs or external borrowing
- Contraventions of FEMA may result in penalties up to three times the transaction value.
6. Litigation and Legal Proceedings
There should be a full examination of threatened or pending litigation. This should include labor claims, consumer cases, tax appeals, or arbitration claims.
Red Flags:
- Concealed or material pending litigation
- Repeat customer or vendor claims
- Inability to resolve regulatory orders or notices
- Inadequate legal paperwork or contracts
- A single unresolved case can significantly affect the deal value or cause a delay in post-closing integration.
7. Third-Party Rights and Contractual Obligations
Every third-party transaction, including leases, franchise agreements, and vendor contracts, must be examined for compliance and termination provisions.
Red Flags:
- Accelerated termination changes of control provisions
- Unresolved related party agreements not reported
- Unsigned or incomplete contracts
- Legal enforceability not granted to rights
- These can lead to loss of revenue or disruption of business post-acquisition.
What To Do If Non-Compliance Is Found
Discovery of non-compliance does not necessarily mean the deal is off. But it needs to be taken care of first. Here's what you can do:
- Quantify the liability: Approximate financial and legal effect.
- Renegotiate valuation: Match the offer price with the risk.
- Seek indemnities: Insert specific indemnity provisions in the contract to shield against subsequent claims.
- Insist on rectification: Request the target to remedy the defaults prior to closing.
- Stagger the payment: Opt for an escrow or earn-out plan to hedge post-closing risks.
Best Practices to Minimize Risk
Identifying non-compliance is only half the battle. Here's how acquirers can minimize the risk:
- Hire an experienced due diligence team (legal, financial, tax, and environmental experts)
- Take an industry-specific checklist-driven approach
- Negotiate representations and warranties under the SPA
- Pursue indemnities for known risks or contingent liabilities
- Date the deal with conditions precedent to address material compliance deficiencies prior to closing
- Consider escrow arrangements or holdbacks to protect against post-deal liabilities
Conclusion
Indian M&A due diligence is not a formality—it's the cornerstone of a safe and successful deal. As regulations tighten, an early detection of non-compliance can avoid losses for investors in terms of financial, legal, and reputational repercussions.
As a startup founder looking for a strategic exit, an acquirer of a competitor, or a foreign investor investing in India, there is one law that is true: compliance is not voluntary.
So, don't put pen to paper without knowing what you are agreeing to—a acquisition of the assets, the goodwill, and the skeletons in the closet.