Lawyers about Due diligence: what exactly we check during the legal analysis of business and how to conduct it. Full checklist

“Due diligence” is a
detailed due diligence procedure, which is carried out in order to identify
various risks, including legal, economic, tax, technical and many others
related to the implementation of a project or transaction.

This procedure can be applied to
various areas of business – in fact, “due diligence” is a fundamental
process of risk assessment before making important legal decisions.

In a business context, the “due
diligence” process can take various forms governed by legal, tax,
financial, economic and other aspects. It provides a comprehensive
understanding of the state of the business and helps to make an informed decision.

Due diligence, or the business due
diligence process, is a key stage recommended before a number of important
events and decisions:

• buying a company or a share in it, as well as other M&A (mergers and acquisitions) type transactions;
• exercising an option on a part of the company (business);
• making a major investment in the company or providing significant non-investment financing (such as grants or loans);
• the process of changing the company’s management personnel;
• preparing for a public offering of shares or IPO, or the offering of other securities, including bonds;
• and other situations in which the company’s legal risks may affect the position of its partners, counterparties, future owners or other persons related to the company.

During the legal “due
diligence” of a business or company, the following key aspects are
checked:

1. Corporate document and the powers
of the company’s management, compliance with the procedure for their
appointment, and the status of the company’s participants or shareholders

• examination of company’s constituent documents as well as the documents  empowering to act on behalf of a company.
• the legality of ownership of shares or shares of the company by participants or shareholders is assessed. Attention is paid to the documents on acquisition of shares or stocks: payment receipts, property acceptance certificates, sale and purchase agreements and other types of transfer of ownership, protocols on distribution of treasury shares, etc..;
• check whether there are no disqualified persons among the company’s directors.

2. Legality of establishment and
existence of a company, payment of the authorized capital of the company

• documents confirming the legality of the company’s establishment.
• documents related to the payment of the authorized capital when the company is established and when it grows.
• check whether the company’s address is a “place of mass registration” and whether there is a connection with the company at the address specified in the Unified State Register of Legal Entities.

This verification
stage helps to confirm the legality of the establishment and operation of the
company, as well as the correctness of the formation of the authorised capital.

3. Checking restrictions on the
disposal of interests or shares in the company and the existence of
transactions affecting the overall treatment of corporate rights and
obligations

• monitoring the Unified State Register of Legal Entities for information on restrictions on the disposal of company shares;
• requesting information from the company’s management or shareholders on corporate agreements, options, share pledge agreements, preliminary agreements for the purchase and sale of shares and other transactions that may encumber the company.;
• Analysing the property and legal status of shareholders or participants.

This step helps to
ensure that there are no hidden problems that could make it difficult to
continue to operate the company’s shares or stock.

4. Checking compliance with the law
and the company’s internal rules when carrying out transactions and procedures

• analysing all company transactions, including share/share transactions, for compliance with the charter, corporate agreements and other legal acts;
• assessing the process of withdrawal of participants from the company and payment of the value of their shares – the regularity and transparency of these actions should be ensured;

The purpose of this
stage is to confirm that all company operations and procedures are carried out
in accordance with the law and internal corporate rules.

5. Assessment of accounts payable
and contractual discipline of the company

• the most important active and completed (usually for the last three years) contracts, deeds and other primary documents.
• potential risks associated with breach of contractual terms and possible debts or other difficulties on this basis are identified.

This stage helps to
establish contractual discipline in the company and the existence of related
payables.

6. Audit of financial liabilities
and bankruptcy risk

• the company’s accounts payable are analysed and the reasons for their occurrence are identified, including tax and levy debts;
• accounts receivable are evaluated, the possibility of repayment is assessed and potential collection costs are measured;
• accounting documents, balance sheet, statements, profit and loss statements, declarations, primary documents, audit reports are studied;

The objective of this
stage is to provide an accurate and complete picture of the company’s financial
position and its bankruptcy risks.

7. Examine the financial and legal
position of the company

Risks and restrictions
are analysed, including property seizures and any restrictions on the company’s
legal activity.

8. Analysis of the company’s
litigation activity

The company’s
involvement in litigation, the presence of lawsuits, claims and risks of
further involvement in litigation are analysed.

9. Analyzing corporate conflicts in
the company

Internal conflicts in
the company are investigated by checking minutes of general meetings and other
corporate documents such as letters, reports and enquiries.

10. Analyzing violations of
legislation by the company

An audit of the company’s activities
is carried out to identify current, past and potential violations of
legislation.

11. Review the legality of ownership
and use of property, including property rights, licences and intellectual
property

In the course of the
audit, the documentation confirming the company’s right to acquire, own and use
property is analysed.

Of particular interest
are intellectual property objects, such as software, design, audio, video,
graphic and textual content.

12. Assessment of the possibility of
deciding on the liquidation or reorganisation of the company

Analysing the disclosures in the
State Registration Gazette helps to see any relevant decisions. In order to
determine whether the issue was discussed at past or planned to be discussed at
future general meetings of participants (shareholders), corporate documents are
also subject to detailed examination.

13. Observance of the rights of the
company’s employees

Documents regulating the work and
remuneration of employees (employment contracts, civil law contracts, primary
documents on salary payments, documents on payment of taxes and contributions
to employees, etc.) are analysed.

14. Analysis of
possible sanctions against the company, its
participants/shareholders/managers/affiliates

It is assessed whether
any sanctions have been imposed on the company and/or these persons by Russian,
foreign, international organisations or whether their data are included in the
databases of persons sought in connection with criminal, tax and other administrative
violations. If the information is doubtful, written assurances/guarantees may
be requested from the persons concerned that no such facts exist.

15. Protection of confidential
information

It is necessary to analyse which
information in the company is subject to the regime of secrecy
(confidentiality) and which is not. The importance of this information is
assessed. It is checked whether the secrecy (confidentiality) regime is
correctly (legally and organisationally) established and observed in the
company.