LEGAL DUE DILIGENCE

Category: Legal Services
Written by David J. O. Tuhusula on 19/09/2022
The author’s views are entirely their own and may not always reflect the views of Putranto Alliance.

Due diligence provides the aid that investors and companies need to understand the nature of a deal, that is, to inform them more regarding any possible risks and if the deal fits with their portfolio. In short, the entire process of due diligence is much like doing homework for a potential future transaction, which is essential to ensure any investment decision goes smoothly.

WHAT IS DUE DILIGENCE?

The Black’s Law Dictionary defined due diligence as such: “Such a measure of prudence, activity, or assiduity, as is properly to be expected from, and ordinarily exercised by, a reasonable and prudent man under the particular circumstances; not measured by any absolute standard, but depending on the relative facts of the special case.”

In the context of mergers and acquisitions, due diligence is equivalent to a form of legal, operational, and financial review; to verify the claims and accuracy of the information provided by the involved parties.

In a simpler explanation, due diligence is an exercise of reasonable care in the course of business. The entire process involves careful investigation of the aspect of economic, legal, fiscal, and financial circumstances of an ongoing business or an individual. The covered aspects involve thoroughly examining sales figures, shareholder structure, and any possible links with economic crime, such as corruption or tax evasion. This form of appraisal is necessary for any company that initiates a new form of relationship with its partners and/or with the agenda of purchasing another company or property for investments.

The due diligence process is usually carried out by equity research firms, fund managers, individual investors, risk and compliance analysts, and broker-dealers. This process, however, does not mean due diligence is only allowed to be done by them, as individual investors are allowed as much freedom to perform their due diligence. Conversely, by default, broker-dealers are required by law to undertake due diligence on security before selling it.

WHAT IS LEGAL DUE DILIGENCE?

Legal due diligence is a thorough examination carried out by a legal consultant on a company or object to obtain material information or facts to find a description of the condition of a company or object of a transaction. To put it in simpler terms, legal due diligence is an activity to assess legal risks that may arise during an ongoing business. The risks in question are those related to the transaction that will be processed. Thus the “activity” (the process of due diligence) is to identify risks that are usually unnoticed. A properly conducted due diligence allows for better decisions, a chance of more opportunities, and better situation management.

Several factors will be investigated/cross-checked during legal due diligence, which includes but are not limited to:

  1. Deed Examination

    Deed examination includes the history of company ownership, structure and amount of company ownership, company condition, and company rights and obligations.

  2. Licensing Inspection

    This inspection includes business and technical permits.

  3. Asset Inspection

    Unlike the license, the inspection of assets includes ownership of tangible and intangible assets and the rights and obligations attached to these assets.

  4. Case-free Examination

    This examination includes the investigation of cases at the General Court (Pengadilan Umum), State Administrative Court (Pengadilan Tata Usaha Negara), Commercial Court (Pengadilan Niaga), as well as in other relevant agencies.

All findings from the examination process are conveyed in a due diligence report, which reviews legal risks based on laws and regulations. Not only that, but the due diligence report also provides recommendations on what steps should be taken regarding these legal risks.

THE PRINCIPLES OF LEGAL DUE DILIGENCE

Some principles must be fulfilled by legal experts when it comes to performing the process of legal due diligence, such as the followings:

  1. Professionality

    This principle would refer that the legal expert in charge must have skills, prudence, integrity, and legal certainty.

  2. Openness

    The principle of openness is a principle that opens itself to the right of the community to obtain correct, honest, and non-discriminatory information about state administration while still paying attention to the protection of personal rights, groups, and state secrets.

  3. Independency

    This principle would refer to the fact that all the agreements chosen are not subject to interference or intervention from other parties. However, the decisions taken are still based on the provisions of the ongoing legislation without causing harm to any party.

NECESSITY OF LEGAL DUE DILIGENCE

To elaborate, legal due diligence is essential because it helps you to:

  1. Understand your business aspect

    Legal due diligence is commonly interpreted as an investigation performed by one company on another, but it can also be a form of investigation into one's own company. This process is important, especially if there are mergers or major sales in consideration, because, through this, one can understand the worth of one's own business.

  2. Value a target company

    In the same nature as understanding one's own business, through due diligence, it is also possible to comprehend another company's worth, using the example of their agreements, assets, and other things as a point of comparison.

  3. Assist in drafting and negotiations

    Most of the time, when doing a sort of transaction, especially large ones, the presence of an agreement becomes a necessity. By conducting due diligence, all factual evidence and good/bad information have been gathered, allowing easier negotiations. Not only that, but it also helps in assessing and mitigating risk.

  4. Identify any potential closing problems

    Potential problems might be found during due diligence, especially problems that might cause serious problems for the ongoing business continuity. By finding these problems during the due diligence process, more options could be explored, allowing for a better take to resolve them efficiently and promptly.

While it may seem to only benefit one party, in truth, due diligence benefits each involved party. From one perspective, due diligence provides peace of mind that they’re making the right deal and have received all the necessary information to make a good decision. This information will either assist in validating good assumptions or alerts them about potential risks.

Conversely, the process of due diligence also assists business owners in taking a deeper look into the financial integrity of their business. Along the way, it also assists them in finding out the market value of their business. Because valuations and acquisition prices are only able to get higher for many sectors, it’s proven necessary for companies to invest in quality due diligence reporting and services.

HOW TO CONDUCT LEGAL DUE DILIGENCE IN INDONESIA

It’s natural for any company who wants to perform legal due diligence to follow the custom of the country’s regulations, which may differ between one country with another. Specifically in Indonesia, the outlines are as follows:

  1. Finding the legal expert

    Finding the relevant Indonesian legal vendor that will be expected to perform the due diligence process should be done before the whole procedure is executed. Even if a large company may have a legal group of experts, it is better to find independent parties with relevant experience. To put it simply, search for the ones that have previously conducted legal due diligence for companies with similar types of target companies.

  2. Meeting between the involved parties

    The decision-makers of the involved parties/companies must hold a meeting to further discuss the goal of the process of due diligence, whether it fits with the companies' visions, it fits their portfolio, and/or it fits the goals of future business decisions. The discussion between these decision makers becomes the foundation of the due diligence process.

  3. Determining the scope of the procedure

    The process of due diligence may be done on all business aspects or just partially. For example, some only check on specific contracts, assets, finances, and reports. Determining the scope assists in assessing how long the entire process might take.

  4. Adjusting the format of the report

    While the process of due diligence is a general practice and is already widely known worldwide, different countries may use diverse formats for document reports. Suppose this process was arranged between parties of different countries. There should be a consensus on whether the format that will be used is a format that is officially recognized in Indonesia.

  5. Site visit and interviews

    The appointed legal experts may visit not only the office building but also come to check the company's assets. Depending on what kind of business the parties are involved in, it may include lands, stores, outlets, manufacturing areas, factories, and so on. The representatives of the companies perform interviews, on the other hand.

  6. Information-based investigation

    At times, the appointed legal experts may see the need to gather information from other institutions or third parties to support the process of due diligence. For example, when it comes to legal history, the local court might be visited by legal experts to find out how the case was settled.

  7. Cross-checking the findings

    Once the interviews, the on-site visit, and the document reviews are done, it does not mean that the process of due diligence has been completed. Instead, the legal experts must cross-check their findings to ensure all important and necessary steps have been taken and conducted properly in alignment with the parties' vision for the future.

HOW CAN WE HELP

Our experienced team is well-versed in performing due diligence to assist you in achieving your business goals. With years of experience, we go above and beyond to ensure that all necessary steps are properly conducted so that the result of the process of due diligence proves satisfactory. We are ready to go above and beyond to assist your future endeavors in business.

REFERENCES

FAQs

Not specifically, but to those unfamiliar, it might seem to be the same.

While it might seem similar to an audit, due diligence differs specifically by focusing on the asserted information given to one party by the other. Most of this information has been formed from financial statements, so due diligence makes it possible to assess benefits, liabilities, risks, and opportunities based on those documents.

Generally speaking, what may be included within the process of due diligence vary and differ from one business to another and from one company to another. The reason is that what’s required depends on what the company wants and needs; not only the company but also the bank, broker, investor, lawyer, and others may need.

Examples of the needed items are:

  • Financial performance and information
  • Company background and history
  • Company structure and organization
  • Cash flow assessment in the present and the future
  • Legal reviews
  • The sustainability of the company

Due diligence is easily recognized as the most time-consuming and especially tiring part of a company review process, no matter how one acknowledges it as essential. Due to it taking a lot of energy to be performed, misconceptions tend to happen here and there, including:

  • Short-changing the process
  • No involvement of the field experts
  • Excluding the assessment of company forecast and working capital assets
  • Reliance on unaudited information

Thank you for sharing

CONTACT US

Keep in touch

Subscribe to our newsletter

Connect With Us

Subscribe to our newsletter to get the latest information about the laws & regulations in Indonesia.