The Importance of Conducting Due Diligence Prior to Entering into Legal Contract or Business Transaction

Why Conduct Due Diligence?

Before entering into any legal contract or business transaction, a reasonable person must exercise care and discretion. Mergers and acquisitions are among the most common transactions in today’s business world. In this regard, before making any acquisition or investment, officers of companies have the fiduciary duty to perform thorough due diligence. After all, these officers have to make sure that their investments would translate to solid Returns on Investments.

What is Due Diligence?

Due diligence refers to the process by which one examines all the critical aspects of the business which is subject to the business transaction. Every aspect of the business – financial, operational, human resource, tax, regulatory, etc.- is opened up to investigation. Due diligence is usually undertaken at the request of a purchaser or investor, helping them verify the provided information and to discover any undisclosed problems.

Due Diligence thus has various purposes. First and foremost, due diligence enables the purchaser to evaluate the current state of the business where they want to invest in. It also helps them determine whether or not the target of the transaction is compliant with relevant laws and are not affected by any regulatory restrictions. Due diligence also helps in terms of finding out any undisclosed information that could threaten the business deal. Finally, due diligence also helps in the evaluation of the legal and financial risks relative to the transaction. Without a doubt, due diligence helps companies in reducing, if not eliminating, the risks associated with their business transactions.

A buyer should thus be able to use due diligence to investigate the company to be invested in or to be acquired before the transaction is consummated and documented. In the United States, courts have been hesitant to provide a remedy to a purchaser that neglects the due diligence process because of their failure to either investigate adequately or by ignoring the information that they have discovered. While the Supreme Court of the Philippines has yet to rule on the negligence of purchasers to adhere to the due diligence process, courts in the country may nevertheless hesitate to grant relief to purchasers that fail to exercise due diligence. After all, the principle of caveat emptor (buyer beware), which requires the purchaser to exercise such care and attention as is usually exercised by ordinarily prudent men in like business affairs, applies in this jurisdiction.[1]

[1] Jaime Guinhawa vs. Tinga and People of the Philippines, G.R. No. 162822, August 25, 2005.

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