Organizations need to be Diligence Ready from Corporate Secretarial Compliance Standpoint

1. Introduction

Compliance Due Diligence or Corporate Due Diligence is an extensive and thorough process by which risks are measured and analyzed through investigating, monitoring and auditing the set of compliances that are applicable on the organization.

The term “Due Diligence” is inclusive of the term “Compliance”. By conducting Due Diligence, it is possible to check whether a Company adheres to the required set of laws, rules and regulations, i.e., whether it is legally compliant. An organization which is diligence ready, will be adhering to all the corporate governance norms thereby meeting the expectations of all stakeholders and requirements of the Regulators. While Due Diligence encompasses compliance from various angles, this article will majorly cover Due Diligence from Corporate Secretarial Compliance standpoint.

2. Different types of Due Diligence

Due Diligence can take different forms. In any transaction, the first step is the commercial and operational due diligence to assess the market risks and opportunities for the products or services the business is offering. Once this is satisfactory, the other types of the due-diligence are undertaken some of which are discussed below:

1. Financial Due Diligence-This involves investigating and monitoring the past & present matters relating to the financial affairs of a Company which includes the Financial Statements (Profit and Loss, Balance Sheet, Cash Flow statement) of the Company, its revenue projections, capital structure, debt, and more.
2. Legal Due Diligence-?Legal Due Diligence?will involve due diligence of all legal matters of the Company, i.e., it will ascertain what are the potential legal risks that will crop up in any upcoming transaction relating to funding, merger, amalgamation or takeover. All material contracts and agreements will be inspected, including joint venture or partnership agreements, licensing agreements, and loan agreements in a legal due diligence.?It will ensure whether the Company has met its legal obligations or not.
3. Human Resource Due Diligence-?In any business acquisition or takeover, human resource due diligence also has to be done considering the No. of employees, Details of employees, Hierarchy pattern, Employment contracts, Employee agreements, contracts including non-compete agreements, Employee benefit plans etc.,

Corporate Secretarial Compliance Due Diligence (broadly under Companies Act, Foreign Exchange Management Act and NBFC Regulations)

There are several compliances under different Acts and Rules that a Company has to abide by and the few applicable acts are discussed below:

Companies Act :The?Companies Act,?2013 regulates the formation and functioning of corporations or companies in India.?The broad scope of work under Companies Act encompasses:

1. Board Management?– Documentation & process for convening of Board Meetings for decision making by the Board and changes in the Board constitution.
2. Shareholder Management?– Documentation & process for convening of General Meetings for seeking members approval
3. Compliances & Reporting to the Regulator?on event based compliances and Annual compliances
4. Maintenance of Records?– Maintenance of Secretarial records including minutes, Statutory Books.
5. Audit and other certifications?as required under the Act.

Foreign Exchange Management Act (FEMA):?

Foreign Direct Investment made?in?an Indian Entity, mandates?compliance?under FEMA?and RBI?regulations?and any failure to report and file necessary documents with the Reserve Bank of India shall lead to compounding of offences and heavy penalties.

The Broad reporting’s under FEMA can be categorized as under:

1. Reporting for Issue of shares to non-resident,
2. Reporting on transfer of shares and other eligible securities between residents and non-residents and vice- versa
3. Reporting for loans availed by an Indian entity from a non-resident lender in the form of External Commercial Borrowing
4. Reporting for Overseas Direct investment made outside India by way of contribution to the capital or subscription to the Memorandum of a foreign entity or by way of purchase of existing shares of a foreign entity
5. Filing of an Annual return on Foreign Liabilities and Assets in the event of Foreign Direct Investment (FDI) & submission of Annual Performance report in case of any Overseas Direct Investment (ODI) by a resident.

NBFC Regulations:

NBFC Compliance?is a mandatory requirement?for?all the registered Non-Banking Financial Companies.?Some of the major compliances are categorized below:

1. Application and Registration and application for license.
2. Intimation to RBI regarding change in information relating to address, telephone Nos and email id etc., of registered office of the entity or directors or the auditors.

Due Diligence under Employment & Establishment Related law Compliances

There are several employment & establishment related acts and regulations which have to be complied with by every organization. Some of the social security laws include The Employees’ Provident Funds and Miscellaneous Provisions Act 1952, The Gratuity Act 1970, Employees’ State insurance Act 1948, Pension Funds Act apart from the establishment related laws like the Shops & Establishments Act etc.,

3. Broad Scope of Due Diligence

Due Diligence/ Corporate Due Diligence can take different shapes and forms. Irrespective of the type of Due Diligence, it encompasses the following aspects:

1. Investigating & auditing:?Due Diligence is an investigative process which ascertains how potential and beneficial the investment is and it will check compliance with the various applicable laws, whether there are regulatory violations or disciplinary actions, whether there are legal pitfalls, or any external trade or cross border issues.
2. Monitoring & mitigating risks:?While conducting Due Diligence, various set off factors have to be considered and risks are to be ascertained and decision has to be taken whether or not to go forward with the corporate action or not.
3. Taking preventive action:?If the degree of risk is much more than anticipated, then steps are to be taken to reduce them. Due Diligence can used as a preventive aid.
4. Regularizing the gaps –?Once the above stages are completed, and the gaps are identified, organization can take steps to regularize the compliances gaps and ensure that all future actions are compliant & diligence ready.

4.When do organizations go through Due diligence? (Funding, M&A, strategic alliance etc.,)

The main reason to conduct Due Diligence is to reduce the level of risks in a potential upcoming investment. There are several instances when a Company needs to conduct Due Diligence. Few examples of such are discussed below:

1. Funding, Business Acquisition or Takeover:?In case a company is seeking potential investment or a Company is being acquired by another, the Investor or acquirer will undertake due diligence which includes knowing the market capitalization, revenue, profit or losses, no of employees, valuation, indebtedness of the later, credibility, reputation and goodwill and so on to assess whether funding/acquiring the later will be beneficial or not and assess the risks involved in due course.
2. Merger & Amalgamation (M&A):?M&A s are one of the most important forms of corporate events these days. If Company A is getting merged with Company B, then both Companies have to check if the merger will be fruitful and what are the potential risks that might crop up.Any takeover, merger or amalgamation requires pre and post takeover/merger compliances which includes conducting meetings, filing forms etc. and adherence to several laws and regulations.
3. Joint Ventures (JVs) or Partnerships:?JVs and Partnerships are good ways of expanding businesses or making Companies more profitable. But in order to do these, extensive background checks have to be conducted to assess and understand the strength of each JV partner, risks & challenges involved, pre and post compliances and several other factors.
4. Secretarial Audit:?As per section 204 of Companies Act, 2013 all listed company and other applicable Companies are required to get a Secretarial Audit Report certified by a Practicing Company Secretary. In order, to issue the Audit Report, the PCS must run due diligence of what all compliances the Company has done, to certify whether such Company is compliant with the applicable laws and regulations.

5. Why should organizations be compliant/Diligence Ready at any point of time?

Every entity must be compliant in order to avail the following benefits at various levels:

1. Protects investor’s wealth and enhances credibility of the entity with the investors and banks in securing investments, loans etc.
2. Enjoy healthy returns in the form of employee retention, customer’s loyalty, public respect towards the organization and also provides greater shareholders returns.
3. Better Brand image and reputation, which in turn helps to secure stronger market capitalization.
4. Attracts prospective buyers or investors to acquire or invest
5. Helps in avoiding penalties, both monetary and imprisonment.
6. Cost savings by avoiding delay filing fees, fines and minimizing litigation.
7. Improved operations and higher productivity

6.Consequences of not being compliant/diligence ready

If a Company is found to be non-complaint, it might have to face some severe consequences such as:

1. Loss of credibility
2. Loss of goodwill and reputation
3. Loss of investor’s trust, as a result of which they might lose interest in the deal
4. Legal actions can go on for years
5. Heavy fines and penalties
6. Imprisonment of Officers in default in worst case scenarios
7. Closure of business

7. Conclusion

Therefore, it is extremely important for organizations to be Diligence ready. Due diligence conducted by an independent external agency will be unbiassed and fair.

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Disclaimer:

The content of this document has been developed based on relevant information and is purely for private circulation. Though the authors have made utmost efforts to provide authentic information, however, the authors expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and consequences of anything done or omitted to be done by any such person in reliance upon the contents of this document.