Business transactions often require that many people trust a few people to make important decisions about investing money, buying or selling businesses, or pieces of businesses, and other complicated matters. The law protects all of the people affected by the business decision by requiring those charged with making the decision to exercise due diligence.
Due diligence is a legal concept that refers to the reasonable care that a person should take before entering a business agreement. At a minimum, this typically requires a review of all pertinent financial records and other documents that are material to the proposed transaction. How to Perform Due Diligence Since every business transaction is unique, the law does not impose specific details about what must be reviewed in order to perform due diligence in every business deal. However, those performing due diligence should be prepared to review the following types of documents, and to defend their position if they decide not to review any of the following: · Bank Statements; · Articles of Incorporation, by-laws and other official governing documents of a business; · Corporate minute books; · Records of stock transfers; · Tax returns; · Loan documents; · Policy and procedure manuals; · Budgets; · Business plans; · Employment contracts and / or union contracts; · Employee compensation plans, including wages, bonuses and raises; · Insurance policies and payouts; · Documents indicating compliance with government regulations (such as environmental regulations); · Pending litigation; · Possible claims against the business; or · Anything else that affects the value of the business that your company is considering purchasing or merging with. This list is far from exhaustive and is meant to give you an idea of the various types of documents that might be important to your transaction. It is important to get an in depth understanding of all of the existing and potential assets and liabilities of the business before you enter a business relationship with that business that could affect the future of your business and the well being of your stockholders or other business owners. Consequences for Not Performing Due Diligence If your stockholders or other business owners are harmed by your failure to complete reasonable due diligence then they may sue for damages. If the failure to perform due diligence was a result of negligence, rather than a malicious intent, then the stockholders may sue you and recover damages for the harm caused by the company’s failure to perform due diligence. If the due diligence was not performed because of a deliberate act of those responsible for completing the due diligence than criminal charges may also be brought and the criminal penalties may include fines and jail time.
The legal concept of due diligence in business recognizes that it is impossible for every stockholder, or business owner, to know all of the minute details that go into making a good business decision. Therefore, a duty of due diligence is imposed on their agents to find out everything that is important to know about the possible transaction.