Due Diligence legal research procedure in Ukraine

"Business is the ability to make the right business decisions in the face of uncertainty" (Harvard Business School).

New terms are being actively used in modern domestic business: marketing, consulting, naming, etc., mostly in English, but historically in Latin, and their knowledge is no longer something to brag about, as it was in the "turbulent 90s." However, the culture of doing business has not changed that much since then, and that is why the active use of such terminology still gives no reason to be confident in the integrity and responsibility of a partner or even a government agency.

The concept of due diligence is one of those purely "Western" concepts that are not peculiar to the Slavic mentality, but business practice shows that it is widely used in domestic business relations. It is also characteristic that it is not possible to translate this phrase unambiguously, which not only does not harm but also expands the prospects for its use - in the literature one can find such interpretations as "due diligence", "legal analysis of the history of a legal entity", "study of the company's activities", "business research", etc. Most broadly, it can be characterized as an informal procedure for collecting and analyzing information in order to assess various risks, without which it is impossible to imagine a live business process. Although the writer said "If there were no risk, there would be no progress!" (V. Veresayev), any risk in business must be based on analysis and calculations, and it is possible to predict the fate of an enterprise, idea or project thanks to due diligence.

The term was first used in the US Securities Act of 1933, when it was explicitly defined to provide a standard for judicial practice on the scope of requirements for its implementation in relation to various companies, and meant "disclosure by a broker to an investor of information about a company whose shares are traded on a stock exchange". In the modern sense, due diligence was developed in Switzerland in the 1970s to avoid strict government regulation and control over the activities of banks.

It is clear that this service began to gradually penetrate our business world only in 2000-2001, when the Ukrainian economy was growing after the long recession of the 1990s, and the due diligence market began to develop most rapidly in 2004, when large foreign companies appeared in Ukraine and the largest domestic financial and industrial groups were formed.

Interestingly, certain elements of due diligence were also manifested during the reign of the administrative command system - although in the USSR there was no question of such unconditional principles of the market economy as private property, free competition, freedom of choice, etc., management decisions on the transfer of an enterprise from the competence of one agency to the competence of another were always justified, including legally.

Of course, the high-profile positioning of consulting firms in practice also often reveals a lack of auditors' experience - excessive concentration on unimportant issues during the analysis, while the aspects that are really important to the investor remain sometimes unexplored. Unfortunately, even the diplomas and knowledge gained by the specialists of such companies in brilliant law and economics universities overseas cannot be fully applied in Ukraine - controversial tax legislation, poor quality of financial reporting, complexity of accounting, and the presence of a large number of assets that cannot be further exploited (at old enterprises established before Ukraine gained independence in 1991) sometimes negate all the aspirations of highly qualified analysts during the due diligence process.

Particular care should be taken when choosing an expert to conduct a due diligence if the buyer and seller are located in different jurisdictions or if the property and the entity interested in it are located in different countries. For Western partners, the very style of domestic entrepreneurship, even its organizational and legal forms, and even more so - Ukrainian legislation, seem not entirely clear, and therefore the key to the transaction may be the establishment of partnerships, which Due Diligence should facilitate.

When is Due Diligence indispensable?

Today, Due Diligence in Ukraine is most in demand by foreign companies, and its volume directly depends on the level of investment, because objectively, it is foreign partners who will not take any business step without a clear analysis and vision of prospects. At this stage, the most commonly practiced in Ukraine is conducting Due Diligence as a support for M&A transactions - any transactions that involve a change in corporate rights.  

Due Diligence is also required when a company enters the international capital markets through an IPO (initial public offering). Practice shows that, unfortunately, in half of such attempts, Ukrainian companies fail in this process due to non-compliance by domestic issuers with the listing requirements (a set of procedures for including securities in the stock exchange register) in their international market. In addition, the main costs of IPOs are the commission payments to partners and advisors, and as you know, our businessmen are known to save money on this. In general, IPOs are only for companies with large turnover and a strong position, and the risks are justified for a modern manufacturer in very limited industries, except for agricultural or processing. 

Globally, it is difficult to list the areas of application of the Due Diligence procedure, in each of which it acquires individual features.  

• in the field of patent activity (industrial property), it is a continuous activity after the conception of an invention aimed at its practical implementation;
• in the financial sector - due diligence and examination:
• by a potential investor - of the financial condition and prospects of a company applying for investment, or by a buyer before the acquisition, purchase of its shares, merger or acquisition;
• by underwriters - completeness and validity of information provided by the issuer in connection with the placement of a new issue of securities; by a lender - loans issued to determine or reassess credit risk;
• in the legal field - care and diligence in analyzing documentation, especially in contractual activities.

For the Western world, this term is so practical that no one will be surprised by environmental due diligence, which is the verification of compliance with the use of subsoil, land, water, air and other resources that are part of the environment, or technical due diligence, which is the verification of design and estimate documentation, or marketing due diligence.

Comprehensiveness and informality are very important in the approach to the practical implementation of due diligence, especially in business research. It is no exaggeration to say that inadequate perception and a certain lack of awareness of these principles impede real due diligence in domestic business processes. Practitioners conducting large-scale research in the West prefer exclusively comprehensive research, moreover, informal research conducted orally, in particular, by interviewing employees. It is due diligence that helps to establish a truly trusting relationship when concluding and executing a major transaction between counterparties.

Stages of legal due diligence

The purpose of legal due diligence is to resolve two key issues: whether to enter into a transaction at all and, if so, at what price. But it is obvious that in practice, attempts to answer these questions can lead even an experienced entrepreneur to a dead end or lead a successful company to bankruptcy. To prevent this from happening, you should entrust this crucial procedure only to proven and practically oriented professionals, primarily lawyers and analytical economists. They will be able to focus your attention on the pitfalls of apparently profitable deals and find the silver lining in seemingly failed projects or bankrupt companies. 

Another problem is the search for reliable information that should be the subject of due diligence. It would seem that in the world of information overdose and Internet technologies, this will not be long in coming, but all such material requires verification of relevance and reliability to serve as material for analysis due to its anonymity and high probability of fake news.

A separate issue is obtaining insider information - "closed" information that for some reason or at the moment is not known to the general public. In some cases, it is extremely difficult to obtain the owner's consent and comply with its legal regime, but it is also difficult to overestimate its importance. For example, in the United States, the Securities Exchange Commission (SEC) is a special supervisory body authorized to check transactions for honesty, and even the presumption of innocence does not work here. The slightest suspicion of dishonesty can undermine a reputation and permanently block an entrepreneur's path to the market.

Restoring the attractiveness of the securities market by legislatively restricting any type of fraud in this area was one of the priorities of American policy during the economic crisis of 1929. It was the Securities Exchange Act of 1934 that defined "insider". Today, just by going to the financial section of Yahoo! and typing in the name of a company, you can see a list of all companies that have been officially considered insiders over the past two years.

Even if similar rules restricting the use of insider information in business were adopted in Ukraine, it would hardly change the real situation - just look at the fate of the terms "commercial" and "bank secret", which are enshrined in law but are forced to exist in a double standard of our legal consciousness. In general, corruption, bribery, and nepotism are the dirtiest features of domestic (and not only) insider knowledge.

The same applies to open information gathering - unfortunately, the culture of communication, not only in business, allows some people and certain companies to ignore the requests of partners, leaving them unanswered.  

Legal analysis involves researching the following issues

• ownership regime;
• administrative and legal aspects (availability of permits, licenses, patents);
• obligations and encumbrances related to the object;
• legal assessment of taxation and other financial risks, etc.

For large objects, political, constitutional and legal issues may also arise.

Due diligence ends with the provision of a report on the state of the research object, which consists, like any document of this nature, of three parts

• introduction (legal grounds for conducting the audit - contract with the customer; documents used as the subject of analysis; regulations applied in the process)
• main part (methods of researching issues; risks - preliminary conclusions, statement of facts);
• conclusions (recommendations to the customer).

Types of business risks ("pitfalls") that are worth paying attention to:

• default by the debtor;
• loss of property;
• seizure of property or other interim measures;
• recognition of the transaction as invalid;
• foreclosure on property, securities (shares);
• bringing the counterparty to liability (tax, administrative or criminal).

In today's world, Due Diligence has long been a necessary step not only in the investment process but also in risk management. Research of the investment object is possible even after the investment, remaining a tool to protect the interests of the investor. It is also very valuable to involve persons who are not professional lawyers or economists but have knowledge in related fields (employees, experts, company personnel), which requires the gradual advancement of our business community and ordinary citizens to truly European humanistic and democratic values in communication.

In today's world, Due Diligence has long been a necessary step not only in the investment process but also in risk management. Due diligence of an investment object is possible even after the investment, remaining a tool for protecting the investor's interests. It is also very valuable to involve persons who are not professional lawyers or economists but have knowledge in related fields (employees, experts, company personnel), which requires the gradual advancement of our business community and ordinary citizens to truly European humanistic and democratic values in communication.

The complexity of providing Due Diligence services in the domestic context is primarily due to the low culture of business relations, the global atmosphere of distrust and, in part, the outright disregard for the principles of honesty and transparency. However, the need to modernize production, develop relations with investors, and enter international capital markets convincingly prove that openness and compliance with contractual terms in business relations are no longer a fashion, but a mandatory requirement.

If you are striving for confidence, reliability and profitability of your business, contact our company for Due Diligence service before signing an important contract or purchasing real estate. Our specialists - both lawyers and qualified economists and accountants - will be able to provide you with comprehensive information on the profitability of a particular transaction. Consider the experience of the greats: "All unscrupulous activity eventually leads to bankruptcy" (Goethe).

 

Comments