The ongoing Parliamentary investigation into the failed retailer BHS has thrown the spotlight onto the often misunderstood process of due diligence.  It’s something which is relevant to most corporate transactions, including the sale and purchase of a business, a joint venture or a high value commercial contract.  The phrase “due diligence” is bandied about by clients and advisers. While it is generally understood to mean a comprehensive investigation into and report on a company, the detail of any due diligence exercise is worth careful consideration at the outset of a deal. 

Traditionally, due diligence will be divided into a number of different workstreams and each will be led by a set of advisers.  At Ortolan Legal, we often conduct legal due diligence on a business on behalf of our clients.  Depending on the circumstances and the nature of the transaction, this may include reviewing the corporate structure of a business, its capacity to enter into the proposed transaction, key contracts and property matters, title to (i.e. ownership of) significant assets including intellectual property, employee and pension issues and the regulatory regime which affects the business.  We will also be interested in any litigation, whether active or threatened. 

Other advisers - and often the client themselves - will do due diligence on the commercial drivers of the business, its strategy, the competitive environment and key stakeholders.  Financial due diligence will focus on the accounts and whether they offer a true and fair view of the financial information set out in them.  Areas such as cashflow and working capital will often undergo particular scrutiny.

Clearly there will be overlap in these workstreams and it is critical that any due diligence exercise is not only properly planned, but also led and coordinated by one adviser.  On larger transactions this may be an investment bank or financial adviser.  On smaller transactions it could be a senior member of the client’s management team or in-house counsel.  The important thing is that one person is clearly identified and the exercise should be run by them like any other project.  If the leader is not a member of the client’s management team then someone of similar status should be nominated by the client as their lead person for the exercise.

Today we need to ensure that more lateral thinking goes into due diligence.  Not only into the type of due diligence to be conducted, but also when some form of due diligence should be undertaken.  For example, manufacturers know that their liability for failures in their supply chain can be financially devastating.  So before entering into a contract with a supplier they need to conduct due diligence to satisfy themselves about the supplier’s ability to deliver the required quantity and quality of goods.  But since the introduction of the Modern Slavery Act in October last year, larger businesses also need to satisfy themselves that modern slavery – which includes slavery, servitude, forced or compulsory labour and human trafficking – is not taking place in their supply chain.  This applies to any business which supplies goods or services, has a global turnover of £36 million or more, and carries on business in the UK.  It should form an essential part of any supply contract due diligence today. 

Another relatively recent piece of legislation, The Bribery Act 2010, has created criminal offences which  are now being successfully prosecuted.  In February this year Sweet Group Plc pleaded guilty to a charge of failing to prevent an act of bribery and were fined £1.4 million as well as receiving a confiscation order and a costs order which brought the total they had to pay to £2.25 million.  Due diligence to ensure that a company has no exposure to liability under the Bribery Act is a real and live issue for UK businesses today.

And what can we learn from the BHS farrago?  Traditionally, the seller’s due diligence on the buyer of a business has tended to focus more on their ability to pay and to properly enter into the transaction.  In the case of BHS, the reputations of a number of individuals and their advisers are at risk of being tarnished because Parliament’s select committee has suggested they should have enquired more fully into the background of the purchasing entity, Retail Acquisitions Ltd, and its directors and ultimate shareholders.  Whether this should have formed part of their due diligence in the context of the powers of the Pension Regulator in relation to “moral hazard” is a separate issue.  This isn’t going to fundamentally change the nature of due diligence exercises, but it should highlight a factor for businesses and their advisers to consider when planning any due diligence.   That is the reputational question.  Perhaps we should all be asking ourselves what might be the reputational impact if we discount an element of due diligence which otherwise seems unnecessary and then reconsider it in that context.