Joint venture partnerships (JVP) have evolved over the years and while these have been successful in a majority of instances in India, many instances of adverse outcomes present a cautionary tale. In this context, integrity due diligence (IDD) has emerged as a powerful tool to unearth additional information and risks that can have a material bearing on the decision to proceed with the JV. Consequently, this has gained increasing importance for companies – especially international investors and corporates operating in a multi-jurisdictional context – keen on establishing partnerships with individuals and companies of high repute and rectitude.
While it is routine for JV partners to undertake a rigorous diligence of the other party, the core focus of such diligence centres around operational, financial, governance and compliance aspects to ensure that they are in line with applicable laws and standards of territories in which it operates. IDD, often undertaken independent of the routine diligence, examines an entity's operations in minute detail and conducts an in-depth analysis of reputation and risks associated with corruption.
Such diligences are usually undertaken by gathering of independent information, as against the typical corporate or financial diligence where target entities provide relevant information and are aware of the processes being undertaken.
IDD can provide useful and actionable intelligence on a range of parameters. Firstly, it can help unearth the ultimate ownership of the target company. Hidden beneficial ownership is a major problem in JVs and M&As, and authorities have increasingly regulated and restricted multiple layers of investments, as well as distinguishing between legal and beneficial ownership. Countries such as India have gone further and imposed restrictions on beneficial ownership depending on the country to which the owner belongs.
Secondly, IDD can help mitigate the risk emanating from inadvertent lapses by, or an oversight on, the part of local partners, who are often entrusted to deal with government officials while setting up industries or factories, obtaining regulatory approvals, liaising with government officials and agencies, etc. These can expose international partners to reputational damage, regulatory inquiries and allegations of money laundering, bribery and corruption. Problems may be red flagged by any reluctance by companies to agree to broad conditions requiring compliance with laws regulating bribery, corruption and money laundering. Integrity due diligence of a JV partner can bring to light prior instances of such situations and allow the investor to take appropriate measures.
Thirdly, a thorough KYC and identity/background check conducted as part of IDD may help identify prior instances of wilful default, criminal allegations, adverse media and market reputation, retired officials being paid to act as directors, etc., which may escape scrutiny during the traditional diligence exercise. Many companies appear to have robust compliance mechanisms in place and do not have, on record, any allegations of malfeasance, fraud, bribery or money laundering. IDD can be especially effective in discovering prior red flags pertaining to the company and its key management personnel.
Fourthly, IDD can aid in unearthing issues pertaining to any potential de facto control leveraged by key officials, organized crime groups or political patronage and also trace the sources of funds which the JV partner is utilizing to operate businesses.
If not complete deal breakers, adverse findings following a comprehensive IDD exercise will allow prospective partners to put in place adequate protection in contractual arrangements. Common protective covenants include unlimited indemnity for any acts of money laundering, bribery or fraud and a comprehensive exit clause that allows the exercise of put options or compulsory IPOs. However, prospective partners should consider whether reputational loss and damage can ever be recovered.
Integrity due diligence conducted before forming any association will save an investor from reputational loss, diminished market value, potential litigation, adverse impact on revenue and profitability, and financial loss. It can significantly increase the chances of an investor becoming associated with a reliable business partner, which is often critical to the long-term success of a JV partner.
Originally Published by India Business Law Journal, December 2020
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