1. Introduction

In simple terms, mergers and acquisitions ("M&A") are similar to marriage and partnership. Before entering into a partnership, it is important to know the current conditions of your prospective, corporate partner. To ascertain the true, legal condition of a company, it is highly recommended to start an M&A transaction with a Legal Due Diligence exercise ("LDD")

LDD shall be conducted by lawyers who are familiar with handling M&A transactions and capable of identifying the key legal issues, to provide the potential buyer with the required information on the prospective target company. The LDD findings should determine whether the target company is appropriate for the buyer's aim and business plan.

2. Why Legal Due Diligence?

Firstly, an LDD would provide the purchaser with an initial overview of the company's condition. This is to ensure that all the possible red flags and liabilities of the target company are known by the purchaser before the transaction becomes effective.

Secondly, should the LDD discover various red flags, the purchaser would know the real value of the company and identify the issues that need to be resolved by the purchaser or target company before completing the transaction.

Having completed LDD before commencing a transaction would be financially beneficial for the purchaser in the long run. The purchaser would be able to identify whether the target company is a viable investment. The purchaser also needs to assess the liabilities and risks associated with the target company. The result of the LDD would allow the purchaser to plan on what needs to be fixed or avoided when commencing the transaction. In essence, it would be good to know your counterpart before entering into any partnership. A blind buy into an Indonesian company would not be the best idea.

Additionally, if the purchaser comes from a different jurisdiction, an LDD exercise would provide the purchaser with a general overview on the regulatory compliances for certain business activities in Indonesia. This matter is important to make sure that the purchaser would be able to manage the newly acquired company in accordance with the prevailing laws and regulations.

3. Key Legal Aspects of a Legal Due Diligence

Generally, an LDD on an Indonesian company should, at least, cover the key, legal aspects. Apart from these aspects, some specifics such as licensing, reporting obligation, and other relevant matters would also be materially important.

a. Corporate Structure and Governance

It is important to review the corporate structure and governance of the target company to ensure that it is in compliance with the Indonesian law, particularly Law No. 40 of 2007 on Limited Liability Company ("Company Law").

This includes reviews on the (i) Articles of Association ("AoA"); (ii) shareholders agreements; and (iii) other corporate documents, such as those on the management board of the company, the shareholder register, and the acknowledgement receipts and/or approvals of the Minister of Law and Human Rights ("MoLHR").

Aspects materially important to be ascertained are, among others, whether the company has been duly established in compliance with the Company Law, the shareholding composition, the issuance of the company's shares, also the material provisions under the company's AoA, and shareholders' agreements that may affect the transaction.

b. Material Contracts with Third Parties

Before proceeding with an M&A transaction, it is important to identify the material contracts that the target company has entered with third parties. This would include: (a) material contracts with vendors, (b) material contracts that contribute to the company's revenue, (c) contracts governing the loans and securities over the company's assets, and (d) other material contracts that result in liabilities or obligations of the company.

Any contract entered by the target company implicates the imposition of rights and obligations under the relevant contract. The purchaser should know the matters governed by these material contracts so that the rights and obligations of the company are identified.

c. Licensing and Regulatory Compliance

It is crucial to ascertain that the target company has continuously fulfilled the applicable regulatory compliance under Indonesian laws for implementing the good governance practice. This would include ensuring that the target company holds the appropriate licences, registrations, and/or documentations corresponding to its business activities.

A company that does not hold the appropriate licenses or operates without the correct licenses may be subject to administrative sanctions. To minimize such risk, the purchaser must ensure that the target company is adequately licensed to operate its business, and complies with the obligations attached to such licenses.

In an LDD exercise, it is important to review the (a) general corporate licences, and (b) operational licences, which include:

a) General Corporate Licences include the: (i) Certificate of Domicile (Surat Keterangan Domisili Perusahaan or "SKDP"); (ii) Company Registration Certificate (Tanda Daftar Perusahaan or "TDP"); (iii) Taxpayer Identification Number (Nomor Pokok Wajib Pajak or "NPWP"); (iv) Certificate of Taxpayer Registration (Surat Keterangan Terdaftar Pajak or "SKT"); (v) Taxable Entrepreneur Confirmation Letter (Surat Pengukuhan Pengusaha Kena Pajak or "SPPKP"); and (vi) Business Identification Number (Nomor Induk Berusaha or "NIB").

(b) Operational Licences include all licences required for the target company to carry out its business activities. In this regard, any business activity of a company should be listed in the Indonesian Business Field Classification (Klasifikasi Baku Lapangan Usaha Indonesia or "KBLI"), and included in the company's NIB. Any business of the target company as listed in KBLI is subject to different requirements regulated by the Indonesian Investment Coordinating Board (Badan Koordinasi Penanaman Modal or "BKPM"). In this regard, Head of BKPM Regulation No. 4 of 2021 on Guideline and Procedure of Risk-Based Business Licensing and Investment Facility Services ("BKPM Reg. 4/2021") stipulates that each business under KBLI is subject to different risks with different licensing requirements:

  1. Low Risk: Only requires NIB;
  2. Medium Low Risks: Requires NIB, Standard Certificate ("SC"), and the owner's statement letter stipulating the minimum standard fulfilment of KBLI requirement;
  3. Medium High Risks: Requires NIB and verified SC. SC is obtained after a verification process before the relevant central and/or regional governments, and/or relevant ministries.
  4. High Risks: Requires NIB and the Licenses. From time to time, the relevant government and/or ministries shall request for the competency license(s) as required under Indonesian laws and regulations.

It is also important to review all documents relating to the company's compliance with the mandatory reporting as required under the laws and regulations for conducting its business in Indonesia, which include the Quarterly Investment Activity Report (Laporan Kegiatan Penanaman Modal or "LKPM").

d. Litigation and Disputes

The purchaser should know whether the target company has any ongoing and pending litigation.

Evaluating litigation and disputes can provide insights into the company's business operations, and the way it dealt with legal disputes in the past. This can help the purchaser to assess the company's risk management practices, as well as its overall approach to legal and compliance matters. Some industries or businesses are prone to risk of litigation. Litigation could impose material legal risk. As such, any active litigation involving the target company must be known by a potential buyer.

e. Assets

Ascertaining the legal status of the target company's assets is materially important. If the target company owns a land or property, the scope of LDD should also include ascertaining the true legal status of the land or property.

The assessment should include, among others, confirmation on whether: (a) the land has been secured or encumbered for the interest of other third parties, (b) the property is properly registered under the name of the target company, (c) the title overlaps with other ownership titles of third parties, (d) the use of the relevant property is appropriate for its designated purpose.

If the company's assets include shares ownership in another company, a limited LDD on the ownership of the subsidiary and/or affiliate entity would be necessary.

f. Manpower Matters

Any companies duly established under the laws and regulations must conform to the Indonesian manpower laws, as stipulated under Law No. 13 of 2003 on Manpower, as lastly amended by Government Regulation in Lieu of Law No. 2 of 2022 on Job Creation ("Manpower Law") and its implementing regulations. Such conformity should include the target company's obligation to meet the Manpower Law requirements for establishing the employer-employee relationship in the company.

The LDD exercise should also identify any ongoing and/or outstanding dispute in the Industrial Relations Court ("IRC") between the relevant employer (i.e., target company) and employee(s). In this regard, any employment dispute in Indonesia is subject to Law of the Republic of Indonesia No. 2 of 2004 on Industrial Relation Dispute Settlements, as lastly amended by Constitutional Court Judgment No. 49/PUU-XIV/2016 ("Law 2/2004").

It is crucial to ensure the target company's compliance with the Manpower Law. Such compliance would even be more important when the target company operates a labour-intensive business activity such as manufacturing. Any incompliance could expose the company to considerable risks of operational as well as financial losses.

4. Risks of not Conducting Proper Due Diligence

In some transactions, the purchaser, seller, and the target company may agree to skip the LDD process to speed up the completion of the transaction. In this case, the parties usually rely on the representation and warranties of the seller or target company. Although this approach is practically possible, there are considerable risks that the purchaser may encounter major financial implications.

To ensure that all the legal and financial risks are known by the purchaser and all parties, LDD, as well as financial and tax due diligence are highly recommended to be done before commencing the transaction. In many cases, taking the most conventional approach would be more cost-effective for a new investor or shareholder in a long run.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.