Due Diligence: How to Conduct a Thorough Examination of a Counterparty within a Company

• What Is Counterparty Due Diligence
• Why Conduct Counterparty Verification
• Who Should Perform Counterparty Checks
• Types of Due Diligence
  • Legal Due Diligence
  • Financial Due Diligence
  • Operational Due Diligence
  • Anti-Corruption Due Diligence
• Step-by-Step Guide to Counterparty Verification
• Specifics of Due Diligence in Russia and Abroad
• How to Conduct Due Diligence Independently
• How to Assess Project Risks
• Final Recommendations

Modern business is unimaginable without partnerships. Companies are constantly entering into new agreements, expanding their supply geography, and at times venturing into international markets. Yet, with opportunities inevitably come risks. A single unreliable partner can jeopardize a company’s reputation, trigger tax claims, or even drive the business to bankruptcy.

To avert such scenarios, companies employ the tool of due diligence — a comprehensive examination of a counterparty prior to commencing cooperation. This is far more than a formality; it is a full-fledged system of evaluation that exposes a partner’s weaknesses in advance, assesses their financial and legal standing, and ensures the transparency of their business practices.

In this article, we will explore what due diligence entails and why it is indispensable. We will also consider who benefits most from it, the principal types of verification, how to conduct a step-by-step analysis of a counterparty, and the particularities of the procedure in Russia and abroad. Finally, we will provide guidance on how to properly assess risks and apply the results of due diligence in practice.

What Is Counterparty Due Diligence

The term due diligence originates from Anglo-American law and is literally translated as “reasonable prudence.” It first appeared in U.S. investment practice during the 1930s, when brokers were required to conduct thorough examinations of companies before listing their shares on the stock exchange. Over time, this practice expanded and came to be applied across virtually all areas of business.

Today, counterparty due diligence is understood as a comprehensive analysis of information about a company or entrepreneur with whom cooperation is being considered. Such verification typically involves an assessment of:

• Legal status and authority
• Financial standing and reporting
• History of litigation
• Operational capacity and human resources policies
• Business reputation and affiliations
• Compliance with anti-corruption and tax legislation

The primary objective of due diligence is to enable businesses to make an informed decision: whether to engage with a particular counterparty or to forgo the transaction altogether.

Although the term itself is not explicitly enshrined in Russian law, the principle of “reasonable prudence” is firmly embedded in tax legislation. Should a company fail to verify its partner, the tax authorities may deem its expenses unjustified or deny reimbursement of VAT. In this sense, due diligence serves not only as a tool for risk management but also as a means of ensuring compliance with state requirements.

Why Conduct Counterparty Verification

At first glance, counterparty verification may seem an excessive precaution. Yet practice demonstrates that even major corporations encounter unscrupulous partners, and the consequences can be catastrophic.

The principal reasons for conducting due diligence include:

1. Mitigating financial risks. An unreliable partner may fail to fulfill contractual obligations, delay payments, or even abscond with prepayments. For small businesses, such missteps can be particularly devastating — a single failed deal may erase an entire year’s profit.
2. Preventing legal complications. If a counterparty is embroiled in litigation, bankruptcy proceedings, or violations of the law, your company risks being entangled in their troubles. For instance, a supplier without a valid license may disrupt deliveries, while a partner facing tax claims could jeopardize your own contracts.
3. Safeguarding reputation. In the digital era, reputational damage spreads instantly. Association with a questionable partner implicated in corruption scandals or “grey schemes” can tarnish your company’s image far more severely than financial losses.
4. Ensuring legal compliance. Russian tax authorities actively enforce the principle of reasonable prudence. If the Federal Tax Service determines that you have engaged with a shell company, VAT deductions may be denied and additional taxes imposed. Counterparty verification provides a safeguard against such claims.
5. Supporting strategic decision-making. Due diligence is not solely about risk avoidance. It can also reveal new opportunities — a partner may possess unique technologies, expertise in government procurement, or access to international markets.

Who Should Perform Counterparty Checks

Counterparty verification is relevant for all business participants, though the depth of scrutiny varies according to the scale and objectives of the enterprise.

1. Large Corporations. For these entities, due diligence forms an integral part of corporate policy. Major businesses assess not only suppliers and contractors but also clients, aiming to minimize the risk of non-payment. Furthermore, multinational corporations are obliged to comply with anti-corruption regulations, such as the FCPA in the United States or the UK Bribery Act in the United Kingdom.
2. Medium-Sized Enterprises. For mid-sized businesses, counterparty verification is a means of maintaining stability. When a company relies on one or two major clients or suppliers, their reliability becomes critically important.
3. Small Businesses and Startups. Errors in partner selection can be particularly costly in this segment. For instance, prepaying a supplier without prior verification often results in financial losses. Basic due diligence—checking open registries and requesting documentation—is usually sufficient for smaller enterprises.
4. Investors and Banks. Prior to extending credit or making investments, financial institutions conduct thorough assessments of the borrower or investment target. This analysis extends beyond documentation to include the business model, growth prospects, and quality of management.

Thus, the necessity for due diligence spans businesses of all sizes—from multinational corporations to nascent startups. The distinction lies solely in the depth and tools of evaluation: small businesses may rely on basic checks through public sources, whereas large organizations and investors are required to undertake comprehensive, multi-layered analyses. The overarching principle remains constant: the higher the transaction value and associated business risks, the more meticulous the counterparty verification must be.

Types of Due Diligence

The scope and focus of a counterparty review can vary significantly depending on the objectives of the partnership and the scale of the transaction. There is no universal approach: in some cases, verifying the legal “cleanliness” of a company may suffice, while in others, a full-scale audit encompassing financials, business processes, and reputation is required.

For this reason, several key types of due diligence are recognized in practice. Each type examines a specific aspect of the partner’s operations, offering insight into potential risks from different perspectives. Taken together, these assessments provide a comprehensive understanding of a company’s reliability, enabling informed decisions regarding collaboration.

Legal Due Diligence

Legal due diligence forms the cornerstone of any counterparty assessment. It ensures that the company genuinely exists as a legal entity, possesses the lawful authority to conduct its operations, and holds all necessary powers to enter into contracts.

This type of review typically examines:

• Constitutional Documents. These include the charter, the decision establishing the company, and information about its founders. Such documents reveal the company’s organizational structure, identify who makes key decisions, and uncover any hidden stakeholders.
• Corporate Capacity. It is crucial to confirm that the organization is not undergoing liquidation, bankruptcy, or reorganization, and that it is authorized to engage in the activities it purports to conduct.
• Licenses and Permits. Many sectors—such as construction, healthcare, transportation, education, and financial services—require valid licenses. The absence of such documentation renders agreements null and void and makes collaboration unlawful.
• Authority of Directors and Shareholders. Contracts are sometimes signed by individuals who lack formal authority to act on behalf of the company, potentially invalidating the agreement. Verification ensures that the director is properly registered in the Unified State Register of Legal Entities (EGRUL) and that powers of attorney for other representatives are duly executed.
• Litigation and Arbitration History. Frequent involvement as a defendant in legal proceedings raises red flags. Evaluating the outcomes of such cases is also important: successful litigation may indicate sound legal acumen, whereas repeated losses may reflect a weak legal position.

Legal due diligence extends far beyond a mere formal review. It is essential to assess whether the company harbors hidden risks, such as seized assets, encumbrances on real estate, or restrictions on land use.

For example, consider a company entering into a warehouse lease agreement. At first glance, all documents appear in order. However, a legal review may reveal that the lessor is not the property owner but merely a subtenant, with the sublease expiring in three months. Consequently, the lessee risks losing access to the warehouse and forfeiting invested funds. Such hazards can only be uncovered through a meticulous analysis of ownership documents and information from the Russian Federal Service for State Registration, Cadastre, and Cartography (Rosreestr).

Thus, legal due diligence is not merely a “paper check” but a comprehensive assessment of a company’s legal stability. It safeguards against invalid transactions, penalties, and litigation that may arise after a contract is executed.

Financial Due Diligence

Financial due diligence focuses on a comprehensive assessment of a business’s solvency, stability, and transparency. Its primary objective is to determine whether a counterparty can fulfill contractual obligations without exposing partners to risks of non-payment or supply disruptions.

The review typically examines key financial indicators:

• Accounting and Tax Reporting. These documents form the foundation for understanding the company’s financial health. Reports reveal actual turnover, profitability, and the correctness of tax practices. Errors or discrepancies often indicate weak financial management or attempts to obscure the true state of affairs.
• Cash Flow. Analyzing cash flow demonstrates the company’s current liquidity. Even a firm with high revenue may struggle with working capital and lack the capacity to meet obligations to partners promptly.
• Debts and Credit Obligations. The review assesses whether the company is overleveraged and whether any loan payments are overdue. The balance between equity and borrowed funds is crucial: excessive debt threatens financial stability.
• Asset and Capital Structure. This analysis identifies the sources of the company’s value—whether derived from production facilities, real estate, intellectual property, or primarily borrowed resources. It also verifies the existence of liens, seizures, or encumbrances on assets.

Financial due diligence not only provides insight into a company’s current condition but also sheds light on its growth prospects. For instance, analyzing revenue trends over the past three to five years can reveal whether the business is in decline or experiencing steady expansion.

Consider a practical example: a supplier claims that its operations are stable and risk-free. Yet a financial review may reveal that 70% of the company’s assets are financed through debt, while working capital remains critically low. While such a situation may be manageable for a short-term transaction, it poses a significant warning for long-term contracts: a rise in interest rates or a downturn in revenues could push the company to the brink of insolvency.

Operational Due Diligence

Operational due diligence focuses on the internal workings of a company: its processes, resources, and capacity to sustain stable operations over the long term. Even if a business is legally sound and financially robust, poorly organized operations can render collaboration highly risky.

Typically, operational due diligence evaluates the following aspects:

• Availability of Production Capacities. This involves verifying whether the company possesses the equipment, facilities, warehouses, and other resources necessary to support its claimed scale of operations. For instance, a firm that asserts it produces thousands of units per month but lacks the requisite infrastructure raises legitimate concerns.
• Staff Composition and Competence. The workforce is assessed in terms of size, skill levels, and turnover rates. High dependency on one or a few key employees increases risk, as their departure could paralyze operations.
• Logistics and Supply Chain Management. It is crucial to examine how supply chains are structured, the availability of alternative suppliers, and the efficiency of logistics. The resilience of the business is directly linked to the reliability of these processes.
• Information Technology and Risk Management. Modern companies cannot operate without robust IT systems, accounting platforms, and internal controls. Evaluation includes their security, adequacy for business scale, and ability to handle increased operational demands.

Practical Example: A logistics company promises delivery anywhere in Russia within three days. However, due diligence reveals that 80% of its fleet is worn out, and warehouse leases are secured for only six months. This indicates a high risk of operational disruption: equipment failure or loss of storage capacity could result in widespread delays, directly affecting your obligations to clients.

Operational due diligence also uncovers hidden vulnerabilities, such as overreliance on a single supplier, absence of quality management systems, or minimal raw material reserves. A seemingly stable organization may, upon closer inspection, be highly exposed to crises and unforeseen events.

In essence, operational due diligence provides a clear picture of whether a partner’s business processes genuinely align with their claims. This insight is particularly critical for long-term collaborations, where operational failures on the counterparty’s side directly impact your business.

Anti-Corruption Due Diligence

Anti-corruption due diligence is a specialized form of assessment that extends beyond standard legal or financial analysis. Its purpose is to identify risks associated with potential involvement in corrupt schemes, money laundering, and other legal violations. This type of due diligence is particularly crucial in international transactions and dealings with governmental entities.

Corruption risks pose severe threats to businesses, encompassing not only financial losses but also reputational damage. Moreover, legislation in many countries imposes strict liability for even indirect participation in corrupt activities.

Anti-corruption due diligence typically examines:

• Connections with Governmental Entities. The analysis seeks to determine whether owners, shareholders, or senior management have affiliations with officials or state organizations. Such links often indicate a risk of leveraging administrative resources.
• Involvement in Corruption Scandals. Media reports, court decisions, and international investigations are reviewed. Even indirect mentions in such matters can negatively affect a partner’s reputation.
• Compliance with Anti-Corruption Laws. Internal corporate policies are assessed, including codes of ethics, guidelines for interacting with officials, and internal control mechanisms. Companies lacking such policies are more prone to legal violations.
• Transparency of Financial Structures. The ultimate beneficiaries of the business are identified, along with any offshore entities or complex ownership chains. Such structures are often employed to conceal income or illicit transactions.

Practical Example: A foreign partner proposes expediting a major contract through “assistance from regional officials.” At first glance, this may seem a harmless shortcut, but in reality, such interactions fall under anti-corruption legislation. Engaging in this manner exposes your company not only to violations of Russian law but also to international regulations, potentially resulting in substantial fines and loss of access to foreign markets.

Anti-corruption due diligence is particularly vital in industries closely linked to the state, such as construction, energy, pharmaceuticals, and defense. Even small and medium-sized enterprises entering international markets or participating in government procurement must remain vigilant against these risks.

Step-by-Step Guide to Counterparty Due Diligence

1. Collection of Initial Data. Gather the company’s essential details: Taxpayer Identification Number (INN), Primary State Registration Number (OGRN), legal address, and contact information.
2. Analysis of Public Registers. Conduct checks through the Unified State Register of Legal Entities (EGRUL/EGRIP), Federal Resources, the arbitration case database, and the registry of unscrupulous suppliers.
3. Legal Review. Examine the company’s founding documents, licenses, and property rights. Verify the authority of signatories to act on behalf of the organization.
4. Financial Analysis. Request accounting statements and assess profitability, debt levels, and credit history to evaluate financial stability.
5. Assessment of Legal and Tax Risks. Investigate involvement in arbitration disputes and any outstanding tax liabilities.
6. Reputation Evaluation. Review client feedback, media coverage, and the company’s activity on social networks.
7. Identification of Affiliations. Determine connections with other companies and identify ultimate beneficial owners.
8. Report Compilation. Prepare a comprehensive document summarizing findings and recommendations: whether to proceed with cooperation, under what conditions, or to decline the partnership.

This outline provides a general framework for due diligence. Each client case is assessed individually, with the depth and focus tailored to specific circumstances.

Due Diligence Practices in Russia and Abroad

In Russia, due diligence primarily emphasizes tax risks and verification through official state registers. The principle of “due diligence” is reinforced in judicial practice: failure to exercise it may result in the forfeiture of tax benefits.

In the United States and Europe, the primary focus lies on anti-corruption compliance. Companies are required to adhere to the Foreign Corrupt Practices Act (FCPA) in the U.S. and the UK Bribery Act in the United Kingdom, with violations potentially resulting in multi-million-dollar fines.

In many Asian countries, both the corporate reputation and the personal reputation of the owners are critically important. Investigations often include the involvement of family members in the business, connections with government officials, and clan or network affiliations.

How to Conduct Due Diligence Independently

Small businesses can often perform preliminary due diligence on their own:

• Utilize public sources such as the Federal Tax Service (FNS), Rosstat, and Federal Resources.
• Review court cases via the Arbitration Case Database.
• Analyze media reports and customer feedback.
• Request founding documents and certificates of no outstanding liabilities from the partner.

However, it is important to remember that independent checks have inherent limitations. Hidden issues—such as regional debts or connections with offshore entities—may go unnoticed. For significant transactions, it is advisable to engage professional lawyers and auditors to ensure a thorough and reliable assessment.

How to Assess Project Risks

Once the information has been gathered, it is crucial to interpret the findings accurately. Risks can be categorized as follows:

• Financial Risks. High debt levels, unstable profitability, and excessive reliance on loans.
• Legal Risks. Ongoing litigation, expired licenses, or non-compliance with applicable laws.
• Operational Risks. Insufficient resources, low employee competence, or disruptions in logistics.
• Reputational Risks. Negative media coverage or associations with shell companies.

For each identified risk, it is important to evaluate both its magnitude (low, medium, high) and the likelihood of occurrence. For instance, a debt of 5 million rubles may be critical for a small enterprise but negligible for a large corporation.

Final Recommendations

• Always conduct due diligence before entering into contracts, especially significant ones.
• Adopt a comprehensive approach encompassing legal, financial, operational, and anti-corruption analyses.
• Establish an internal protocol for counterparty verification.
• Do not limit checks to a single instance—regularly update assessments when renewing contracts.
• For complex transactions, engage professional consultants.

Due diligence is far more than a buzzword; it is a practical instrument for safeguarding your business. It enables the identification of hidden risks, supports informed decision-making, and fosters transparent relationships with partners.

Companies that systematically implement due diligence gain a competitive advantage: they reduce the likelihood of financial losses, avoid legal complications, and strengthen their reputation.

In today’s dynamic market, due diligence is no longer optional—it is an essential practice for any business aiming for resilience and long-term success.

Q&A