Due diligence of contracts

Mar, 04 2020

Due diligence of contracts is one of the procedures used in business to prevent or minimize risks that may arise as a result of problems with the counterparty or invalidation of transactions.

In Russian financial and legal literature, term “due diligence” is translated into Russian as “due diligence check”, “legal analysis of the history of a legal entity”, “study of a company’s activities”, “business research”, etc.

Purposes of Due diligence of contracts are:

1) exclusion of obvious losses due to the transaction or its subsequent execution with a problem counterparty;

2) exclusion of probability of recognition of transaction with the counterparty invalid. In case of conclusion of contract and subsequent recognition of such transaction as invalid (vicious), court commits parties to return to their original position.

3) elimination of negative tax consequences – i.e. ensuring the legitimacy of one’s own legal position in relations with the tax authority concerning legality of calculating and paying taxes, since the legality of calculation can very easily be called into question due to counterparty’s unreliability and dishonesty.

The essence of this process is to check counterparty before appropriate transaction is concluded.

Counterparty verification stages:

1 . The first stage is collection of information about counterparty. This stage includes:

1.1. Request for necessary documents from the counterparty;

1.2. Collection of information about counterparty through publicly available sources;

1.3. Formation of dossier of the counterparty.

2 . The second stage – verification of data provided by the counterparty, with information from publicly available sources;

3 . The third stage – legal and financial analysis of counterparty (due diligence).

The first stage is the collection of information about the counterparty:

1.1. Request for necessary documents from the counterparty;

Copies of duly certified documents should be requested from the counterparty before the transaction is concluded for preliminary verification:

  • certificate or record sheet confirming the fact of state registration of legal entity (individual entrepreneur);
  • certificate of tax registration and assignment of TIN;
  • Charter of legal entity as amended at date of transaction (with all changes);
  • protocol of general meeting of founders (participants) or decision of sole participant on appointment of executive body of organization.
  • information letter from the statistics authority on assignment of statistics codes (if any);
  • extract from the Unified State Register of Legal Entities (USRIP) on date as close as possible to the time transaction was completed;
  • power of attorney to sign contract, transaction (in case of signing a contract by a person who is not an authorized sole executive body or other person not entitled to act without a power of attorney);
  • documents confirming right to perform work (to provide services), due to specifics of transaction: licenses, documents confirming membership in relevant self-regulatory organizations;
  • Regulation on the branch or representative office and power of attorney for head of branch or representative office, if branch or representative office acts on behalf of counterparty;
  • decision of legal entity to approve major transaction;
  • List of affiliates of legal entity;
  • extract from the unified state register of rights to real estate;
  • documentation on a transaction, on basis of which the rights to real estate were transferred to current owner (when concluding transactions with real estate);
  • a list of persons authorized to represent the counterparty in the execution of the transaction, and a power of attorney for each authorized person;
  • accounting statements as of the last reporting date.

1.2. Collection of information about the counterparty through publicly available sources;

In parallel with the request for documents from the counterparty itself, it is necessary to organize the collection of information about him as of the relevant date, using publicly available free sources, such as:

  • electronic statement of the counterparty from the Unified State Register of Legal Entities or the USRIP;
  • information on the lawsuits of the counterparty;
  • information on the location / absence of legal address of the counterparty in the lists of mass registration addresses;
  • information on the existence of enforcement proceedings related to the counterparty;
  • information on the presence / absence of the counterparty in the registry of unscrupulous suppliers:
  • information on the reorganization, liquidation or bankruptcy procedures available with respect to the counterparty;
  • information on the material facts of the counterparty, as well as on the cancellation of the power of attorney issued by him;
  • information on registered pledges on movable property that is the subject of a transaction with a counterparty;
  • information on rights to real estate that is subject of a transaction with a counterparty, or which is an asset of a counterparty;
  • information on finding the head of the counterparty in the register of disqualified persons;
  • information on legal entities with tax arrears and / or not presenting tax reports for more than a year;
  • information on legal entities with which there is no connection to the indicated address (location) entered in the Unified State Register of Legal Entities;
  • information on individuals who are directors or founders (participants) of several legal entities;
  • information on the validity of Russian passports of the head of the legal entity and / or signatory to transaction.

An electronic extract on counterparty-legal entity from the USRLE must be obtained from public sources at least once a month and transferred to paper throughout the term of counterparty’s dossiers.

It makes sense to review following information about counterparty every two months during entire period of the relationship with such counterparty in order to track changes and to respond to them in timely manner.

If necessary, you can connect to paid specialized systems.

1.3. Counterparty dossiers

All submitted documents, as well as information received from publicly available sources, are generated in the counterparty’s dossier, which must be stored for entire period of the relationship with counterparty, and also for at least 3 years from the expiration of this period.

The second stage is data verification:

Information and data received from the counterparty are subject to verification with information and data obtained from publicly available sources.

Identified obvious discrepancies are subject to clarification with counterparty in course of legal and financial analysis.

Until reasons for discrepancy of the available information are clarified, it makes sense to refrain from signing any legally binding documents with counterparty.

The third stage – legal and financial analysis of counterparty – due diligence;

The result of this work should be a conclusion containing an assessment of level of risks of cooperation with this counterparty from point of view of its integrity, legal reliability and financial solvency, as well as legal and financial recommendations regarding the transaction with this counterparty.

Both financiers (as far as the analysis of financial and tax documents is concerned) and qualified lawyers (as far as the legal aspects of the company’s activity are concerned) should take part in due diligence of agreements.

Thus, objective independent assessment of risks helps to significantly optimize work, to avoid or minimize risks of adverse consequences. Due diligence of contracts results in confidence in compliance with the law, elimination of “weak links” in the structure of the company, growth of financial indicators.

VALEN lawyers have extensive experience in implementing various types of due diligence, including due diligence of contracts. You can order the due diligence of contracts service by calling us by +7 (495) 7-888-096 or by visiting our office, having previously agreed upon meeting.

Author of the article

Due diligence of contracts
Roman Matyushekov

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