Due diligence of contracts

Mar, 04 2020

Contents:

When two parties sign a contract, they both want to get some guarantees, but in practice, you can hardly exclude all risks, you can only minimize them, due diligence procedure was invented just for these purposes. It is performed to estimate all the possible problems with a counterparty or to minimize the risk of a contract being considered as invalid.

According to RF laws, the analogs of the procedure called due diligence are: “analysis of a company history”, or “legal assessment of company activities”, or “business research”. All these procedures have the same goals:

  1. prevent losses due to a transaction with an obviously problematic counterparty;
  2. reduce to zero the probability that the transaction with this counterparty will be invalidated. In this case, by a court decision, the parties return to their initial position and two parties have no mutual obligations.
  3. minimization of negative tax consequences to substantiate your position with the tax service regarding all possible taxes (the correctness of the calculation can be challenged if your counterparty is unreliable).

So here are the goals of due diligence. As for the sequence of actions according to this procedure, it can be described in the following way (verification is carried out before the parties conclude a contract):

The 1st step is to collect all the data. This includes: request some papers from the counterparty itself and collect data about it from publicly available sources. After that, based on the collected information, they create a dossier.

The 2nd stage is to check the received information. That is, compare data from documents you’ve got from the counterparty with data from publicly available sources. The goal is to find possible inconsistencies and identify potential problems.

3rd stage is due diligence itself.

Now let’s look at this in detail.

Collect information

So, at the first step, it is needed collect all possible information that one can find about the company or a private entrepreneur. These are papers from the counterparty and information from publicly available sources.

Among the papers that are to be demanded from a counterparty, we should mention the following ones:

  • a paper confirming the state registration of a legal entity (or a private entrepreneur), for instance, a certificate, and a document that confirms the receipt of a tax identification number;
  • (for legal entities) – the charter in the latest edition (topical with the latest amendments);
  • (for legal entities) – the minutes of the board of directors appointing the executive body of a company.
  • (for legal entities) – a letter from the state statistics body with codes (if any);
  • permitting documents from government services that give the right to legally perform work or provide services – licenses, etc;
  • (for legal entities) – a document from the USRLE (Unified State Register of Legal Entities) with data on the counterparty;
  • (for branches) – documents confirming the legal status of a branch (a representative office) and a power of attorney, if it acts as a counterparty;
  • (for legal entities) – if a person who is not authorized as an executive body signs the contract or any other person who is not entitled to act without such a power of attorney;
  • (for legal entities) – approval by the board of directors of a major transaction;
  • (for legal entities) – affiliates list (full);
  • (for legal entities) – a document confirming the rights to real estate objects;
  • (for legal entities) – the list of persons who have the right to represent the counterparty, including those who act by power of attorney;
  • Accounting reports for the last period.

When this is finished, one should obtain data from official government sources. Here is the topical data received from publicly available sources:

  • (for legal entities) – a document from the USRLE (Unified State Register of Legal Entities) with data on the counterparty and, for the purpose of achieving up-to-date information, this document should not be received earlier than one month representing the final dossier;
  • Information on legal proceedings where the counterparty is involved, and the data on enforcement proceedings on it.
  • Information on the place of registration (legal address) from the list of registered addresses;
  • Information from the state register of unscrupulous suppliers (whether the counterparty is it or not);
  • Information on liquidations or bankruptcy procedure for the company;
  • Information on the licenses (valid/canceled);
  • Information on property pledges (movable and real estate), if this property is included in a contract with a counterparty;
  • Information from the state register of disqualified persons;
  • Information from the federal tax service (are there any tax debts or other problems);
  • Information on companies, communication with which has been lost by their contacts and place of registration (USRLE);
  • Information on the other companies owned by the head of the counterparty, and if there are some, collect data on them too;
  • Verify the authenticity of the papers (passports of all persons who sign documents on behalf of counterparties).

Besides, when you sign a contract, it is good practice to regularly check the documents described above so that potential problems do not catch you by surprise and to respond timely.

If there is a lot of money involved in your contract, you should also apply for the services of paid specialized systems to check your counterparty even more thoroughly.

Form a dossier

All data is collected in a dossier. This folder is kept (data in it is regularly updated to track changes) as long as there are contractual obligations with this contractor and even after the completion of contracts for 3 years (in case of potential problems).

Check

Now that all the available information has been collected, it has to be assessed and inconsistencies (if any) identified in it to estimate the reliability of the company.

All inconsistencies must be checked. In some cases, your potential partner submits a not up-to-date document by mistake, or the information obtained from official registers, by mistake and not the most topical.

However, some inconsistencies may indicate the unreliability of the counterparty, and until you investigate the reason for that, you must not sign any contracts.

Due diligence

So, after all the information has been gathered and checked, you have to conclude it. This conclusion should describe possible problems associated with the company and potential risks from cooperation with it, and an overall assessment of its reliability and solvency and implications for the near future.

The papers you’ve got must be analyzed by experts in finances to assess the solvency and lawyers to assess the legal basis and give their own assessment.

Services of the VALEN company

Naturally, to do due diligence properly, you need good specialists who understand legal and financial issues and are familiar with Russian laws. If there are not such at your disposal, we offer you our services.

Our specialists have the qualifications and relevant experience, they will conduct an independent analysis for you, help you assess and minimize risks and give qualified advice in your specific situation. After carrying out this procedure, you can be sure that no unpleasant surprises will arise in your work, and you will be able to focus on developing your business in the Russian Federation.

If you have any questions or want to get advice regarding due diligence from our lawyers, you can contact us by phone at +7(495)7-888-096, or come to our office in person.

Author of the article

Due diligence of contracts
Roman Matyushekov
Lawyer

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